What crisis? High-stakes crypto lending looks set to stay

by Arthur · September 20, 2022

LONDON/WASHINGTON, Sept 21 (Reuters) – On May 11, Scott Odell, an analyst at UK crypto lender Blockchain.com, sent a direct message to Edward Zhao of Three Arrows Capital requesting that the Singapore hedge fund repay at least part of a loan of 270 million dollars. .

Three Arrows had just taken a hit from the collapse of the cryptocurrency Terra, raising doubts about its ability to repay. That was a concern for Blockchain.com since it had not taken collateral to secure the loan, court documents show.

“This is time sensitive, so let’s sort out your availability,” Odell said of the refund.

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Zhao seemed lost for words.

“Yeah,” he replied.

“ohh”

“hmm”

Three Arrows filed for bankruptcy in July and Blockchain.com told Reuters it had yet to recoup a cent of the loan. The text exchange is among the declaration documents submitted by liquidators as part of the hedge fund’s liquidation proceedings. read more

Three Arrows did not respond to requests for comment. Odell declined to comment, while Reuters was unable to reach Zhao.

The loan was part of an opaque web of unsecured lending between crypto companies that left the industry exposed when cryptocurrency prices crashed 50% earlier this year, according to a Reuters review of bankruptcy court and regulatory filings, and interviews with about 20 executives and experts.

Institutional crypto lending involves the lending of cryptocurrencies as well as cash in return for a return. By waiving the requirement for the borrower to provide collateral – such as stocks, bonds or, more commonly, other crypto tokens – lenders can charge higher prices and increase profits, while borrowers can generate cash quickly.

Blockchain.com has since largely ended its unsecured lending business, which had represented 10% of its revenue, chief business officer Lane Kasselman told Reuters. “We are not willing to engage in the same level of risk,” he said, although he added that the company would still offer “extremely limited” unsecured loans to top customers under certain conditions.

Unsecured lending has become common in the crypto industry, according to the review of records and the interviews. Despite the recent shakeout, many industry insiders said the practice is likely to continue and could even grow.

Alex Birry, head of financial institutions analytics at S&P Global Ratings, said the crypto industry is actually seeing a trend toward unsecured lending. The fact that crypto was a “concentrated ecosystem” increased the risk of contagion across the sector, he added.

“So if you’re only lending to people who operate in this ecosystem, and especially if the number of those counterparties is relatively limited, yes, you’re going to see events like the one we’ve just seen,” he said of the summer collapse of lenders.

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CRYPTO BOOM AND BUST

Cryptolenders, the de facto banks of the crypto world, flourished during the pandemic, attracting private customers with double-digit interest rates in return for their cryptocurrency deposits. On the flip side, institutional investors such as hedge funds who wanted to make leveraged bets paid higher prices to borrow the funds from lenders, who profited from the difference. read more

Crypto lenders are not required to hold capital or liquidity buffers like traditional lenders, and some found themselves exposed as a lack of collateral forced them – and their customers – to take big losses. read more

Voyager Digital, which became one of the biggest casualties of the summer when it filed for bankruptcy in July, provides a window into the rapid growth of unsecured crypto loans.

The New Jersey-based lender’s crypto loan book grew from $380 million in March 2021 to about $2 billion in March 2022, and it took collateral for just 11% of that $2 billion, the company’s regulatory filings show.

The lender collapsed after Three Arrows defaulted on a crypto loan worth more than $650 million at the time. While neither party has said whether that loan was unsecured, Voyager did not report liquidating any collateral over the default, while Three Arrows listed its collateral status with Voyager as “unknown,” the companies’ bankruptcy filings show. read more

Voyager declined to comment for this article.

Rival lender Celsius Network, which also filed for bankruptcy in July, also offered unsecured loans, court documents show, although Reuters could not determine the extent.

Since most loans are private, the amount of unsecured lending in the industry is unknown, and even those involved in the business give completely different estimates.

Crypto research firm Arkham Intelligence put the number in the $10 billion range, for example, while crypto lender TrueFi said at least $25 billion.

Antoni Trenchev, co-founder of crypto lender Nexo, said his company had turned down requests from funds and traders asking for unsecured loans. He estimated unsecured lending across the industry “probably in the hundreds of billions of dollars”.

BULLISH ON LOANS

While Blockchain.com has largely retreated from unsecured lending, many crypto borrowers remain wary of the practice.

Most of the 11 lenders interviewed by Reuters said they would still provide unsecured loans, although they did not specify how much of their loan book this would be.

Joe Hickey, global head of trading at BlockFi, a major crypto lender, said they would continue their practice of offering unsecured loans only to top customers for whom they had seen audited financials.

A third of BlockFi’s $1.8 billion in loans were unsecured as of June 30, according to the company, which was bailed out by crypto exchange FTX in July as it cited losses on a loan and increased customer withdrawals. read more

“I think our risk management process was one of the things that saved us from having major credit events,” Hickey said.

Furthermore, a growing number of smaller, peer-to-peer lending platforms are seeking to fill the gap left by the exit of centralized players such as Voyager and Celsius.

Sid Powell, co-founder and CEO of unsecured crypto lending platform Maple, said institutional crypto lenders were more cautious after Three Arrows’ insolvency, but conditions have since normalized and lenders are now comfortable lending unsecured again.

Executives at two other peer-to-peer lenders, TrueFi and Atlendis, said they had seen an increase in demand as market makers continue to seek unsecured loans.

Brent Xu, CEO of Umee, another peer-to-peer platform, said the crypto industry would learn from its mistakes and that lenders would do better by extending loans to a more diverse range of crypto companies.

It would include, for example, firms looking to make acquisitions or finance expansion, he added, rather than focusing on those making leveraged trades on crypto prices.

“I am very positive about the future of unsecured loans and lending,” Xu said.

MILLION DOLLARS BITCOIN

To be sure, many crypto loans are secured. Even then, the security is often in the form of volatile tokens that can quickly lose value.

BlockFi sub-collateralized a loan to Three Arrows but still lost $80 million on it, the lender’s CEO Zac Prince said in a tweet in July. BlockFi said the loan to the hedge fund was secured by a basket of crypto tokens and shares in a bitcoin trust.

“A more traditional lender would probably want more than full collateral on a crypto-backed loan, because on any given day the collateral value can fluctuate by 20% or more,” said Daniel Besikof, a partner at Loeb & Loeb who works in bankruptcies.

“Lending a million dollars against a million dollars of bitcoin is riskier than lending against more traditional, stable collateral.”