BlockFi’s fall shows that Peter Thiel’s philosophy is not good for the financial market

*David Z Morris

Crypto financial services provider BlockFi has announced a deal with Sam Bankman-Fried’s FTX that could lead to a sale of $240 million or less. That would be a sharp reduction from the $1.3 billion that has been invested in the company since 2019, but much better than rumors and reports suggested.

BlockFi’s fate, while not great, still looks better than that of other centralized crypto lenders such as Celsius and Babel Finance, which have also raised hundreds of millions of investors.

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That’s because BlockFi’s investors look at least like they’ll get a lot of their money back, while Celsius and others look really insolvent. While not obvious, this group also includes the Anchor protocol, which masqueraded as a decentralized finance (DeFi) protocol on the Terra blockchain, but was actually managed by a close group of supporters who have already run out of investor money.

So where did all that money go?

How to burn VC money

Investments in cryptocurrency lending platforms have fallen into at least two gigantic holes.

On the one hand, all these creditors seem to have invested recklessly in pursuit of the promised high yields. This has led them to place big bets on bad assets such as LUNA, native to Terra, and BadgerDAO, an Ethereum (ETH)-based protocol for lending Bitcoin (BTC).

Some are also betting on stETH (stETH), an ETH derivative that pays staking rewards (deposit with income in a smart contract), as well as Grayscale BTC Trust – the largest Bitcoin fund in the world.

These last two are respectable but currently illiquid assets and have ended up leaving temporary but large holes in creditors’ balance sheets. According to CEO and founder Zach Prince, one of the reasons BlockFi survived is that it avoided most of these pitfalls.

But another slice of investor capital didn’t go to risky bets, but directly to fund the yields that were being paid to depositors. This was explained by investors themselves as a strategy of acquiring customers with deficit spending that, in the future, would translate into revenue.

This strategy was taken directly from the Silicon Valley playbook that spawned Amazon (AMZO34) and Meta (FBOK34). It was a theme articulated as a philosophy by Peter Thiel in his book “Zero to One”, which argues that startups must invest heavily in their early stages to beat the competition, creating their own monopolies.

Read more:
• World’s largest digital asset manager sues SEC over Bitcoin ETF rejection

The success of Amazon and Facebook, in particular, has turned the monopoly playbook into a Silicon Valley mantra. But after a first wave of genuine successes came a wave of eternally unprofitable companies like Uber and a few more money-burning companies like WeWork.

For a time, this was seen as a “Millennial lifestyle subsidy”, as consumers took advantage of rides and rentals at prices below true cost and venture capital funds (VCs) covered the difference with (erroneous) faith. ) that everything would work out in the end.

But accepting to jeopardize finances because of a customer acquisition deficit can be dangerous. It’s a fundamentally absurd approach to growing a banking or lending business. The “collapse” we are now seeing is far less a condemnation of crypto than this outdated and misapplied Thiel growth manual.

false returns

So how do we know that investor funds were subsidizing yields on Celsius and other platforms? In part, it’s simple math: the demand for deposit income has totally outpaced that for expensive institutional cryptocurrency loans, so all the lenders together couldn’t be generating the full income they were paying depositors.

Also, while we don’t have clear visibility into either Celsius or BlockFi spending, we do know the obfuscated flows from the biggest fake crypto bank: the Anchor project.

Some might even argue that Anchor does not belong in that category, but while it ran on a public blockchain, it was by no means a “real” DeFi protocol. This was obvious well before the Earth’s collapse.

While DeFi protocols such as Aave adjust investment returns based on actual borrowing demand, entities in the Terra ecosystem have had to replenish the “yield reserve” that was paying artificially high returns from depositors on Anchor several times.

A “backstop” (insurance policy) was needed because Anchor was not generating enough loan income to meet its obligations to depositors.

This was recognized as a temporary fix, with the promise that “real” earnings would arrive at some point – just as Uber keeps promising real profits someday. While not the same thing, the project was the equivalent of Uber selling rides for less than they actually cost and making up the difference with money from investors.

Both Terra (LUNA) and the TerraUSD (UST) stablecoin grew almost entirely on account of the 20% interest paid on deposits made at Anchor using the UST stablecoin. These subsidized returns meant that Earth was, in effect, a technologically obfuscated Ponzi scheme.

Cryptos vs “tech” stocks

Regardless of the legal niceties, the same argument can be made about the reality of Celsius and its ilk. These cases may even highlight certain “ponzinomic” elements of venture capital investing as a whole, notably the ability of early stage investors to continue to sustain the book value of their own positions in new rounds of funding.

As with the Anchor project, in the same way that a VC can subsidize this moneyless customer acquisition, a company can advertise growth and promise future profitability.

Read too:
• Crypto platform Celsius lays off 23% of employees amid restructuring

This, however, is a disastrous model for finance because, unlike technology revenues and profits, investment returns are not proportionate. In fact, they do the opposite of scale: the bigger an investment fund gets, for example, the harder it is to keep delivering the same percentage returns it did with less money under management.

Whether in cryptocurrencies or technology stocks, investing in this way can become a kind of trap. When people keep putting money on you, you have to look more and more for investment opportunities that match your past performance.

These later bets, almost inevitably, provide lower returns or carry higher risks. That’s what happened with Celsius: BadgerDAO is to Celsius CEO Alex Mashinsky what Twist Bioscience (a speculative medical gamble) is to ARK Invest’s Cathie Wood.

“One to Zero”

Another reason Thiel’s model just doesn’t make sense to the retail investor is that it’s structurally impossible to build the kind of “moat” that can, at the very least, keep a bad business like Uber limping.

A great characteristic of the financial market, mainly for retail, but also in general, is that you want your investments to be as liquid as possible. To attract deposits, customers must be convinced that it will be easy to withdraw – and possibly deposit the money elsewhere. This makes banking a fundamentally very, very difficult business to monopolize, even in a marginally free market.

Loss-based customer acquisition makes no sense, simply because there is no such thing as free money. Yields that are artificially inflated to attract customers will inevitably be forced to align with macro trends over time, and customers will simply drop out of strategy.

Part of what made Celsius and Anchor functional frauds (whatever the legal conclusions may be) is that their outsized returns were based on the idea that the cryptocurrency somehow magically generated more revenue than regular money.

This has always been absurd, but the last few weeks have made it painfully obvious.

*David Z Morris is CoinDesk’s Chief Insights Columnist. He is a former academic technology sociologist with a PhD in Media Studies from the University of Iowa, USA.

How far will cryptocurrencies go? What’s the best way to buy them? We have prepared a free class with step by step. Click here to watch and receive InfoMoney’s cryptocurrency newsletter

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