The key challenge for the crypto market right now

In our previous post, we compared the current crypto market crash to the one that happened in March 2020. The main difference between the two is this: a year and a half ago, central banks were lowering the interest rates and printing huge loads of money. But now the interest rates are rising and liquidity is being taken out of the system.

This process has indirectly led to the collapse of DeFi. In the past couple of years, investors would lend real dollars or euros paying 0-2% a year — and deposit them in DeFi protocols to earn 10-20% a year or even more. DeFi protocols would actually pay that sort of yield.

The longer this feast of high yields lasted, the more money investors were bringing in. More than that, so-called liquid staking protocols made even more complex schemes possible. You could stake ETH, LUNA, SOL and other coins to earn the promised APY — and get special staking tokens in return (stETH, stLUNA, stSOL, etc.). These could be redeemed for the original coins at any moment.

The trick is that stETH and other staked tokens could be used as collateral to take out loans in crypto (in the same ETH or LUNA, for example, which, in turn, could be staked to earn more yield, and so on in a cycle.

If you can't understand how the scheme works, don't worry. The same thing was happening in the US mortgage market before the 2008 crash, when mortgage-backed bonds could be used to secure other loans and were treated as highly secure assets. Even the IRS couldn't make heads nor tails of the situation.

The outcome in DeFi was the same as in 2008. As liquidity started contracting and investors began withdrawing money from the staking protocols, it became clear that the high yield rates couldn't be sustained. The cycle of staking, collateralizing, and re-staking, where there was only 10-30 cents really invested per each dollar of the 'official' DeFi value — that cycle was broken.

This situation triggered a collapse of the crypto market. What will happen next? Read our next article to find out.

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