The crypto lending industry, which has given borrowers billions of dollars in just the past few years, is facing its biggest crisis yet as some of its leading companies collapse.
Genesis Global Capital, which has committed $130 billion in 2021, filed for bankruptcy last week and joined BlockFi Inc., Celsius Network and Voyager Digital among the companies that have failed, leaving investors frustrated and regulators uneasy.
- The bankruptcy of Genesis dealt another blow to cryptocurrency lending platforms.
- Several crypto-loan companies went bankrupt last year, prompting increased scrutiny by regulators.
- The interconnectedness of the crypto industry exacerbates financial problems, causing contagion that can lead to widespread damage.
The crypto lending industry is facing challenges
Genesis was the largest unsecured creditor of failed trading platform FTX, whose former CEO, Sam Bankman-Fried, is facing fraud charges. Due to the collapse of FTX, Genesis fell into financial trouble, forcing crypto exchange Gemini to terminate its lending product in which Genesis was a lender.
”I won’t be surprised if this is the end of the guys [lending] programs that we’ve seen over the past few years,” said prominent crypto critic and computer scientist Molly White. “They promised high returns for relatively low risk, and in the end proved that it was not sustainable.”
It’s not the first time critics have indulged in schadenfreude at the expense of the crypto industry. Some analysts have practically built careers predicting the imminent demise of a system deliberately built to exist outside of the traditional banking system. However, this time seems different as it is not only the investors that have been harmed, but also the quasi-banking companies that have provided the rocket fuel to fuel growth.
Moreover, the SEC has been cracking down on cryptocurrency lending products by calling them securities. The financial watchdog even ordered BlockFi to pay a $100 million fine and forced Coinbase to cancel its cryptocurrency lending program. He recently fined cryptocurrency Nexo for launching his product.
What do investors need to understand?
Crypto lending platforms offer attractive returns, and investors invest their capital in them. Typically, interest rates on crypto lending platforms can go up to 20% APY. By comparison, the national average yield for savings accounts is 0.23% annual percentage yield (APY).
Crypto assets have both advantages and disadvantages. They are ideal collateral because they can be cashed out at any time (unlike real estate or yachts). However, they carry a high level of volatility, which is why the amount of collateral must be greater than the amount that is to be borrowed. Crypto lenders didn’t follow the rule and “many crypto lenders were lending to each other,” White said.
If the loan-to-value ratio (the amount of collateral versus the amount borrowed) isn’t high enough, the value of the collateral can fall below the value of the loan faster than it can be sold, said crypto expert and editor of “Crypto is Macro Now,” a newsletter, Noelle Acheson .
“When loans are not fully collateralized (with less than 100% collateral posted), the risk is obviously much higher,” she said.
The bottom line
The crypto lending industry is facing challenges, but that doesn’t mean decentralized finance or DeFi will die out as developers work to make crypto lending more risk-averse and efficient. Acheson believes that trust has been damaged, but not completely destroyed, and will recover as new processes are introduced and new players enter the market.
Regulators will play a key role in determining where checks and balances should be placed. “Increasing regulatory oversight will imbue emerging market leaders in this segment with robust disclosure and risk management practices,” she said.
(Vinamrata Chaturvedi contributed to this article.)