Crypto Yields 3

Deconstructing CeFi

July 2021
 Table of Contents

1. Introduction
2. Currency Risk
3. Platform Risks
4. Conclusion

Disclosures
This report has been prepared solely for informative purposes and should not be the basis for making investment decisions or be construed
as a recommendation to engage in investment transactions or be taken to suggest an investment strategy with respect to any financial
instrument or the issuers thereof. This report has not been prepared in accordance with the legal requirements designed to promote the
independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Reports issued by Payward, Inc. (“Kraken”) or its affiliates are not related to the provision of advisory services regarding investment, tax,
legal, financial, accounting, consulting or any other related services and are not recommendations to buy, sell, or hold any asset. The
information contained in this report is based on sources considered to be reliable, but not guaranteed to be accurate or complete. Any
opinions or estimates expressed herein reflect a judgment made as of this date, and are subject to change without notice. Kraken will not be
liable whatsoever for any direct or consequential loss arising from the use of this publication/communication or its contents. Kraken and its
affiliates hold positions in digital assets and may now or in the future hold a position in the subject of this research.
1.
Introduction

The crypto lending market is an increasingly vibrant sub-sector of the crypto ecosystem;
the yields, higher than anything comparable in the legacy financial market, appeal to
those seeking to make a return on their assets. With the emergence of the Decentralized
Finance (DeFi) sector in recent years, the cryptoasset industry is seeing an explosion
of activity in lending. Yields play a vital role in crypto and financial markets as they
bring together those with surplus assets and those in need of assets for productive use.
As we've seen with DeFi, crypto savings accounts have the potential to bring in new
money. It provides an incentive for crypto holders to move assets out of storage and
into open markets, ensuring that large portions of tokens aren't permanently taken
out of circulation but rather used to enhance market liquidity. Crypto yields appeal to
many participants who want to negate the low—even negative—interest rates offered in
traditional savings accounts. However, much like DeFi platforms, we believe Centralized
Finance (CeFi) lending platforms also carry risks.

While the total value locked (TVL)1 in CeFi is not as easily identifiable as is with DeFi, it
has become apparent that businesses are jumping into the world of crypto lending. Per
figure 2, CeFi savings rates are comparable to the rates found in DeFi and surpass most
traditional yield-bearing instruments. CeFi lending operates in a similar way to that of
traditional savings accounts, where holders deposit a certain asset on a flexible or fixed

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term, in exchange for a pre-agreed regular return. However, we intend to identify some
of the risks present in centralized lending platforms, namely: default risk, custodian
risk, and trust and transparency risk. By doing so, market participants can price in risks
and discover real crypto yields. Sometimes the yields advertised by lending companies
may not represent the real rate of return. But to understand yields, we must first seek to
understand CeFi lending.

Figure 1
CeFi vs. DeFi
CeFi DeFi

Custody Managed by an entity Managed by the user

Security Managed by an entity Managed by the user
Main services Lending/borrowing, trading, and Lending/borrowing, trading, and
payments (fiat on/off-ramps) payments (crypto on/off-ramps)
Customer support Centralized client support No centralized client support
Accessibility Verification needed (KYC, AML) Permissionless, available to all

Figure 2
A comparison of yields across CeFi, DeFi, treasuries, and bank savings

CeFi DeFi
Asset Nexo Celsius Binance Bitfinex Aave Compound dYdX Fulcrum
ETH 6.00% 5.35% 0.24% 0.40% 0.00% 0.17% 0.17% 0.06%
DAI 10.00% 4.60% 4.53% - 2.31% 2.17% 2.17% 5.89%

Treasuries Savings
Asset UK Germany US Japan UK Germany US Japan
10 year bond yield National average
Native 0.82% -0.20% 1.60% 0.09% 0.40% 0.09% 0.04% 0.001%

Source: Nexo, Celsius, Binance, Bitfinex, defirate.com, tradingeconomics.com, swanlowpark.co.uk, euro-area-statistics.org, Federal Deposit
Insurance Corporation (FDIC), Bank of Japan (BoJ).
Note: APY rates at the time of writing, yield rates are subject to change at any given time. Binance yields denote flexible savings account rates.

