The rise of crypto loans: should traditional lenders be worried?

Inno­va­tions with­in the decen­tralised finance (DeFi) space have already shown how util­is­ing blockchain tech­nol­o­gy for finan­cial ser­vices can offer an alter­na­tive to con­ven­tion­al finance prod­ucts. From insur­ance to sav­ings accounts and secu­ri­ties trad­ing, DeFi tech­nol­o­gy has opened up a vari­ety of ser­vices that fin­tech star­tups can offer.

One of the fastest grow­ing areas of DeFi is cryp­tocur­ren­cy-backed loans. Just as tra­di­tion­al finan­cial insti­tu­tions offer secured fiat cur­ren­cy loans against a car or house, a cryp­to loan is secured using cryp­tocur­ren­cy as col­lat­er­al.

Unlike con­ven­tion­al loan prod­ucts, cryp­tocur­ren­cy-backed loans use smart blockchain con­tracts to gov­ern the loan and can­not be altered by a third par­ty.

“Cryp­to investors are often praised for tak­ing the HODL (hold on for dear life) approach to invest­ing. But the man­ner in which one HODLs can vary great­ly,” explains Nicole DeCi­c­co, founder of cryp­tocur­ren­cy con­sult­ing firm Cryp­to­Con­sultz.

“‘Hodlers’ often con­sid­er and par­tic­i­pate in cryp­to lend­ing and stak­ing plat­forms in order to earn inter­est on their invest­ments. While not with­out risk, the ben­e­fits of such plat­forms are unar­guably impres­sive to say the least.”

Complex ecosystem

It’s not dif­fi­cult to see why bor­row­ers are increas­ing­ly inter­est­ed in cryp­to loans, thanks to the abil­i­ty to gain access to rel­a­tive­ly low inter­est rates, prac­ti­cal­ly instant fund­ing and no cred­it check. Data from Coin­Mar­ket­Cap shows that the glob­al mar­ket cap­i­tal­i­sa­tion of all cryp­to assets, includ­ing bit­coin and ethereum, is close to $1.8tn, illus­trat­ing the major mar­ket poten­tial for cryp­to loans.

For cryp­to whales (peo­ple who have mil­lions upon mil­lions of cryp­to in their dig­i­tal wal­lets), lend­ing their cryp­to through online plat­forms can pro­vide them with fiat cur­ren­cy from inter­est, with­out fac­ing the same lev­el of tax­es that sell­ing their cryp­to could result in.

How­ev­er, like many finan­cial prod­ucts, tak­ing out a cryp­to loan is not with­out its risks. Bit­coin and oth­er cryp­tocur­ren­cies are well known for their high volatil­i­ty, and with­in days can increase sub­stan­tial­ly or col­lapse. Due to this inher­ent insta­bil­i­ty, cryp­to loans typ­i­cal­ly have an extreme­ly low loan-to-val­ue (LTV) ratio and require bor­row­ers to pro­vide addi­tion­al cap­i­tal if the cryp­to price falls below a pre­set val­ue.

“It’s imper­a­tive that those inter­est­ed in using cryp­to loans under­stand the rules of the smart con­tract and scru­ti­nise the fine print just as one would a tra­di­tion­al loan,” adds DeCi­c­co. 

Crypto loans face regulatory hurdles

Although many reg­u­la­tors around the world are begin­ning to set out cryp­tocur­ren­cy reg­u­la­tions, a lack of clear and com­pre­hen­sive guide­lines has cre­at­ed a dif­fi­cult oper­at­ing envi­ron­ment for many cryp­to loan plat­forms. In Feb­ru­ary of this year, a sub­sidiary of major cryp­to plat­form Block­Fi called Block­Fi Lend­ing LLC was alleged by the US Secu­ri­ties and Exchange Com­mis­sion (SEC) to be offer­ing a lend­ing prod­uct that was ille­gal.

