Is Crypto Lending Done or Is Better Execution Needed? This is a question that is being asked more urgently after Genesis Global Capital filed for bankruptcy on January 19th. This follows the demise of other prominent crypto lenders such as Celsius Network and Voyager Digital in July 2022, and BlockFi, which filed for Chapter 11 protection in late November 2022.
Unlike many traditional creditors like banks, cryptocurrency lenders do not need to have a buffer of capital or liquidity to help them weather tough times. The collateral they hold – cryptocurrencies – typically suffers from high volatility. Therefore, a plunge in the market could hit cryptocurrency lenders like an avalanche.
Edward Moya, Senior Market Analyst at Oanda, told Cointelegraph: You don’t have to touch FTX to go bankrupt, and that theme may continue for a while for many struggling crypto companies. ”
Echoing these comments, Francesco Melpignano, CEO of CadenaEco, a layer-1 blockchain, expects “contagion from these meltdowns to continue to ripple through this year, and possibly the next few years.” increase.
“It’s a failure of risk management.”
Is crypto trading kaput? This is a question Campbell Harvey, a professor of finance at Duke University, was asked recently. His answer: “I don’t think so.” He believes the business model is still sound and has room for the future of finance.
After all, many of today’s traditional loans are overcollateralized. In other words, the collateral provided may be worth more than the loan, which is unnecessary from the borrower’s perspective and results in an inefficient financial system. Of course, the problem with many cryptocurrency lending transactions is the opposite: insufficient collateral.
But Harvey, co-author of the book, says that applying professional risk management techniques to cryptocurrency lending could lead to a safe compromise. DeFi and the future of finance.
He believes that the failed cryptocurrency companies were not ill-informed, unable to imagine the worst-case market scenarios. “They knew the history of cryptocurrencies,” Harvey told Cointelegraph. Bitcoin (BTC) has fallen more than 50% at least half a dozen times in its short history, and lenders have had to prepare for significant drops. “This is a failure of risk management,” he says Harvey.
Crypto lending firms also failed to diversify their borrower portfolios in number and type. The idea here is that if a hedge fund like 3 Arrows Capital (3AC) goes bust, it shouldn’t bring down its creditors. Genesis Global Trading said he lent 3AC her $2.4 billion — too much for a company of that size to lend to one of her borrowers — and now he’s owing $1.2 billion to the bankrupt fund. I am asking for dollars.
Traditional lenders typically perform due diligence on borrowers and check their business prospects before lending. Collateral is often adjusted based on counterparty risk. However, there is little evidence that this was done among failed cryptocurrency lenders.
What could explain this disregard for basic risk management practices? “It’s easy to start a business when prices are rising,” said Harvey. everyone is making money. It’s easy to put aside worst-case-scenario plans.
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The appeal of crypto loans during a boom is the ability to provide liquidity to individuals and businesses without having to sell their digital assets. Loans can be used for personal or business expenses without creating tax events.
Some say we are in a transitional period. Eylon Aviv, principal at venture capital firm Collider Ventures, who sees crypto lending as “an essential primitive for the growth of the crypto ecosystem,” further explained to Cointelegraph:
“We are currently stuck in a transitional ambiguity between centralized actors. [Genesis, 3AC, Alameda Research] Poorly managed risk and have a scalable solution for failing handshake transactions.and distributed actors [Compound, Aave] It has a resilient but not scalable solution. ”
Why DCG?
Genesis is part of Digital Currency Group (DCG), a venture capital firm founded by Barry Silbert in 2015. This is the closest thing the cryptocurrency industry has to a conglomerate. Its portfolio includes Grayscale Investments, the world’s largest digital asset manager. His CoinDesk for crypto media platforms. Foundry, bitcoin mining business. and London-based cryptocurrency exchange Luno. “What is the fate of DCG is a big question mark on everyone’s minds,” said Moya.
If DCG goes bankrupt, “mass liquidation of assets could shock the crypto market,” said Oanda’s Moya. However, he believes that the market will not necessarily return to its recent lows, despite the DCG playing a major role in the crypto world.
“Much of the bad news in this space is priced and while DCG’s bankruptcy is painful for many cryptocurrency companies, it is not game over for Bitcoin and Ethereum holders.”
“It is rumored that [Genesis] The bankruptcy was part of our plan with our creditors,” Tegan Klein, co-founder and chief business officer of software developer Edge and Node, told Cointelegraph. Whether it is or not, “filing means DCG and Genesis are unlikely to dump their coins on the market, which is one of the reasons these days. [market] The price action is positive,” Klein said.