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Centralized Finance
In CeFi, all crypto-related activities go through a centralized entity. CeFi lending,
therefore, is where a centralized entity allows users to deposit assets, bears custody of
the assets, and acts as the lender of assets. CeFi lending includes platforms like BlockFi,
Celsius, and Nexo, as well as certain centralized exchanges that offer lending/borrowing
services. Lending in CeFi is different from DeFi in a number of ways. For starters, loans
originate from and are managed by a centralized entity, meaning CeFi platforms may
adhere to regulation that requires their clients to go through an identification process.
Conversely, DeFi is an open platform with a permissionless onboarding experience
that only requires market participants to create and connect a digital wallet to the
platform. Given the nature of CeFi, businesses and organizations own the platform and
are responsible for managing and maintaining the software, the infrastructure, as well
as customer data and funds. As a result, clients effectively pass on custody risk to these
third-party service providers.

Figure 3
Example of borrowing and lending on CeFi

Borrower Lender Borrower Lender

Platform 'A'
1 BTC receives
Lending 1 BTC
User 'X' Platform 'A'
platform 'A'
deposits pays out 5%
offers 5% 1 BTC
1 BTC in to user 'X'
annual yield
CeFi lending and collects
on all BTC Trading firm 'B'
platform 'A' 3% spread
deposits borrows 1 BTC
from platform
'A' at 8% annual
interest rate

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However, CeFi companies are generally much more user-friendly to the everyday user
than many other modes of lending as many have direct relationships with traditional
banks and can offer fiat on and off-ramps, meaning loans can be seamlessly paid out
in fiat currency. As part of the service, they also offer robust customer support for
both institutional and retail customers, and have more stable interest rates than DeFi
as supply and demand are not wholly determined by the market alone. Additionally,
there's often consistent demand stemming from institutional clients looking to borrow
assets. Currently, DeFi rates tend to be higher and more volatile than CeFi rates, though
theoretically arbitrage should cause the rates to converge. In reality, DeFi still offers
higher rates due to many protocols issuing network tokens in addition to the other fees
paid out for network participation, and the ease with which market participants can move
in and out of liquidity pools. This is also known as liquidity mining and is a well-known
incentive for activity on DeFi.

Within CeFi lending, interest rates can vary depending on the business model and how
these centralized entities generate the interest paid out on assets. To understand the rates
associated with the different venues in CeFi lending, we delve into the risks present on
various CeFi platforms as well as currency risk and try to quantify the impact of each risk
in order to calculate the implied hurdle rate2 of different CeFi platforms.

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2.
Currency Risk

As a reminder, interest is the cost of borrowing money, often expressed as a percentage

over an annual basis. The foundational interest rate is known as the risk-free rate, which
is the interest rate associated with what is perceived as a guaranteed future payment.
An investment is considered “guaranteed” when the issuer of the currency is a monetary
sovereign with the theoretical power to print more of its currency to finance its future
payments.3 Risky assets will often carry a higher interest rate than the risk-free rate,
which reflects the risk attributable to the specific asset and/or issuer. This is also known
as the risk premium and is seen as the level of risk an individual is willing to take on a
risky asset. Accordingly, interest rates will generally be made up of two elements—a risk-
free rate and a risk premium.

The risk-free rate for fiat is straightforward when compared to cryptoassets, largely
because government bond yields are generally used as the benchmark risk-free rate.4
In the case of crypto, more specifically stablecoins that are pegged to fiat, we argue the
risk-free rate follows that of the pegged fiat.5 For example, USD-pegged stablecoin USDC
would have a risk-free rate of 1% if the risk-free rate for USD is 1%. Say the interest rate
for USDC deposits is 10% on a particular platform, then the 9% spread would be the risk
premium. As said above, interest rates are largely a function of the risk-free rate of a
“risk-free” investment and the default risk (counterparty risk) associated with lending to
a counterparty. This 9% spread would represent the default risk, or risk factors tied to the
mechanisms of this particular CeFi lending platform, such as scenarios of platform hacks,
exploitations, fraud, or misappropriation, as well as risk factors tied to the mechanisms
of USDC, such as scenarios of the whole system de-pegging from the USD or risks with the
issuing entity of the token itself.