Accord­ing to the SEC, Block­Fi Lend­ing LLC did not reg­is­ter the Block­Fi Inter­est Account lend­ing prod­uct as a secu­ri­ty and also failed to accu­rate­ly rep­re­sent the product’s risks. Although the cryp­to plat­form did not agree with the alle­ga­tions pre­sent­ed by the SEC, they did approve pay­ment of a $100m set­tle­ment charge, which is the largest penal­ty ever for a cryp­to enforce­ment action.

“One main rea­son for scruti­ny focused on lend­ing rather than trad­ing in gen­er­al is that lend­ing is mul­ti­fac­eted. With­out clear reg­u­la­tion, cryp­to lend­ing com­pa­nies are not held to the same stan­dards of report­ing. There is very lit­tle dis­clo­sure about what is going on behind the scenes,” adds DeCi­c­co.

From a reg­u­la­to­ry per­spec­tive, more is need­ed for these plat­forms to thrive. At the moment, cryp­to lend­ing plat­forms are not required to meet cer­tain bank­ing reg­u­la­tions and are also not cov­ered by any form of deposit pro­tec­tion or Finan­cial Ser­vices Com­pen­sa­tion Scheme. This leads to cus­tomers hav­ing lit­tle recourse if the plat­form were to fail or face liq­uid­i­ty chal­lenges.

Is it a disruptive platform?

A num­ber of firms have sprung up in recent years to offer cryp­to loans through a cen­tral com­pa­ny. Firms like Block­Fi, Cel­sius, YouHodler and Coin­Loan pro­vide loans in the cen­tralised finance (CeFi) space and offer cus­tomers sim­i­lar ben­e­fits to DeFi but with the cus­tomer expe­ri­ence and strong secu­ri­ty of con­ven­tion­al finan­cial com­pa­nies.

In a short amount of time, many plat­forms have report­ed extreme­ly high growth when it comes to cryp­to loans. For exam­ple, Coin­Loan saw cryp­to-backed loans increase by 2000% in 2021, mir­ror­ing the strong year for cryp­to in gen­er­al. As these plat­forms con­tin­ue to grow, are large finan­cial insti­tu­tions at risk of los­ing cus­tomers to inno­v­a­tive cryp­to loans?

For Ilya Volkov, CEO and co-founder of cryp­tocur­ren­cy exchange and lender, YouHodler, the rise of cryp­to-based lend­ing does not present any risks for tra­di­tion­al lend­ing mar­kets.

“Tech­ni­cal­ly speak­ing, cryp­to-based lend­ing is a form of tra­di­tion­al pawn­shop loans, where cryp­to is used as a form of col­lat­er­al [pledge]. That means that we speak not about dis­rup­tion or com­pe­ti­tion with lega­cy busi­ness­es, but about some kind of an exten­sion to them,” he says.

Com­pared to tra­di­tion­al finance organ­i­sa­tions that date back often hun­dreds of years, there’s no ques­tion that cryp­to lend­ing is still a new indus­try. But as cryp­to adop­tion grows, with a sur­vey by research firm Piplsay find­ing that 49% of mil­len­ni­als own cryp­tocur­ren­cy, it may not be long before cus­tomers and high-street banks con­sid­er cryp­to loans.

“At this moment it’s a hus­tle to bor­row mon­ey from a bank,” says Alex Fal­iushin, CEO and founder at cryp­to lend­ing plat­form, Coin­Loan. “Cryp­to loans allow any­one with funds to loan mon­ey instant­ly and to be a lender as well, giv­ing healthy returns in com­par­i­son to hold­ing mon­ey in the bank.”

The account open­ing process at an exchange or cryp­to lend­ing plat­form is also usu­al­ly sim­pler and more inno­v­a­tive when com­pared to bank accounts.

It may be some time before cryp­to loans reach their full poten­tial and peo­ple feel com­fort­able embrac­ing a rel­a­tive­ly new finan­cial prod­uct. How­ev­er, the ben­e­fits for cryp­to own­ers in secur­ing a loan against their hold­ing could be too attrac­tive to turn down.

“In time we will see more and more ways to use cryp­to lend­ing plat­forms to have the best util­i­ty for your mon­ey and the use cas­es will devel­op in time with the indus­try,” con­cludes Fal­iushin.