Paradigm Letter to Investors: In the next 2 years, Buidl and a good time to invest

22-08-01 15:04

Read this article in 15 Minutes

AI summary

View the summary

Original author: Matt Huang, Paradigm

Original compilation: Shenchao TechFlow

On July 20th, Matt Huang, founding partner of well-known encryption VC Paradigm, sent a message to LPs letter, explaining the underlying causes and implications of the recent collapse of the cryptocurrency market, arguing that although the market has been disrupted in the short term, the lessons learned from this crisis will translate into a healthier crypto in the long run ecosystem. The next 12-24 months will be a great time to build and invest in cryptocurrencies.

In general, you can interpret it as a psychological Massage is in plain language that is easy to understand, share it with everyone, and massage together.

Original text:

2022 will be characterized by macroeconomic uncertainty and a brutal global sell-off that has affected tech, cryptocurrency and other markets.

Bitcoin and Ethereum are down 49% and 58% respectively YTD, other crypto Currency-related assets have been more severely affected, such as COIN (down 71% YTD). The big sell-off exposed the entire crypto ecosystem built on unhealthy leverage, triggering a series of distresses and bankruptcies.

Cryptocurrency headlines and sentiment have turned decidedly negative, leaving The bear markets of 2018 and 2015 are reminiscent, but these events are now playing out on a larger stage with cryptocurrencies.

Despite the shock to the market, we are optimistic about the long-term prospects of cryptocurrency as a technology and asset class Faith is still strong. The quality of talent entering the crypto market has never been stronger. At the same time, speculators who came for short visits have withdrawn. We believe that the next 12-24 months will be a very productive period for building and investing in cryptocurrencies.

What happened?

A full account of the ongoing crypto deleveraging requires hindsight.

Right now, based on what we have learned, it is clear that certain crypto entities are Unsustainable large positions have accumulated under the implicit assumption that the price has been rising all the time.

In 2020-2021, the market is full of enthusiasm, companies and funds feel confident, risk limits become Barriers to chasing scale and returns, explicit and implicit leverage accumulate. The external shock of the global crash was a reality check, and while these events were clearly negative, we are optimistic thatlessons learned will translate into a healthier cryptocurrency ecosystem in the long run .

Terra, LUNA, UST

The first domino to fall is the Terra blockchain. In short, Terra is known for its native blockchain asset LUNA (similar to Ethereum’s ETH) and the dollar-pegged stablecoin UST built on top of it.

The UST peg is maintained through a two-way redemption process to LUNA: when UST falls When it is below $1, you can "burn" $1 of UST to "mint" $1 of LUNA, conversely, when UST grows above $1, you can "burn" $1 worth of LUNA to "mint" $1 USD UST. In theory, this process should keep UST near $1...as long as confidence in the system remains strong.

Like many "Algorithmic Stablecoins" before it, if the value to UST and LUNA is lost Confidence, UST's design is subject to a potential negative spiral that will cause everyone to run for the exit.

In fact, there are so many problems with algorithmic Stablecoin design that perhaps the most interesting problem is not "Why did UST crash?" rather "How did UST get so big before it crashed?" It's a question we've been asking ourselves from the sidelines during LUNA/UST's meteoric ascent.

Although it is difficult to pinpoint the root cause precisely, a charismatic founder (Do Kwon ); many reputable investor backers (including the now-bankrupt 3AC); an Anchor protocol that couldn't be better, offering a 20% UST yield; a flamboyant attempt to acquire large amounts of BTC as collateral, and many other factors This combination fueled retail and institutional frenzied speculation on the underlying asset LUNA and the seemingly low-risk 20% UST yield.

The rise in the value of LUNA led to greater confidence in the stability of the UST, while more UST deposits lead to greater confidence in LUNA.

This positive feedback loop is very powerful on the way up, but on the way down , the negative feedback loop is stronger. Currently, LUNA has dropped from over $100 in April to less than $0.01 today. The UST Stablecoin broke the $1 peg and is now worth close to 0, over $18 billion in UST deposits and $40 billion in LUNA market cap have disappeared.

Crypto sell-off accelerated as air flees LUNA and UST, problems start to emerge in Elsewhere in the crypto market.

3AC and Cryptocurrency Lenders

Three Arrows Capital (3AC) started as a traditional foreign exchange arbitrage fund in 2012, and then expanded to the encryption market through arbitrage and directional strategies. 3AC's founders (Su Zhu and Kyle Davies) used their own capital to grow their starting assets from less than $1 million to over several billion dollars in 10 years.

