The Liquidators Get Liquidated

by Chris Coney
By Chris Coney

In previous articles, I’ve emphasized that our current financial, banking and governmental systems will resist DeFi, primarily because it’s an existential threat.

Put simply, DeFi has the potential to make traditional finance redundant.

That’s why many professionals within TradFi groups have a mental block when it comes to understanding crypto and DeFi — because to understand would feel like facing oblivion.

This quote from Upton Sinclair sums it up nicely: “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

But objectively, there’s not much to worry about. There’s plenty of room for financial professionals in DeFi.

However, the old infrastructure and some common corrupt practices would have to go.

Accountability

I wrote a previous article on the subject of smart contracts and their absolutely ruthless adherence to the terms of the agreement.

It appears that the liquidators in charge of the Alameda Research wallets have found this out the hard way.

If you recall, Alameda Research is the sister company of FTX and was at the heart of the collapse.

It continues to be a part of a complex interconnected web of finances that are still being unraveled to determine exactly how FTX went from hero to below zero in short order.

As part of the insolvency process, the Alameda liquidators have been consolidating funds by transferring assets from all the disparate wallets into a single, multi-signature wallet.

Losing 4.05 BTC

Now, Alameda’s liquidators managed to lose 4.05 Bitcoin (BTC, Tech/Adoption Grade “A-”) by incorrectly operating the Aave (AAVE, Tech/Adoption Grade “B”) DeFi platform.

Alameda had some outstanding loans they had taken out and secured against some of their Bitcoin collateral.

As with most on-chain collateralized loans, the borrower must maintain a certain collateralization ratio for the loan to remain in good standing.

If the value of the collateral drops below the liquidation threshold, it’s automatically sold in order to make the lenders whole.

This is what happened to Alameda’s liquidators.

Through a simple error of process, they submitted transactions to Aave that removed excess collateral before they paid off the outstanding loan.

The value of the remaining collateral was then too close to the liquidation price, so the price fell, and the liquidation was triggered.

This caused 4.05 BTC that was backing that loan to be lost.

At time of writing, Bitcoin is trading at $20,812, making that loss worth $84,288.60.

A Small Loss Is Still a Loss

Now, considering liquidators have over $150 million in their consolidated wallet, this $84,000 is a small amount of money.

But customers are still owed their deposits back, so this could be seen as $84,000 of customer money that’s been lost in addition to whatever losses FTX made through bad trading and business practices.

DeFi Could Have Prevented All of This

The FTX bankruptcy has created a huge boom in the use of noncustodial, on-chain exchanges.

There was nothing stopping any of these traders using on-chain exchanges before FTX collapsed … except maybe a lack of will and disbelief in the risks.

While believing that “it’ll never happen to me” may give some comfort in the short term, if it does happen, the results can be devastating.

Isn’t it better to eliminate all risks that can be eliminated?

I happen to think so, because then I have fewer risks to manage. At the end of the day, an eliminated risk is no risk at all.

Conclusion

So, not only could the use of DeFi by traders have prevented their losing any money through FTX mismanaging their business … but if FTX itself had been doing business on the blockchain, there’d be no need for liquidators or bankruptcy proceedings.

The whole thing would have resolved itself in real time based on the agreements each investor made through the relevant smart contract.

We don’t currently live in a world of strong accountability.

That configuration is to the great benefit of some and a great detriment to others.

I foresee a trend toward greater accountability enforced by DeFi, and that’s why I’m getting out ahead of it.

I encourage you to join me.

But that’s all I’ve got for you today. Let me know if you also think we’re moving toward a future of greater financial accountability by tweeting @WeissCrypto.

I’ll catch you here next week with another update.

Until then,

Chris Coney

About the Contributor

Chris Coney is among the world’s most experienced educators in the field of decentralized finance (DeFi) and cryptocurrencies. He is also one of the few analysts in the world specializing in the field of “yield farming” — hunting for the high yields now possible in the fast-growing DeFi world.

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