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To illustrate, let’s use DAI as an example. DAI is pegged to the USD but backed by ether
(ETH), meaning the risk-free rate of DAI will follow the quoted currency through which
it was acquired. Assuming we deposit ETH for DAI, the rate for DAI would follow ether’s
hurdle rate of 3.77% (also ether’s current inflation rate, as we will explain below).6 For
Proof of Work (PoW) currencies, such as bitcoin, we argue that the risk-free rate is zero.7
Conversely, in the case of cryptocurrencies with borrowing and issuance tied together as
part of their network consensus mechanism (i.e., Proof-of-Stake), there may be a risk-free
rate that accrues to those who lend the currency to the issuing network, also known as
staking. This may be the case for ERC-20 tokens or ether (ETH) when it moves onto PoS
with the launch of Ethereum 2.0.

Though we assume ETH has a risk-free rate of zero, we believe it has a hurdle rate.8 Ether
has an annual issuance cap of 18M ETH and with a capped annual issuance, relative
dilution decreases annually as more ether is in circulation, and the supply growth rate
trends towards zero over time. As of writing, the estimated current circulating ether
supply is around 116M ETH with an estimated 3.77% annual supply increase.9 We will
consider this dilution rate the hurdle rate of the ETH protocol to compensate for the loss
of purchasing power due to inflation.

Overall, there will be varying degrees of risk-free rates or none depending on the
cryptoasset, and for those with none, interest rates will be a result of the risks endemic to
each currency, platform, and yield product. Understanding the risk-free rates tied to each
currency as well as platform risk rates can help market participants determine the real
yield offered for lending on any given CeFi platform.

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3.
Platform Risks

Not all platforms are created equal. While those who compete in CeFi all offer somewhat
similar products and services, each has their own set of risks that should be carefully
considered when weighing the potential return on investment. We look to the major
players that exist in the CeFi market today to illustrate some of the common risks present
across platforms—namely default risk, custodian risk, and trust and transparency risk.
Per figure 4, various lending platforms offer different rates on the same cryptoasset,
which is a reflection of their business model. For instance, some institutional lenders
generate interest on assets by lending them to institutional and corporate borrowers,
while some crypto exchanges source and pay out interest from internal revenue streams
like trading, treasury management, and investment activity. Regardless of financing
methods, all platforms carry common risks.

Figure 4
Major players and their respective yields

Nexo BlockFi Celsius Binance Coinbase Bitfinex

Flexible Locked
Tier 1 Tier 2 Tier 3 Savings Savings
BTC 6.00% 4.00% 1.50% 0.25% 6.20% 0.80% 7.00% - 1.20%
ETH 6.00% 4.00% 1.50% 0.25% 5.35% 0.24% - 5.00% 0.40%
USDC 10.00% 7.50% 5.00% - 8.88% - 4.24% 1.25% -
USDT 10.00% 7.50% 5.00% - 8.88% 2.00% 4.24% - -
DAI 10.00% - - - 4.60% 4.53% - 2.00% -

Source: Nexo, BlockFi, Celsius, Binance, Bitcompare.net, Bitfinex

Note: APY rates at the time of writing. Please note that yield rates are subject to change at any given time and listed yields are in-
kind reward rates. Celsius yields listed are international reward rates.

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Default Risk
Our previous note on DeFi yields touched on liquidity and collateralization risk. When
it comes to CeFi lending, there is always a loan default risk: the risk that a borrower
fails to pay back the loan. Generally, the risk of a borrower defaulting is limited because
centralized lending platforms will ask borrowers to be over-collateralized in order to
reduce default risk. For instance, venues like BlockFi allow users to borrow up to 50% of
the value of clients’ locked crypto. This 50% Loan-to-Value (LTV) ratio means that if the
locked value of a clients’ crypto amounts to $10,000, the client can borrow up to $5,000.
A traditional business loan will typically require a 50%–90% LTV ratio, depending on
the collateral’s liquidity and the borrower’s credit score.10 Collateral is essential for an
operational ecosystem. Centralized platforms sell off the collateral if the collateral value
of a loan falls under a given threshold and the clients fail to supply more to meet the
threshold. This can result in significant risk in cases of sudden market crashes or volatility.
If extreme volatility weighs on the broader market considerably and liquidates multiple
market participants, the sudden dumping of collateral assets on the market all at once
would likely lead the spot price to crash, making it difficult for the centralized platform
to pay back all the lenders. In the worst-case scenario, this could lead to a default, and
those who placed assets in their crypto savings accounts run the risk of being unable to
withdraw their assets, and even losing them entirely.

