Cred Files for Bankruptcy, What Does it Mean for Users?

CredEarn is Still CeFi (Centralized Finance)

Just because a lending company deals in cryptocurrency, doesn’t mean they are a decentralized finance company. The nomenclature used should inform the end user of this fact. Companies are centralized institutions and are vulnerable to the same types of failures of any other financial institution.

Users should use extreme caution when lending their funds on a platform such as CredEarn. Caution is warranted because there is typically very little, if any transparency behind how users funds are being used. It is the responsibility of the company to make good decisions with respect to where they lend money. They must lend the money at a high enough rate so that they make good on the interest agreements made with users, as well as earn a margin for the business to have profit. Learning about how CredEarn (and other lending platforms) work is a good primer to understand the macro banking environment.

How to Follow the Story of CredEarn

There is one website that popped up shortly after CredEarn announced that they’re filing for bankruptcy. The sole purpose of the website appears to be to document the press releases and information as it pertains to CredEarn’s bankruptcy. You can visit that website at credearnexpert.com. The majority of the information surrounding the case is available because of past and present employees of CredEarn. Enough individuals have come forth to paint a semi-clear picture of what went wrong.

A Series of Bad Loans

We can now say with reasonable certainty that CredEarn is filing for bankruptcy due to a series of bad loans. As outlined above, if you’re a company that brokers loans, it is imperative that these loans are made with the least amount of risk in mind.

There are two bad loans that are worth examining. The first of the bad loans reveal something interesting about the nature of government intervention. The second reveals the importance of due diligence. Lets dig in.

MoKredit, a Chinese Gaming Company

A Chinese gaming company named MoKredit took a loan from CredEarn in 2019. Everything was going smoothly (on paper) until March of 2020 when financial markets faced a liquidity crisis. The interesting part about this arrangement is that it was the Chinese government that paused the requirement to pay back unsecured loans. While this is good for consumers, it ultimately spelled disaster for the arrangement between MoKredit and Cred.

The customers of MoKredit were using credit provided by the platform to buy games now, and pay for them later. The entire agreement fell apart due to government intervention, but perhaps this is a shortsighted position. Cred gave users money to a company offering unsecured loans to a Chinese gaming company. Would customers of Cred continue to deposit their funds had they known this was the nature of the arrangement?

Kingdom Trust, A Shadow Crypto Custodian

The second failure of Cred began in February 2020 when they decided to invest in a company called Quantcoin. The company received 800 Bitcoin from Cred in order to fund their operations. As it is articulated in this article, an alleged crypto custodian company called Kingdom Trust contacted Cred on behalf of Quantcoin.

They were the supposed custodians appointed by Quantcoin to manage the bitcoin in a secure fashion. Kingdom trust eventually went radio silent, and was completely unavailable for contact by Cred. In effect, the investment meant for Quantcoin was taken by an unknown third party.

Lessons to be Learned

There are several large takeaways from this debacle. The first is that government intervention can be unpredictable and have unexpected consequences on business. Even though the underlying relationship between MoKredit and Cred may have been flawed, it may have been working fine until the COVID-19 induced financial crisis.

Transparency is appreciated, but not always possible within the context of business arrangements. This is why some cryptocurrency investors prefer to lend to decentralized protocols such as UniSwap, and Compound. The loan arrangements set up through these dApps are written in code, and are confined to operate within those boundaries. Contrasting this to the CeFi loan arrangements made with brokers such as Cred, users have absolutely no idea how their funds are ultimately being used.

The second lesson has more to do with due diligence. The failure to identify Kingdom Trust as a shadow corporation is a mistake that cost Cred 800 bitcoin. While this is a fraction of their entire portfolio, it absolutely damns their “cred”ibility. There is no recourse for recovering confidence in Cred to make good investment decisions with users funds.

One trick used within DeFi smart lending contracts is to require collateral from the borrower in order to secure funds. Collateral is used throughout the lending industry as a way of recouping losses, in the event that the borrower defaults on the loan. With these business to business loan arrangements, the discretion for them to use collateral to de-risk the arrangement is completely at the discretion of the broker, i.e. Cred.

Is DeFi Lending Safer than CeFi Lending?

The answer to this question entirely depends on the platform that you’re interacting with. Fractional reserve banking itself (which most world banks use) is an example of centralized financial institutions engaging in lending. Most large banks do have extensive due diligence processes in place in order to give out loans to those who they deem to be low risk. However, the 2008 financial crash was a breakdown of this very system.

On the other hand, the crypto industry just saw a literal buffet of DeFi lending platforms come and go, taking users deposits along with them. There are some objective advantages to using DeFi for making a return on your idle assets. Borrowers that use DeFi to secure a loan are required to lock up collateral in order to secure the loan. In fact, they’re usually required to lock up at least 150% of the loan’s value (Lock up $150 to receive $100). This collateralization of loans gives lenders the confidence that the money they’re loaning to DeFi protocols are going to be there when they want them later. In short, it partially de-risks the loans.

Lastly, DeFi lending is all based on smart contracts. This means that the rules of the lending arrangement are available for the public to view. Code auditors are able to validate that there are no back doors, no side arrangements, and no “gotchas” within the codebase that allows the administrators to steal users’ funds. All this being said, you will still want to lend to reputable DeFi services that have been independently audited.