Compound’s founder is unworried about DeFi defaults

Decentralized finance (DeFi) may seem weird, but it’s not going to implode like other crypto lenders have, at least not according to Robert Leshner, the CEO of Compound Labs and founder of one of DeFi’s blue chip protocols, Compound Finance.

Why it matters: Outsiders reading the odd story about cryptocurrency might think any company doing finance with bitcoin nearby is “DeFi,” but it’s not. It’s only DeFi if it functions autonomously, out in the open.

• Because it’s so open, there is $70 billion deployed in this sector that is extremely unlikely to unwind in a way that sends shockwaves elsewhere.

“The reason why this won’t happen with DeFi protocols is because, by design, they are completely the opposite of these centralized platforms that are imploding right now,” Leshner tells Axios in an interview.

“They’re radically transparent, you can see exactly what’s happening. But more importantly than that, they operate based on open source code that can’t change its mind on a whim.”

Zooming out: DeFi lenders, such as Compound, Aave, MakerDAO, Solend, Liquity and others are the most directly parallel to the companies that have had dramatic flameouts in recent days, firms like Celsius, Voyager and BlockFi.

• In DeFi, loans are extended against collateral. If the collateral loses enough value that it no longer has enough cushion against its debt, the collateral gets sold to close the loan.
• This happens autonomously, via code, so there’s no one to call in a favor to and keep it open. It just gets closed.
• As the market took its sharpest downturns in mid-June, there were over $300 million in liquidations across the three biggest lenders.

Reality check: Nobody wants to see their collateral liquidated while they were sleeping. And this is something anyone participating in DeFi needs to monitor — especially in a volatile market.

• But at the same time, nothing went wrong. This is how it is supposed to work.
• “Big liquidation moments are the protocols doing what they are designed to do,” Leshner says, “that is transparently managing risk.”
• “A DeFi lending protocol’s lending playbook, so to speak, is incredibly simple and transparent.”

No one wonders what DeFi operations are up to. Every deposit and every loan — and the exact terms of every loan — are viewable on chain, all the time.

• Compound has less than $3 billion in it right now, well down from the nearly $11 billion it had last November. To Leshner, this is a sign of health. DeFi can grow and it can shrink as needed, without pain reaching people who didn’t opt in to some risk.

By contrast: “Unlike opaque centralized lending business where nobody knows what the business is or what their policies are,” Leshner said. “It turns out that most everyone threw their policy playbook out the window and just made uncollateralized loans to Three Arrows Capital, which came back to bite them in the ass.”

Yes, but: DeFi isn’t indestructible, Leshner noted. If the crypto markets tanked extremely fast, like they did in March 2020, liquidations might not be able to keep up and protocols could be saddled with bad debt.

• But markets falling 80% over a matter of months? That’s just another day at the office for robots on the internet.

Plus, hacks: New users should be really careful about which DeFi projects they put money into. There’s been a lot stolen (though not so much against the top tier products).

• Chainalysis clocked $2.2 billion stolen in 2021. A guideline: the longer a project has gone without a breach the safer it is likely to be — fools rush in.

The intrigue: “The first reason why centralized lending businesses are imploding is because they are not in the advertised business of lending,” Leshner said.

• “All of these firms were operating, essentially, as proprietary hedge funds using customer money, and the reason this was able to occur was because these businesses were opaque. Nobody had any visibility,” Leshner said.