Figure 5
Delinquency rate on consumer loans

Source: Board of Governors of the Federal Reserve System (US), Federal Reserve Economic Data (FRED)

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While there can be different ways to measure default risk, we will use US loan delinquency
rates as a benchmark. According to the Federal Reserve Economic Data (FRED), the
delinquency rate on consumer loans in the US in 2020 was between 1.88%–2.52%.11 While
the likelihood of a market crash resulting in enough liquidations to produce mass defaults
is unlikely, to combat this risk, some companies will have an insurance policy or systems
in place that guarantee a certain amount of loss coverage for their lenders. For example,
some exchanges will have in-house insurance plans financed by a percentage of the trading
fees generated on their platform placed into a cold wallet to offer protection to clients'
funds. However, it is important to remember that no platform can guarantee complete
safety from extreme market conditions despite these insurance programs and systems
advertised to protect customers. Platforms and exchanges still retain ownership of the
insurance funds and unless the platforms have a regulated self-insurance vehicle so that an
overseeing party has the authority to offer the funds placed into this self-insurance entity
to cover losses, there is no guarantee for the consumer.

Custodian Risk
In CeFi, when a client deposits funds into a crypto savings account, funds are lent out
or held in custody by the centralized entity themselves or by a third party whose sole
responsibility is to ensure funds are safeguarded and accessible when necessary. In all
cases, custodian risk is one of the most significant risk factors in CeFi lending because
there is a centralized point of attack. If a malicious actor is able to hack and steal from
the custodian holding user assets and collateral, loans will no longer be backed and
lenders could lose their deposit and find themselves unable to withdraw their funds.
Many custodians will therefore have insurance policies in place to hedge against the risk
of hacks, but will generally set a ceiling to the amount of loss that can be covered and
reimbursed.

This risk is only amplified if a large number of market participants are affected by the
hack, and it leads to a company or custody provider's inability to cover the loss of all
participants affected. In many cases, crypto custody providers have larger clients such as
exchanges, institutions, and even other crypto lenders, which means one custodian hack

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can have a ripple effect in the larger crypto ecosystem. For instance, there were roughly
$516M worth of crypto-related hacks and thefts in 2020.12 Approximately $312M, or roughly
60.5%, of which were known to have occurred on centralized crypto exchanges.13 As an
example, the biggest CeFi hack of 2020 occurred on a centralized exchange where roughly
$285M was stolen.14,15 According to an industry report, the estimated active debt in the
crypto lending market for 2020 was around $38B.16 If we assume this represents the total
value of crypto in lending offerings in the market, we can take the total value of crypto
related hacks and thefts of $516M and divide it by this total value of crypto in the lending
market, $38B. From this, we multiply the likelihood of it happening on a CeFi platform,
60.5%, to arrive at a CeFi custodian risk of 0.81%.17

Just as exploitations increased with the rise of DeFi, CeFi is also at risk of platform hacks.
However, while the nascent DeFi space still lacks proper loss coverage or insurance
measures in place to guarantee fund safety, CeFi platforms have evolved with a greater
awareness of risk and are incorporating various systems in an attempt to protect customers.
For instance, lenders like Ledn or Unchained Capital provide users with segregated wallet
addresses, which allow for funds to be monitored in real-time and prevent funds from being
rehypothecated, or what is known as 'proof-of-reserve'. While the industry has progressed
and platforms are finding ways to incorporate better security validation measures,
individuals should always conduct thorough research into companies’ historical exposure
to hacks or security breaches. Finding out how platforms have mitigated or dealt with past
instances of custodian risk-related events and what precautions they take to protect against
hacks, thefts, and even the most extreme of market conditions may be the best means for a
client to evaluate the future safety of their assets on that platform.

Trust & Transparency Risk

While centralized companies offer greater support and stability than DeFi platforms,
they also raise concerns over lack of transparency. As the crypto lending industry is still
nascent, some worry lending platforms could use clients’ posted collateral for purposes not

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outlined in the company's terms & conditions, such as to provide riskier, insufficiently
collateralized loans for additional revenue.18 This is a practice traditional financial
institutions (e.g., brokers and banks) may use, whose risks could play out in the crypto
industry if platforms integrate these practices and the market becomes overleveraged
without the knowledge of the participants. Platforms can also choose where user funds go
to yield interest in a way that optimally aligns with their business models. In the case that
this is not in line with client interests, it can be a source of risk as customers do not know
how their funds are used, who has taken custody of them as a borrower, and the associated
counterparty risks in those transactions.