An incredible feat from any angle. However, it was this track record, achieved without regard for risk, that arguably paved the way for 3AC's demise.

Going into 2022, 3AC’s inflated overconfidence and the crypto lending ecosystem are dangerously combined Together, the latter are all too willing to provide unhealthy leverage in order to grow their loan books in search of higher yields.

Incredibly, a cryptocurrency lender, Voyager Digital, appears to have offered 3AC As much as $350 million in U.S. dollars and 15,250 BTC (a total value of over $1 billion as of March 30) was withdrawn completely unsecured. Such a large loan without any collateral clearly shows a misjudgment but also hints at the intense competition among lenders to add assets and the fact that they are working with a large and reputable fund like 3AC feel relatively comfortable.

Not all lenders are so flippant. The Celsius and Genesis loans appear to be partially collateralized, while the BlockFi loans appear to be overcollateralized.

In general, 3AC is able to Billions in debt have accumulated on assets that have had a lot to do with the continued growth in crypto asset prices. Once the market sell-off and subsequent LUNA/UST crash, what happened next was inevitable.

3AC went from billions in net worth to over $1 billion in net debt, collapsed Yep, blowing a hole in the balance sheet of a cryptocurrency lender.

While 3AC caused the biggest losses, crypto lenders are also guilty of various other mistake. Some engage in risky trading strategies (e.g., so-called “yield farming” across DeFi protocols) with clients’ assets. Others locked capital in seemingly low-risk arbitrage trades (such as betting that the prices of GBTC and BTC would converge), implicitly assuming a long-term bull market in the market, which did not match the short-term nature of customer deposits. For the surviving crypto lenders, risk management seems likely to gain new prominence internally.

Lessons Learned

The cryptocurrency ecosystem is rebuilding currency, financial systems and Internet applications based on new technological and economic foundations. A process so ambitious is bound to be messy. Every failure is a learning opportunity, and we are optimistic that the cryptocurrency ecosystem will become smarter and more resilient.

This isn’t the first crisis for cryptocurrencies, and it certainly won’t be the last.

In 2014, MtGox was the largest Bitcoin trading platform, handling more than 70% of the world's transactions A hacker attack caused a loss of more than 7% of all circulating BTC.

In 2016, when a smart contract application called "DAO" was hacked, Holds nearly 15% of all ETH supply.

At the time, both events seemed to exist. Fear is pervasive and asset prices rise with it. However, in our experience,events like this ultimately do not stop the underlying drive for cryptocurrency advancement: the dedication of developers and entrepreneurs to build the future.

These crises have also catalyzed positive change. The decline of MtGox made way for more secure and well-functioning exchanges like Coinbase, and led to the development of fully non-custodial exchanges like Uniswap.

The DAO hack incident has made people pay more attention to the security of smart contracts. Hopefully the debacle of LUNA/UST will lead to a broader understanding of the risks surrounding algorithmic stablecoins, and the explosion of 3AC and crypto lenders will lead to better risk management.

It is an underreported fact that,with Centralized Finance (CeFi) Decentralized finance (DeFi) protocols performed relatively strongly compared to lenders and funds.

DeFi lenders such as MakerDAO, Compound, and Aave are able to The mechanism established to liquidate the collateral when the margin limit is reached to maintain solvency. These systems are on-chain, transparent, anyone can inspect the code, and there is little chance of accumulating unhealthy leverage. DeFi still has a long way to go before it can match the existing financial system, but some of its fundamental advantages are already beginning to emerge.

Amid the gloomy headlines, our optimism remains unaltered by recent events . Not a day goes by without us encountering a talented college student or a seasoned tech executive considering spending the next 5-10 years building his career in the cryptocurrency space.

The cryptographic infrastructure and developer tools are maturing. The opportunities for new DeFi protocols, especially after this unbundling of CeFi, are huge. We see many emerging green shoots in consumer areas such as gaming, digital art and social networking. Progress and opportunity abound, largely unaffected by asset prices and continued deleveraging.

Going forward, we will continue to focus on the multi-decade opportunity in cryptocurrencies. Our team and the entrepreneurs we support find that in a calmer environment, it's easier to focus on the substance without distractions. Speculative tourists have left and valuations are beginning to rationalize. Strong companies are finding it easier to hire great people.

In general, We are optimistic that the next 12-24 months will be a good time to build and invest in cryptocurrencies.