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December 14, 2022

Proof of reserves; self custody; Maple Finance

Welcome to Swarm Markets’ media memo. This weekly update provides comments from Swarm Markets’ co-founders, Philipp Pieper and Timo Lehes, on key industry news that has caught our eye, plus our own developments. 

Comments available on the following news items:

  • Proof of Reserves won’t be enough to allay investor worries
  • Self custody soars in November
  • Maple Finance is onto a good thing, but needs improvement

Proof of Reserves isn’t going to cut it

With reports circulating about another major crypto platform, the idea of Proof of Reserves (PoR) seems dead on arrival. Investors need more transparency when it comes to collateral than just a snapshot of assets at one moment in time. 

The question of collateral is quite simple – if you don’t have enough of it to meet redemptions then your platform is going to get into trouble as soon as the market doesn’t move in the direction you want it to go. This is amplified exponentially when leverage is added into the mix. 

PoR as a solution relies on too many caveats to be an effective solution to the market’s current fears about these platforms’ ongoing capital supplies. Major leverage issues have taken down some big players this year, and this won’t improve unless a complete view of collateral and debt is put in place to alleviate investor concerns.

Of course, the best way to see if your assets are where they should be is by redeeming them. Users need constant ongoing reassurance that their assets are there to be redeemed if necessary. Self custody will signal a major shift in the sector that will reduce crypto market participants’ reliance on centralised platform dependence. 

Crypto investors jump into self custody

Data from CryptoCompare shows investors are ditching centralised platforms in favour of self custody at record rates in the wake of the collapse of FTX. 

It is little surprise that crypto users and investors would react in this way to the events of the past few months. With this clear demand now in place the sector needs to work hard to provide easier and more user-friendly options for those who wish to utilise self custody. 

For centuries, business models have been built on the notion of custodying assets for others. Likewise, generations of people all over the globe are used to having assets managed for them by third parties we are supposed to trust. 

But the price of this custodianship has burned the fingers of thousands of investors as centralised crypto platforms have turned out to be poorly run, leveraged to the hilt, and even playing with deposits in the background. 

Fortunately, unlike old-school banking, DeFi does have solutions that don’t force holders to be dependent on centralised, fallible institutions. The market should now respond by providing solutions to users that promote seamless, safe self custody. Adding a regulatory layer to that in the way Swarm has applied KYC and AML procedures to all wallets, thereby removing counterparty risk, presents an outstanding value proposition to the market. 

Maple Finance has a strong lending model, but needs some improvement

Maple Finance fundamentally has a good model for lending but it needs some improvements, as recent events show. For example, a real time view of crypto assets and liabilities and accounting data would provide a better continuous health check of a company’s assets. Also, the incentives to provide cover (insurance) in an event where loans cannot be paid back, should be developed so that it becomes more attractive to be an insurer. 

However, it is clear that there has been a big sector concentration of crypto companies borrowing, meaning there is a knock-on effect when one position starts to devalue. The Maple model would be better supported if its ecosystem of lenders and borrowers were more diversified.

There is a general issue of unsecured lending in the crypto industry, where the lending platforms and underwriters need increased supervision, regulation and bank-like due diligence checks. 

Again, where Maple’s model could succeed is offering companies a real time view of collateral, meaning underwriters can adjust accordingly. This will replace on-demand due diligence checks, as underwriters can see on-chain the value of a position and if it is sufficiently backed at all times.

Real time data would tighten the relationship between underwriters and borrowers, making the business of lending more robust. We could even get to a point where people are awarded a lending score based on how they have handled loans in the past.

Centralised lending platforms will have to get more comfortable with the idea of regulation. Currently, it looks easier to enter unregulated offerings and take on bigger risks because safer alternatives enforce onboarding. Regulatory oversight, even within a Defi setting, is useful where platforms or counterparties represent risk.