As an example, a crypto lending platform filed for bankruptcy in 2020 after losing
its funds due to fraud.19 It claimed to lend out customer crypto deposits on a “fully
collateralized and guaranteed basis” insured by custodial partners. However, according to
its bankruptcy filings, the company was found to have put roughly $140M of user funds
at risk, with $115M owed to holders of its lending contracts. Public reports indicate that
the risk was a result of the company not properly vetting third parties and onboarding a
fraudulent asset manager, which ultimately led to the material loss of funds.20 According
to CipherTrace, crypto-related fraud and misappropriations vastly exceeded crypto hacks
and thefts in 2020. Precisely 73% of the $1.9B total crypto crime in 2020 accounted for
fraud-related crime, mainly in the form of companies defrauding customers.21 However,
by the second half of 2020, nearly 99% of major crypto fraud stemmed from DeFi
protocols.22 CeFi platforms are less likely to see blatant fraud as company executives are
subject to arrest, fines, and other legal measures that hold public individuals accountable.
If 99% of total crypto-related fraud stemmed from DeFi, we hypothetically assume the
remaining 1% stemmed from CeFi. Similar to custodian risk, if we assume the estimated
$38B active debt in the lending market represents the total value of crypto in lending
offerings, this figure gives us a trust & transparency risk of 0.36%. This can be calculated
by taking the total value of crypto related fraud and misappropriations of $1.3B and
dividing it by the total value of crypto in the lending market, $38B. From this, we multiply
the likelihood of it happening in CeFi, which is 1%.

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Figure 6
Total crypto crime in 2020
$4.5B

$1.9B
$1.7B

2018 2019 2020

Hacks and Thefts Fraud and Misappropriation

Source: CipherTrace 2020 Cryptocurrency Crime and Anti-Money Laundering Report

The root of the risk is a central authority misappropriating assets without adequate
transparency. In addition to lack of transparency, CeFi platforms can arbitrarily deny or
decline user accounts or geographically restrict users. At times, there can even be instances
of regulatory scrutiny and uncertainty that could lead to restricted access for users.23
Therefore, when looking to engage with a CeFi lender or exchange, it is in the user’s best
interest to look at the platform’s history of fraudulent activity, fund misappropriation,
consumer protection, and transparency. Lenders that value transparency generally
communicate all relevant information on their website on how they protect their
customers in times of unforeseen risk or market distress. A good practice for users is to pay
attention to contract terms, provider’s licenses, company insurance policies or insurance
funds as these can be important indicators of risk.

Implied Platform Risk Rates

As these examples of risks all illustrate, the level of risk on CeFi can be measured in
different time frames or around specific events. In figure 7, we consolidate all mentioned
risks and the implied risk rates to get a better understanding of the market pricing of
each of the risks based on our examples. Please note that these risk rates are based on

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very specific events around specific time frames and are only meant to illustrate a way
of finding implied CeFi hurdle rates. They are by no means a permanent or definite
measure of the current risk present on the platforms mentioned and are subject to
change at any time.

Figure 7
Implied platform risk rates

Risks Implied risk

Default risk 1.88% – 2.52%

Custodian risk 0.81%
Trust & transparency risk 0.36%
Implied hurdle rate24 3.05% – 3.69%

Note: The risks rates listed are merely anecdotal and based on specific scenarios on chosen platforms, and not meant to be taken as definitive
figures of each risk.

There is more than one way to measure the level of trust we can place in CeFi, but
having a benchmark rate to which you can extrapolate layers of risk will be helpful in
understanding that depositing in CeFi carries different risks than depositing in DeFi or
in a bank. For instance, using the risk calculation methods above, we can see if a platform
is providing adequate yield. First, let's assume a borrower is offering a 6% yield on ETH
deposits. At first glance, it’s easy to think this is a high return on an asset, especially if
we compare it to offerings seen in legacy markets or traditional bank savings accounts.
However, per figure 8, an implied hurdle rate of 6%-7% for CeFi lending could outweigh
the yield offered on ETH and deem the reward not worthy of the risk.

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Figure 8
Scenario analysis

Risks
Currency risk (ETH) 3.77%
Platform risk 3.05% - 3.69%
Default risk 1.88% - 2.52%
Custodian risk 0.81%
Trust & transparency risk 0.36%
Implied hurdle rate 6.82% - 7.46%
Yield offered (ETH) 6.00%
Net yield -0.82% - -1.46%

Note: The risks rates listed are merely anecdotal and based on specific scenarios on chosen platforms, and not meant to be taken as definitive
figures of each risk.

