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12th March 2023 - DeFi.

tl;dr

DeFi (decentralised finance) is more complex than some realise, reinforcing one of the key lessons we all need to appreciate when using cryptos.


Market Snap








Market Wrap

The collapse of SVB (Silicon Valley Bank) that we touched on yesterday is already causing ructions elsewhere.


The GFC (Global Financial Crisis) of 2007-2009 was caused by a loss of confidence between banks leading to the hoarding of cash. As fractional reserve banking is inherently highly leveraged, loss of liquidity can quickly lead to a solvency crisis. The US response, perfected during the Savings and Loans crisis of the 80s, was to replicate the bad bank/good bank approach with TARP (Troubled Asset Relief Programme). This was very successful for banks and their shareholders, and, crucially, the taxpayer too. The UK response – for taxpayers to become bank shareholders – was the worst possible idea, though one cannot escape the sense that it was a politically motivated decision devoid of any appreciation of the economics and the risk.


Right on cue, we are already seeing a slippage in 10-years swap spreads, alerting us to an elevated view of general financial concerns.


Corporate bond desks should always hedge some of their interest rate risk with swaps, but most rarely do. Traders will arrive at their desks tomorrow morning with the majority scratching their heads as to why they start the week with large losses as they labour mistakenly under the belief that hedging with bunds (German government bonds) takes care of all their interest rate problems.


I read claims that the demise of SVB will be an extinction event for many tech start-ups. Accompanying these predictions of doom – which may or may not have some legs – are demands for a bank bail-out, to prevent further contagion to other small US banks.


From there, it is only a short hop, skip, and jump to demanding a resurrection of QE (quantitative easing). Oh dear.


Occasional Series – Gary Lineker

Some people believe the BBC is biased to the right wing, others that it is biased to the left.


There are reports that senior journalists have set up a Watts App group entitled “Right wing watch” to report evidence of political machinations within suggesting that even the employees view the company as biased in its output. It seems likely that very few people would try to claim that the BBC remains impartial – there is no other media organisation in the world that has been set that impossible task.


Confected or not, the Lineker row has brought forward the inevitable date of the BBC becoming a fully-fledged commercial organisation, allowing it to position itself in line with its values and beliefs, wherever that may fall on the political spectrum. He has done us all a favour.


As an aside, I stopped (legitimately) paying my license fee several years ago. It is quite extraordinary the overly aggressive letters and phone calls I receive from the BBC threatening me with all sorts of retribution for my perceived crime of opting out of an elitist view of the world, up to and including a stint in a Siberian coal mine.


British Bullying Corporation in my experience.


Curious Cryptos’ Commentary – CBDCs (Central Bank Digital Currencies)

















The good news is that the US - issuer of the world’s most important fiat asset - is NOT going down the route of CBDCs.


Curious Cryptos’ Commentary – DeFi is complex

In August 2021, Curve set up a liquidity pool comprising DAI, USDC, and USDT.


Investors can deposit one or more of each of these stablecoins into the pool in return for a cut of the trading fees that accrue from others who swap from one of these coins to another. Investors’ claim on the assets of the pool and the trading fees is represented by a liquidity token known as 3CRV (LP 3pool Curve).


As will all things DeFi, those tokens can be used elsewhere in the space, including as collateral for loans, providing further liquidity, or exchanged for another crypto.


Following the loss of USDC’s dollar peg (see yesterday’s CCC for more details) there was a temporary sell-off from $1 to 94c for 3CRV as investors worried about the long-term health of USDC and therefore 3CRV.


The natural course of action for these worried investors would have been to simply exchange 3CRV back into any one of the three stablecoins in the pool, capping losses at a maximum of 6%. Right now, that loss would be restricted to 1.5%.


But one investor – with $2mm worth of 3CRV – made a fateful decision to exchange their 3CRV tokens elsewhere. Spoiler alert: the net proceeds came to 5c. That is not a good day at the office.


One of the many intrepid blockchain sleuths that make a positive contribution to Twitter, highlighted this list of transactions:


I do not claim to be a blockchain investigator, so the following explanation is derived almost entirely from the commentary provided by BowTiedPickle.eth (https://twitter.com/BowTiedPickle).

The owner of $2mm of 3CRV used KyberSwap aggregation router, the first transaction seen above.


The router found an old, dead, liquidity pool on Uniswap V2 which paired 3CRV with USDC. Unused for nearly a year, this pool contained just $2 of liquidity.


When interacting with DeFi one of the core rules is to always set a slippage tolerance. If the owner had done so, the aggregation router would not have interacted with this pool. Making the schoolboy error of allowing up to 100% slippage, the smart contract got on with its job and swapped $2mm of 3CRV for 5c (the 2nd and 3rd transactions above), after paying transaction fees.


The 5c was returned to the router, and then back to the original owner (the 4th and 5th transactions above).


I suspect he or she was a little upset at this outcome.


Meanwhile an MEV (maximum extractable value) bot answered the pool’s call to rebalance by adding 1.45c worth of USDC for $2mm of 3CRV.


I suspect the bot owner was rather pleased with this outcome.


There is a lesson in this sorry tale for all of us, whether we are DeFi degens or not.


Whenever executing a new crypto transaction, even one as simple as moving an asset off Coinbase to a new Ledger Nano X hardware wallet, always, always, always, conduct a small test transaction first, for if you have made a mistake the downside is limited to mere cents plus fees.

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