A Comparison Between the Collateralized Crypto Lending and the Repo Market (conclusion)
As the comparison showed, both systems are inherently flawed and are susceptible to systemic risks. The reality is that the possibility of an asset price collapse exists if there is enough leverage in any system. The difference between the traditional financial market and crypto market, though, is that the central banks are the ultimate backstop that will step in to prevent a widescale collapse across all assets (for now). Crypto, in its current form, doesn’t have an equivalent backstop.
The Fed intervened in the repo markets in both 2019 and 2020 and effectively protected the cash lenders who invested in the ”low risk” repo market from any substantial losses. The March 12th crypto crisis, however, annihilated the DeFi protocol lenders who were under the impression that investing in the crypto equivalent of fixed income was relatively low risk.
There are no easy solutions to the issues that the crypto lending markets face, but what is certain is that the continued growth of these markets is critical. Metcalfe’s law has been used to assess the fundamental value of Bitcoin and it states that a network’s value is proportional to the square of the number of its users. In other words, the network’s value grows as the number of users grow. Financialization has been critical to growing the crypto network over the last two years and will remain a critical part in the future. Any attempts to scale back financialization will likely result in the destruction of the network value.
Crypto will need to continue to look towards the traditional financial markets for solutions to the problems that it faces. Avoiding crises all together is simply not plausible, but the lessons from the traditional financial markets can provide tremendous value to the development of the crypto financial ecosystem. After all, it has already experienced the same issues many times throughout its long history
26.Diamond, Douglas. (2017 Nov 27) Douglas Diamond Says the Next Crisis Will Be Different https://review.chicagobooth.edu/finance/2017/article/douglas-w-diamond-says-next-crisis-will-be-different
27.Peterson, Timothy (2017 Dec 2) Metcalfe’s Law as a Model for Bitcoin’s Value https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3078248