Market Risk: Opportunity Costs

For a more comprehensive risk overview, we consider an additional risk that may exist
on CeFi lending depending on the offerings or systems of a lending platform. As with
most centralized systems, there exists market risk for those who are utilizing services
administered by a third party. While DeFi systems execute directly and immediately
between platform and user, CeFi can come with an additional time lag that may result
in an opportunity cost. For instance, users that want to deposit or withdraw funds may
have to wait a couple of days to receive their funds, or find that they cannot immediately
access their account, which creates a risk for market participants seeking to exit or enter
the market at the most opportune time. The lag can also create risk should the centralized
entity experience a hack or exploit that makes it impossible for users to retrieve or receive
their funds.

Accordingly, one way to quantify this market risk is to estimate the potential loss caused
by the time lag. As an example, many CeFi lending platforms advertise a withdrawal period
of 2 days, on average. Say that a user is trying to withdraw ETH from a crypto savings

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account in order to sell it at current market price, but it takes 2 days for the withdrawal
to complete. Currently, annualized volatility for ETH stands at around 101.4%, which
translates into an average daily volatility of around ±5.3%. This means that due to the
longer withdrawal time on CeFi, the user theoretically misses out on an opportunity to act
on a market that sees two consecutive days of ±5.3% returns, or a +10.9% or -10.3% return
in total. While this does not account for upside or downside volatility and assumes the
market moves in one direction, it gives an idea of the opportunity cost resulting from time
lag.

In addition to buying and selling cryptoassets, there can be a mix of other external
opportunity costs. One example is market making. One of the beauties of the crypto
industry is a lower barrier to entry, unrestricted to the everyday user. Individuals can
participate as liquidity providers, also known as market makers, and play the essential role
of providing liquidity in a market. Market makers will place market orders on both sides
(bid/ask) of the market and profit the spread when the orders fill. Another example of an
external opportunity cost could be staking, where users can lock-in, or “stake,” a portion
of their crypto on a network. Staking yields a return as users are rewarded for the amount
and time they stake their cryptoassets. Whichever the external opportunity, the longer it
takes for users to access their funds or capital placed on centralized platforms, the greater
the opportunity cost.

While this overview of hurdle rates and external market risks is not to discourage
participation in lending or borrowing activities, we hope you understand that not all
offerings are from high-yield environments and some decisions may need an evaluation
of your risk portfolio. We also note that our research provides an aggregate view of hurdle
rates within the crypto lending landscape. In reality, risks will generally be specific to
each lending platform and each platform will have a different risk profile resulting from
its business offerings and practices. We hope this exercise encourages users to conduct
thorough research and carry out independent analysis to fully understand the risks
that can arise from a particular platform before choosing to engage with it based on the
advertised yield.

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4.
Conclusion

Not only has centralized finance made it easier than ever for anyone to jump into crypto,
but CeFi has also granted billions of underbanked and unbanked individuals an entry
into services they could not access otherwise. While DeFi has certain seen tremendous
growth over the past several years, CeFi borrowing and lending services have also had
great success. The growth has been accompanied by an increase of token holders turning
to opportunities for greater returns, especially as traditional banks continue to fail to
offer attractive rates. But as we’ve discussed in this note, when comparing the yields of
the various CeFi companies that exist in the crypto space today, it is important to have
a foundational understanding of the potential risks. CeFi companies have different
offerings, and analyzing the real risks on each platform can help potential clients discern
if the promised return is worth the risks.

As the industry progresses, companies and customers are becoming more cognizant
of the risks associated with CeFi services, which we believe is something that will
further push the centralized entities themselves to incorporate methods of security and
transparency into their business models. We encourage you to do thorough research and
engage with companies with a track record on security and trustworthiness, and urge you
to protect yourselves from any avoidable risks by choosing platforms that are experienced,
prepared, and transparent.