Klein thinks the DCG may have enough resources to weather the storm. It “depends on how well DCG can ring-fence from Genesis,” Klein added. “DCG has a valuable venture portfolio. Based on that alone, I believe it has a good chance of survival by raising outside capital or transferring some equity to creditors.”
A new wave of lenders
DCG aside, the crypto lending sector could see some changes by the end of 2023. Harvey expects a new wave of crypto lenders to emerge, led by traditional finance (TradFi) companies, including banks, to replace the currently depleted crypto lenders. “Traditional firms with risk management expertise will enter the space and fill the void,” predicted Harvey.
These banks are now telling themselves: “We have the expertise in risk management. These lenders have failed and now we have an opportunity to do it the right way,” said Harvey.
“I totally agree,” added Collider Venture’s Aviv, who believes TradFi could be on board soon. While the main players are centralized entities such as banks and financial companies, Aviv expects more players to use decentralized protocols built on Ethereum and other blockchains. “The winners are consumers and users who will receive better, cheaper and more reliable service.”
Sean Owen, interim CEO of SALT Lending, told Cointelegraph:
Few come out unscathed
SALT Lending built one of the earliest centralized platforms to allow borrowers to use crypto assets as collateral for fiat loans. It is registered with the U.S. Financial Crimes Enforcement Network and has a history of third-party audits. We do not perform credit checks on borrowers, but we do, among other screens, complete anti-money laundering and know-your-customer checks. Still, SALT Lending is not immune from the recent turmoil.
The company froze withdrawals and deposits to its platform in mid-November 2022 because “the collapse of FTX has impacted our business”. announced the end of its acquisition efforts. SALT Lending’s consumer finance license was also recently suspended in California.
This is not published as a notice of bankruptcy. Pausing to deal with dropouts from FTX and ensuring that there are no additional risks for counterparties so that all efforts can be proceeded with the utmost care to avoid bankruptcy. Details soon.
— Shawn Owen (@Shawn_OwenJ) November 15, 2022
The “pause” of withdrawals and deposits, as the company calls it, was still in effect earlier this week. We will be issuing an official statement on this shortly. ”
Yet, amidst all the turmoil, Owen argues that with proper management, cryptocurrency lending and borrowing practices “could be a valuable tool for achieving financial growth and stability.” .
More regulations?
Looking ahead, Owen expects further regulation of the cryptocurrency lending sector, including measures “such as implementing capital and liquidity buffers similar to those required for traditional banks,” Cointelegraph said. told to
Some practices, such as the re-hypothesis, where lenders reuse collateral to secure other loans, may need closer scrutiny. Owen also expects to see increased interest in “cold storage” loans, which “allow borrowers to monitor their funds for the life of the loan.”
Some agree that regulation will be considered. “The DCG fiasco [had] It’s an incredibly detrimental effect for institutional investors and means retail investors will also bear the brunt of it,” Cadena Eco’s Melpignano told Cointelegraph. “I liken this to a one-two punch that gives regulators the ammunition they need to move aggressively against the industry.”
“The bright side is that the industry finally has a clear regulatory catalyst for entering this space. I need to clarify.”
“poison”
It may be too early to ask, but what lessons have been learned from the January 19th bankruptcy filing? It reinforces the narrative that it should be destroyed,” Melpignano said. “While it may be dire for the industry in the short term, on-chain lending protocols were immune to all of the unfortunate events of 2022.” It solidifies the use cases and makes the financial system more transparent and accessible.
“If there’s an important lesson to learn from last year, it’s not to worship or trust ‘thought leaders’ and ‘talkers,'” Aviv said. The industry should pursue “maximum transparency and audibility.”
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“High leverage is the most poisonous drug in the financial industry, not just cryptocurrencies,” Yuwei Yang, chief economist at crypto miner Bitmining, told Cointelegraph. This is perhaps the most important lesson, but it also highlights the need for better risk management protocols.People have learned to ‘relax standards while being hyped’ [up] Market conditions can be catastrophe after the liquidity is withdrawn,” Yang added.
Stronger and ‘better prepared’
Aviv said cryptocurrency lending “strengthens and simplifies both audibility and regulation.” By using on-chain assets, it will survive the crypto winter and become “stronger from the other side.” says. He expects continued innovation in this area, including “new forms of collateral like real-world assets, transparent custodians, and enforceability with new account abstraction primitives.”
Overall, crypto lending remains a useful financial innovation, but its practitioners must embrace some of the cutting edge risk management practices developed by traditional financial firms. , summed it up, “Good idea, but a failure in execution.” “The second wave will be better prepared.”
