over 2 years ago • 4 mins
A tale of woe from the crypto markets – involving billionaire Mark Cuban and a token called titanium – brought an unwelcome reminder of one of the oldest rules of investing last week: there’s no such thing as reward without risk.
This reminder of old school investing fundamentals came courtesy of the newest segment of the investing universe: decentralized finance, or DeFi, which – for those that don’t spend their lives swapping crypto tips in Telegram groups – is the system of financial services built on top of blockchain networks like Ethereum.
There are hundreds of DeFi projects out there aiming to replace traditional financial services like banking, trading, and insurance. The difference is that DeFi projects don’t need a central authority to verify transactions: it all runs in code, at least in theory.
Of course, these DeFi projects can’t do much until they have some money in the system. So to encourage people to deposit funds, they often offer a return of 10% or more, which can look mighty attractive when most bank accounts pay close to zero. Plenty also pay out bonuses in the form of tokens to win more people on side.
The DeFi space has boomed in recent months: there’s currently $51 billion locked up in DeFi projects, up from just $1.5 billion a year ago. And a subsection of crypto investors have been jumping at the chance to earn a return on their crypto holdings. But because these yields can fluctuate wildly, some have taken to hopping from project to project in the hunt for the best returns – a process dubbed “yield farming”.
Unfortunately, yes. These DeFi projects don’t offer such elevated returns out of the goodness of their hearts. They need to pay double- or occasionally even triple-digit yields to compensate people for the risk they’re taking on by locking up their crypto in such nascent, unregulated projects.
Those risks include:
Yep, all this brings us on to last week’s fiasco: the collapse of Iron Finance’s titanium token (ticker: TITAN).
Iron’s pitch was that their so-called stablecoin (ticker: IRON) would pay investors a healthy yield and peg its value to the US dollar, helping it avoid the recent losses in most crypto assets.
But unlike tether (ticker: USDT) and USD coin (ticker: USDC), Iron’s stablecoin wasn’t fully backed by dollars, which could be paid out whenever an investor wants to redeem their token. Instead, IRON was only partially backed by actual dollars (in the name of “capital efficiency”), with the shortfall made up from sales of the titanium token.
In other words, if the value of IRON started falling versus the dollar, Iron Finance would issue more titanium tokens to prop up the price. That’s the “algorithmic” part of the stablecoin – so called because some computer code decides when to issue or destroy the relevant tokens.
Anyway, the project was proving popular and had attracted more than $2 billion of funds as of last Monday. That was about 4% of assets in all DeFi projects globally – a not-insignificant sum.
For this “algorithmic” system to work, however, it requires a constant pool of willing buyers for those titanium tokens. That’s easy to come by when the price of titanium is climbing, but once the price started falling, they suddenly disappeared. And the price of a titanium token plummeted from about $65 to a few pennies in a matter of hours last Wednesday – blowing up the entire project.
In a blog post on June 13th, Mr Cuban explained why he’d invested $75,000 into this project – and boasted of his “annualized return of about 206%”. Iron Finance, unsurprisingly, tweeted the post out the next day, glad of the vote of confidence from such a famous name.
Luckily for Cuban – who has a net worth of more than $4 billion – $75,000 isn’t a lot of money. But it shows that even the most sophisticated investors can get it wrong. “The investment wasn't so big that I felt the need to have to dot every I and cross every T,” Cuban told Bloomberg. “I took a flyer and lost.”
So the next time you’re tempted by an investment yield that appears too good to be true, take a breath before committing any money. Or at the very least, be like Cuban and only invest what you can afford to lose...
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