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Footnotes

1. Total Value locked (TVL) is a metric, first created and popularized by DeFi Pulse, that represents the USD value of all tokens locked in smart contracts of
decentralized lending projects. Please note that the TVL may be skewed as a result of price volatility of the USD.
2. The hurdle rate is the lowest required rate of return that users must earn to offset the costs of an investment.
3. The assumption of a ‘guarantee’ is moreso theoretical and has its limitations in real-life applications.
4. “Crypto Yields: A Simple Breakdown” Kraken Intelligence (https://kraken.docsend.com/view/5ppb7gzt9ih7cz6f)
5. "Crypto Yields: Deep Dive on DeFi" Kraken Intelligence (https://kraken.docsend.com/view/dg34s3izvsbfa9uh)
6. ETH Annual Inflation Rate (https://www.icrypex.com/en/features/products/ethereum/details)
7. We assume that PoW tokens’ risk-free rate is zero as its consensus mechanism does not tie the issuance of new tokens into the lending (or staking) of
its tokens. "Crypto Yields: Deep Dive on DeFi" Kraken Intelligence (https://kraken.docsend.com/view/dg34s3izvsbfa9uh)
8. A hurdle rate is also known as the ‘minimum acceptable rate of return,’ which denotes the return an investor would seek on an investment opportunity
in order to be compensated for the level of risk present.
9. ETH Annual Inflation Rate (https://www.icrypex.com/en/features/products/ethereum/details)
10. "How Much Collateral Do You Need for a Business Loan?" Value Penguin (https://www.valuepenguin.com/small-business/how-much-collateral-
business-loans#:~:text=Depending%20on%20the%20liquidity%20of,of%20collateral%20you%20can%20provide.)
11. Delinquency Rate on Consumer Loans (https://fred.stlouisfed.org/series/DRCLACBS)
12. "Cryptocurrency Crime and Anti-Money Laundering Report, February 2021" Ciphertrace (https://ciphertrace.com/2020-year-end-cryptocurrency-crime-
and-anti-money-laundering-report/)
13. "The Impact of Crypto Exchange Hacks - 2020" Coinstop (https://coinstop.io/blogs/blog/the-dampened-impact-of-2020-crypto-exchange-hacks)
14. "The KuCoin Hack: What We Know So Far and How the Hackers are Using DeFi Protocols to Launder Stolen Funds" Chainalysis (https://blog.chainalysis.
com/reports/kucoin-hack-2020-defi-uniswap)
15. "KuCoin CEO says insurance covered remaining losses stemming from $285M hack in 2020" Cointelegraph (https://cointelegraph.com/news/kucoin-
ceo-says-insurance-covered-16-of-losses-from-285m-hack-in-2020)
16. “The Crypto Credit Report, Issue 7: Q4 2020” Credmark (https://reports.credmark.com/TheCryptoCreditReport-q4-2020.pdf)
17. $516M/$38B *5.3% = 0.07%; $516M/$38B *60.5% = 0.81%; This results in a range of 0.07%-0.81%.
18. "Crypto lending service Cred announces bankruptcy" Brave New Coin (https://bravenewcoin.com/insights/crypto-lending-service-cred-announces-
bankruptcy)
19. "Cryptocurrency Lending: Lessons from the Cred Bankruptcy" Guidehouse (https://guidehouse.com/insights/financial-crimes/2021/cryptocurrency-
lending-lessons-cred-bankruptcy)
20. "Cryptocurrency Lending: Lessons from the Cred Bankruptcy" Guidehouse (https://guidehouse.com/insights/financial-crimes/2021/cryptocurrency-
lending-lessons-cred-bankruptcy)
21. "Cryptocurrency Crime and Anti-Money Laundering Report, February 2021" Ciphertrace (https://ciphertrace.com/2020-year-end-cryptocurrency-crime-
and-anti-money-laundering-report/)
22. "Cryptocurrency Crime and Anti-Money Laundering Report, February 2021" Ciphertrace (https://ciphertrace.com/2020-year-end-cryptocurrency-crime-
and-anti-money-laundering-report/)
23. "New Jersey Attorney General Issues Cease And Desist Order Against Multi-Billion Dollar Bitcoin Financial Services Platform" Forbes (https://www.forbes.
com/sites/stevenehrlich/2021/07/19/new-jersey-attorney-general-prepares-cease-and-desist-order-against-multi-billion-dollar-bitcoin-financial-
services-platform/?sh=6c14429a21a5)
24. A hurdle rate is also known as the ‘minimum acceptable rate of return,’ which denotes the return an investor would seek on an investment opportunity
in order to be compensated for the level of risk present.

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