Is crypto lending dead, or does it just need better execution? That’s a question asked with more urgency in the wake of Genesis Global Capital Jan. 19
Is crypto lending dead, or does it just need better execution? That’s a question asked with more urgency in the wake of Genesis Global Capital Jan. 19 bankruptcy filing. That, in turn, followed the demise of other prominent crypto lenders, including Celsius Network and Voyager Digital in July 2022, and BlockFi, which filed for Chapter 11 bankruptcy protection in late November 2022.
Unlike many traditional creditors, like banks, cryptocurrency lenders aren’t required to have capital or liquidity buffers to help them weather hard times. The collateral they hold — cryptocurrencies — typically suffer from high volatility; thus, when markets plunge, it can hit crypto lenders like an avalanche.
Edward Moya, a senior market analyst at Oanda, told Cointelegraph, “The demise of crypto lender Genesis reminded traders that there still needs to be a lot more cleaning up in the cryptoverse. You don’t need exposure to FTX to go under and that theme might continue for a while for many distressed crypto companies.”
Echoing those comments, Francesco Melpignano, CEO of Kadena Eco, a layer-1 blockchain, expects to see “contagion from these meltdowns continue to reverberate this year and maybe the next few.”
‘It’s a failure of risk management’
Is crypto lending kaputt? It’s a question Duke University finance professor Campbell Harvey was asked lately. His answer: “I don’t think so.” He believes the business model remains sound and there is a place for it in future finance.
Many traditional loans today are overcollateralized, after all. That is, the collateral provided may be worth more than the loan, which is unnecessary from a borrower’s point of view and makes for a less efficient financial system. Of course, the problem with many crypto lending transactions is the opposite — they are undercollateralized.
However, a safe middle ground could be reached if one applies professional risk management practices to crypto lending, said Harvey, co-author of the book, DeFi and the Future of Finance.
He believes that those bankrupt crypto firms failed to plan for worst-case market scenarios and it wasn’t for lack of knowledge. “Those people knew crypto’s history,” Harvey told Cointelegraph. Bitcoin (BTC) has fallen more than 50% at least a half-dozen times in its short history and lenders should have made provisions for significant drawdowns — and then some. “It’s a failure of risk management,” said Harvey.
Crypto lending firms also failed to diversify their borrower portfolios by number and type. The idea here is that if a hedge fund like Three Arrows Capital (3AC) collapses, it shouldn’t bring down its creditors with it. Genesis Global Trading lent $2.4 billion to 3AC — far too much for a firm its size to lend to a single borrower — and presently has a claim for $1.2 billion against the now-insolvent fund.
A traditional lender typically performs due diligence on a borrower to check out its business prospects before lending it money, with collateral often adjusted based on counterparty risk. There is little evidence this was done among failed crypto lenders, however.
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 simple to push worst-case-scenario planning to the side.
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The appeal of crypto loans in good times is that they offer individuals or businesses liquidity without having to sell their digital assets. Loans can be used for personal or business expenses without creating a tax event.
Some suggest we are now in a transitional time. Eylon Aviv, a principal at venture capital firm Collider Ventures, views cryptocurrency lending as an “essential primitive for the growth of the crypto ecosystem,” but as he further explained to Cointelegraph:
“We are currently caught in transitional limbo between centralized actors [Genesis, 3AC, Alameda Research] that have a scalable solution with poor risk management and handshake deals that go belly-up; and decentralized actors [Compound, Aave] that have a resilient but non-scalable solution.”
Wherefore DCG?
Genesis is part of the Digital Currency Group (DCG), a venture capital company founded by Barry Silbert in 2015. It’s the closest thing that the crypto industry has to a conglomerate. Its portfolio includes Grayscale Investments, the world’s largest digital asset manager; CoinDesk, a crypto media platform; Foundry, a Bitcoin mining operation; and Luno, a London-based crypto exchange. “One big question mark on everyone’s mind is what will be DCG’s fate?” said Moya.
If DCG were to go bankrupt, “a mass liquidation of assets could deliver a shock to crypto markets,” said Moya of…
cointelegraph.com