The promise of cryptocurrencies as decentralized, uncensorable forms of payment has been seen as a new and innovative solution to the traditional financial market. Piggybacking off of this model, new forms of lending have arisen to provide liquidity and capital to this market.
The majority of crypto-loans operate on a peer-to-peer lending model. Lenders, which offer a variety of services, operate by lending cryptocurrency to customers, or providing them access to capital which is backed by their own crypto-assets.
While cryptocurrencies prices have taken a beating over the past year, this isn’t stopping the lending industry from growing at a rapid rate. In fact, this crypto bear market has been a lightning rod for lenders in the industry.
- Genesis Capital processed $1.1 billion in loans during 2018, $500 million of which came in the year’s fourth quarter alone
- Celsius has originated $630 million loans since July, 2018
- Galaxy Digital, led by former Wall Street executive Michael Novogratz, recently raised $250 million for a credit fund targeting blockchain companies
This market growth, while promising, is also deceiving. As market prices have depreciated, crypto holders have looked for ways to access capital without giving up their crypto-assets. This created a growing group of borrowers that need to access cash but still want to benefit financially from the next bull run.
Therefore, this bear market has generated the need for lending solutions for speculators, but not much else. “I think it’s fair to hypothesize that the majority of crypto-collateralized borrowers are hodlers who are unwilling to sell at what they view is a depressed price, and are looking for a way to do something with the funds they have parked in crypto,” said Canary Data co-founder Galen Moore.
This means extremely limited upside for the lending market as it currently exists. “These speculative financial use cases are unlikely to drive significant growth in the value of crypto markets,” claims Moore.
Other industry experts agree. “The main use cases we’ve seen for crypto-backed loans are typically speculative in nature, such as gaining additional exposure to a digital asset with leverage, shorting a digital asset you believe may be overvalued or taking advantage of arbitrage opportunities,” said David Siemer, CEO of Wave Financial.
Even crypto-lenders like BlockFi are aware that their current customer base consists mostly of speculators and retail investors. “Our main customers are crypto investors that are looking to hold on to their investments in the longer term and access liquidity without selling their crypto,” said Flori Marquez, co-founder and vp of growth. “Most of our customers use our loans to buy real estate, pay taxes and diversify into other investments.”
Because of a small market full of speculators, big lenders might avoid this business until other areas of growth are proven. “For the short term at least, crypto-backed lending likely will be dominated by niche players,” said Gray Sasser, Blockchain and Digital Currency co-chair of the law firm Frost Brown Todd,
Growing beyond speculative lending
If crypto-lending is to grow, it won’t be driven by speculation. Instead, new avenues for growth will have to drive business for lenders.
“We believe the next wave of growth will come from use cases that draw new users into holding and transacting in crypto assets,” noted Galen Moore .
Institutional investors have yet to fully embrace crypto-assets, as volatility and liquidity fears remain a concern. Yet, this is slowly changing, as big media players like Forbes are gearing up for crypto interest by institutions, while JP Morgan just announced the first ever cryptocurrency backed by a bank to be used with institutional clients only.
Crypto-lender BlockFi is excited about what lending in the space can do to increase institutional investment via financial vehicles like derivatives and futures. “Part of this is driven by increased institutional participation from proprietary trading firms, hedge funds and market makers with a net effect of creating stronger liquidity in the asset class,” said Flori Marquez.
Partnerships to build infrastructure
Institutional borrowers are unlikely to enter a market which doesn’t have the proper tools, liquidity, and security to handle large transaction volumes.
The right strategic partnerships create lending opportunities across a wider array of assets, as well as strategic relationships to provide better services to customers. Such partnerships are already well underway.
One of the world’s biggest cryptocurrency exchanges, Binance, recently invested in Cred, a decentralized global lending network. Through this partnership, Binance Coin (BNB) holders can receive cash loans collateralized by BNB and access the $300 million in lending capital Cred offers.
Crypto-lender Nexo partnered with the trading platform Blockport to give users immediate access to loans on the exchange. This comes on the heels of its partnership with wallet service BitGo to provide Nexo customers a means of securing their crypto-assets.
Galaxy Digital invested $52.5 million in BlockFi in a partnership which will help the crypto-lender build on its marketing and business development efforts.
Shoring up regulation
There remains much unknown about the legal and regulatory aspects of this market. As a new lending market, both borrowers and lenders are speculating on how these financial instruments will play out legally.
Without proper regulation, there are more regulatory questions than answers, even for industry legal experts. “Article 9 of the Uniform Commercial Code generally governs how you perfect a lien,” notes Gray Sasser. “I don’t know of any state that has updated it’s statute to govern how you perfect a lien on crypto.” This regulatory concern has kept major financial institutions out of crypto-lending.
Currently, each state in the US legislates on smart contracts, the backbone of lending in the cryptocurrency industry, although some experts claim this attempt at clarity could impede the industry in the end.
If these legal issues are eventually solved, the potential of crypto-lending, and the technology it brings to the financial industry, could be quite important from a legal and usability perspective. This stems from smart contract technology, which, “provides a potentially elegant solution to perfecting a security interest in collateral, as the contract could be written such that if the borrower does not make a payment by a certain date the collateral could automatically be transferred to the lender’s wallet,” predicts Sasser.
Extending credit to new markets
The censorship-resistant property of blockchains provides opportunities to extend credit to new markets more easily than traditional lending. This ideology also applies to lending in regions where access to capital is difficult to come by.
Recently, crypto-lender Karma partnered with Thomson Reuters in a program to provide liquidity to SMEs in the Middle East and North Africa, both regions where credit can be hard to come by for small businesses.
Extending out to new markets in this way can provide a much-needed spark to the industry, and is an exciting prospect for crypto-lenders. “In the near future, we’ll be able to extend credit products in countries where previously people had no access to simple things like a secure savings account,” noted BlockFi’s Marquez.