Curve Finance's token CRV has sold off significantly in the past few days. While the protocol was exploited, I believe a lack of proper risk management in the industry is to blame for the crash. In today's article, I discuss what happened, why the market is selling off, and how I believe this could all have been prevented.
Michael Egorov bought not one, but two mansions!
A couple of months ago, Curve Finance founder Michael Egorov borrowed over $100 million dollars in stablecoins. He allegedly secured these loans to buy two lavish mansions in Australia.
Egorov's $18.25m mansion "Verona"
Good for him, right? Well – it sounds like it, until we get to the part where he put up well over $250 million dollars worth of CRV tokens – or about a third of all CRV in existence – as collateral for those loans. In doing so, the entire DeFi industry was put at risk of liquidation.
Experts believe he took out these loans instead of just market selling CRV directly, which would have made the industry turn on him.
What happened to Curve this weekend?
Unfortunately for Egorov, the past few days have resulted in a colloquial target on his back nonetheless. After stablecoin lending platform Curve (yes, the same Curve he founded) was exploited, the value of the CRV token (his collateral) plummeted.
While the hacker only got away with about 7 million CRV tokens – an amount the market would be able to absorb even if market sold in a single transaction – the initial sell-off significantly increased Egorov's risk of liquidation.
The market knows this – and has actively pushed for his liquidation, resulting in a rapid correction, reaching as low as $0.50 per token.
It gets even trickier when you consider that part of Egorov's debt has a variable interest rate, that would double every 12 hours, unless he managed to get Fraxlend's utilization rate below 100% – which means his liquidation level was rising, fast. A liquidation of his Fraxlend position will trigger a massive CRV sell-off, and a chain-reaction of sell-offs across the entire DeFi sector. Protocols like Aave would take a $63m hit, for example.
Essentially, the entire DeFi industry was put at risk of collapse to fund Egorov's mansion purchases, and nobody was there to stop him from borrowing a truckload of money.
Read more about the different liquidation risks here.
Justin Sun to the rescue
Luckily, it seems that Egorov was able to avert liquidation (for the time being), after securing an OTC deal with Justin Sun - selling 5 million CRV tokens for 2 million in USDT, stablecoins he much needed to post additional, less volatile collateral.
Source: LookOnChain
The move makes sense for Sun too, a player known to come to the rescue at opportune moments. Not long after the OTC deal, Sun tweeted: "Excited to assist Curve! As steadfast partners, we remain committed to providing support whenever needed. Our joint efforts will introduce an STUSDT pool on Curve, amplifying user benefits. Together, we aim to empower the community and forge a decentralized finance!"
As the day progresses, Egorov continues to make OTC deals with various known player, selling 4.25 million CRV to Twitter user DCFGOD, 3.75 million CRV tokens to Jeffrey Huang, 2.5 million to DWF Labs, and another 2.5 million to Cream Finance.
At the time of writing, Egorov has been able to raise about 15 million dollars in stablecoins – which he added as additional collateral to his Aave, Fraxlend and Abacadabra positions, significantly reducing the risk of him getting liquidated.
18/ Update: Having paid down some of his loans, Egorov has managed to significantly reduce his liquidation price points.
— Delphi Digital (@Delphi_Digital) August 1, 2023
*Note on his Fraxlend position: Utlization has fallen to 37% so the APY should continue to decline* pic.twitter.com/LUyeopWRMp
Crypto's reputation has taken a big hit, again
All in all, it looks like Egorov has been able to avert the worst of the crisis. Nevertheless, the situation calls for questions about how someone was able to borrow against so much of a single token's supply, and if lending protocols like Aave or Frax should have safeguards in place to prevent situations like this one from happening again.
In a time that the industry is already under heavy scrutiny from regulators, this episode of DeFi Drama has dealt another blow to the reputation of crypto. While many onlookers were already skeptical of crypto (and especially DeFi), situations like these further cement the common belief that crypto is a sector you should steer clear of, while also giving the SEC further reason to crack down on the industry.
Twitter user JulianHosp even went as far as comparing the saga to SBF's borrowing against FTT – stating that "the only difference is that SBF did so (...) with everyone except for him having limited knowledge, and here, everyone sees everything and seems to be ok with it."
Preventing the next Defi Drama
It is clear that the industry needs to do better. For future reference, protocol founders should think twice before putting up a third of their token's circulating supply as collateral – be it for a mansion or not – as it is incredibly risky. While borrowing against your own project's tokens may not be inherently bad, doing so requires extensive risk management.
Lending protocols should put additional safeguards in place to prevent a new meltdown in the future, and take into account the potential market impact of a potential liquidation before closing a transaction, to minimize unnecessary stresses on the sector.
Closing thoughts
In conclusion, it is reckless behavior and a lack of risk management that resulted to the sharp correction and unnecessary risk in the DeFi sector. It puts the industry under even more scrutiny, delaying the path to mainstream adoption by months, if not years.
Lending protocols have work to do to prevent situations from happening again, and the industry as a whole will need to step up once again, in order to repair the reputational damage this incident caused.
Author's Disclaimer: This article is based on my limited knowledge and experience. It has been written for informational purposes only. It should not be construed as trading or investment advice in any shape or form.
Editor's note: CryptoJelleNL provides insights into the cryptocurrency industry. He has been actively participating in financial markets for over 5 years, primarily focusing on long-term investments in both the stock market and crypto. While he watches the returns of those investments roll in, he writes articles for multiple platforms, including WOO.
Check out his twitter: twitter.com/cryptojellenl
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