Crypto Lending Suffers Amid Bear Market and Terra UST Debacle

Crypto Lending Suffers Amid Bear Market and Terra UST Debacle

TVL in DeFi is down 41% in the last 7 days

The total value reserved in the major lending protocols is dropping as investors start flipping tokens into stablecoins with the aim of cashing in to fiat currencies. Major lending protocols across many networks are seeing their TVL numbers drop while lending dapps on Terra, seeing TVL dwindle by more than 99% amid the largest drain of wealth in crypto history.

There are two main reasons for investors to consider crypto-related lending. First, investors can put up their crypto holdings as collateral for a cash loan. This way, investors can release liquidity without having to cash out their entire holdings. Another reason for collateralizing crypto assets is short selling.

Short sellers guarantee their cryptocurrency to place an effective bet that the price of the crypto asset will fall. When the open short position is closed, the investor who placed the bet will receive either cash or an additional amount of cryptocurrency depending on how the contract is drawn up. On the flip side, if the price goes up while opening a short position, part of the security will be lost.

However, amidst massive concerns from Terra, UST, and LUNA traders it appears that they have panicked and moved large amounts of stablecoins from the protocols. Ironically, three years ago during the last bear market scenario, CEO Aave Stani Kulechov described crypto-backed lending as “real magic” because the business model continued to perform well during a bear market.

Terra & UST Lending Problems Threaten

The general rationale behind crypto lending is to offer investors a more graceful exit way rather than making them sell their cryptocurrency for a money order. Because that will negatively affect the prices. However, the failure of Terra’s LUNA and UST coins sent waves of fear across the industry. First of all, it boosted the BTC price drop, while also driving other stablecoins out of their pegs. Moreover, Terra’s drop re-confirmed spectators and investors’ concerns about the viability of the stablecoin asset class.

The total value booked in DeFi has fallen from $224 billion on May 1 to $132 billion at writing. Crypto lending appears to be the next victim as data indicates that traders are moving cryptocurrencies from DeFi protocols to stablecoins like USDC and USDT with plans to redeem fiat currencies.

Institutional investors are using stablecoins to stay away from cryptocurrencies

USDC is a significant player in the space as it is heavily used by institutional investors and traders based in the United States due to its regulatory compliance. USDC trading volume usually hovers around the $5 billion mark per day, however, the volume has exploded in the past few days, peaking at nearly $25 billion in the last 24 hours. The circulating supply of USDC is now 49.8 billion, down from 53 billion at the beginning of March 2022.

Today’s lending and borrowing market capitalization is $4.67 billion, a 14.6% change in the last 24 hours. Moreover, the prices of the lending protocol do not react well to the situation. Across the board, major lending protocol coins are down with AAVE down 38% this week. KAVA is down 45.2% over the past week and COMP is down over 32% over that period.

More evidence comes from looking at the amount of gas that has been burned in the past seven days through the UltraSound Money leaderboard, as USDT and USDC are both in the top five after burning over 5,000 ETH, or about $10 million in between, in transactions. While data from Nansen shows that gas fees from USDC and USDT rose by about 190% and 160%, respectively, in the past week. While Curve, Balancer and Aave all saw massive increases in gas usage over the same time period.

Although the greenback is thinly traded, it does not appear to have much appetite under a bear market scenario. Trading is expected to decline and any planned investments in infrastructure may be delayed until some stability is restored.

The future of stablecoins is in doubt, but it is worth noting that unlike terrestrial treasuries that are backed by crypto assets, the majority of stablecoin assets are backed by more tangible backing. For example, USDC is backed by paper money with USDC reserve assets held in segregated accounts with regulated financial institutions in the United States.

Once the dust settles, we may see traders return to the table and resort to more established trading techniques during a bear market. Lending has boomed over the past cycle and we expect measures such as sustainability and cash back rewards to emerge victorious as investors look for a safe store of value and hedge against global inflation. For now, the popcorn is out and we’ll continue to track this story as it unfolds.

The above does not constitute investment advice. The information herein is purely for informational purposes. Please exercise due diligence and do your own research. The writer holds positions in several cryptocurrencies, including BTC, ETH, and RADAR.

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