Cryptocurrency company Genesis Capital’s downfall could transform crypto loans. A Duke finance professor predicts that TradFi firms with expertise in risk management may soon ‘fill the gap’ left by bankrupt crypto lenders.
“There still needs to be a lot more clean-up in the cryptocurrency world”
Is crypto credit dead or does it just need a better app? That’s a more pressing question after Genesis Global Capital filed for bankruptcy on January 19. This followed the expiration of other leading 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 such as banks, cryptocurrency lenders do not need to have capital or liquidity buffers to help them get through tough times. The collateral (cryptocurrencies) they hold typically suffer from high volatility. Therefore, when markets fall, it can hit crypto lenders like an avalanche. Edward Moya, a senior market analyst at Oanda, says:
The death of crypto lender Genesis has reminded traders that there is still a lot more cleaning to be done in the crypto world. You don’t need to have invested in FTX to fail, and that theme may continue for a while for many troubled crypto companies.
Francesco Melpignano, CEO of Tier 1 Blockchain Kadena Eco, echoes these comments, expecting to see “the contagion caused by these meltdowns will continue to resonate this year and perhaps in the next few years.”
‘Failure of risk management’
Crypto credit closed? That’s a question recently asked to Duke University finance professor Campbell Harvey. His reply: “I don’t think so.” Harvey believes the business model remains intact and there is room for it in future finances. After all, many traditional loans today are overcollateralized. That is, the collateral may be more valuable than the loan, which is unnecessary from the borrower’s point of view. It also makes the financial system less efficient. Of course, the problem with many crypto lending transactions is that it’s the other way around.
However, Harvey, co-author of DeFi and the Future of Finance, says that a secure middle ground can be reached if professional risk management practices are applied to crypto loans. He believes that bankrupt cryptocurrency firms fail to plan for worst-case market scenarios, and it’s not because of a lack of knowledge. “These people knew the history of crypto,” Harvey explains. cryptocoin.comAs you follow, Bitcoin has dropped more than 50% at least half a dozen times in its short history. “This is a failure of risk management,” Harvey says.
Why is DCG important to the cryptocurrency market?
Genesis is part of the Digital Currency Group (DCG), a venture capital firm founded in 2015 by Barry Silbert. This is the closest feature of the crypto industry to a conglomerate. Grayscale Investments, the world’s largest digital asset manager in its portfolio; CoinDesk, a crypto media platform; Foundry, a Bitcoin mining operation; and Luno, a London-based crypto exchange. Edward Moya, “One big question mark on everyone’s mind is what will be the fate of DCG?” says.
Moya states that if DCG goes bankrupt, the mass liquidation of assets could create a shock in the crypto market. However, he believes that while DCG plays a large role in the crypto world, the market may not necessarily see a return to recent lows. In this regard, Moya said, “Most of the bad news for space has priced in, and a DCG bankruptcy would be painful for many crypto companies. But for Bitcoin and Ethereum holders, it’s not game over,” he says.
“The Genesis bankruptcy is said to be part of a plot with creditors,” says Tegan Kline, co-founder and chief operating officer of software development firm Edge and Node. “Whether or not that is the case, the filing means that DCG and Genesis are unlikely to crash into the market, and this is one of the reasons the recent market movement has been positive,” explains Kline. Kline thinks DCG may have enough resources to fend off the storm.
A new wave of cryptocurrency lenders
Leaving DCG aside, the crypto lending industry can probably expect some changes before the end of 2023. Harvey predicts that a new wave of crypto lenders will emerge to replace the currently depleted crypto lenders, spearheaded by traditional finance (TradFi) firms, including banks. “Traditional firms with expertise in risk management will enter the field and fill the gap,” Harvey predicts.
“I totally agree,” said Aviv of Collider Venture, who believes that TradFi may soon be available. It is on its way to competition for the highly lucrative lending market,” he adds. The main players will be centralized institutions such as banks and financial companies. However, Aviv expects to see more players with decentralized protocols built on top of Ethereum and other blockchains.
“The emergence of traditional finance firms in the crypto loan market is a development we see coming and demonstrates the growing mainstream acceptance and potential of this innovative industry,” said Shawn Owen, interim CEO of SALT Lending.
Few emerge unharmed
SALT Lending has created one of the oldest centralized platforms to allow borrowers to use crypto assets as collateral for fiat loans. Registered with the US Financial Crimes Enforcement Network and has a third-party audit trail. While it does not perform credit checks on borrowers, it does perform full Anti-Money Laundering and Know Your Customer verification, among other scans. Still, SALT Lending was unable to emerge unscathed from the recent turmoil.
The firm froze withdrawals and deposits to its platform in mid-November 2022, saying that “FTX’s collapse affected our business.” Meanwhile, crypto securities firm BnkToTheFuture announced that it is ending efforts to acquire parent company SALT Blockchain. SALT Lending’s consumer loan license was also recently suspended in California.
In the company’s terms, the ‘pause’ in withdrawals and deposits was still in effect earlier this week. However, a Salt Lending source said, “We are in the final stages of an out-of-court restructuring that will allow us to continue with our normal business operations. We will have an official statement on this very soon,” he says. Yet, in the midst of all this confusion, Shawn Owen insists that with proper management, the practice of lending and borrowing crypto assets “can be a valuable tool for achieving financial growth and stability.”
More regulation coming in the cryptocurrency world?
As Shawn Owen looks to the future, he says he expects more regulation in the cryptocurrency lending industry, including measures ‘like the implementation of capital and liquidity buffers similar to those required by traditional banks’. Owen also expects to see more interest in a ‘cold storage’ loan, where borrowers can monitor their funds throughout the loan term.
Others agree that regulation will be on the table. Melpignano of Kadena Eco said, “DCG’s collapse had an incredibly damaging effect on institutional investors. This means that individual investors will feel the burden of this. “I liken it to a punch or two that will give regulators the ammo they need to act aggressively against the industry.”
‘Toxic medicine’
Maybe it’s early to ask, but what lessons were learned from the January 19 bankruptcy filing? The Genesis bankruptcy “reinforces the narrative that crypto loans need to happen in a transparent on-chain manner,” Melpignano says. He states that no matter how dire the situation for the industry in the short term, on-chain lending protocols are not affected by all the unfortunate events of 2022. According to him, this solidifies the use case of decentralized finance, a more transparent and accessible financial system.
“If there is one fundamental lesson to be learned from last year, it is not to trust ‘thought leaders’ and ‘talking heads’. The industry must push for maximum transparency and auditability,” he says. “High leverage is the most toxic drug not only in crypto but also in finance,” explains Youwei Yang, chief economist at crypto miner Bit Mining. This is probably the most important lesson to be learned. But the need for better risk management protocols is now also clear. “People have learned that easing standards in exaggerated market conditions can be a disaster after liquidity is withdrawn,” Yang adds.
Cryptocurrency market will be stronger and more prepared
Aviv says crypto lending will “survive the crypto winter and emerge stronger on the other hand” by using on-chain assets that “enforce and simplify both auditability and regulation.” Continuous innovation awaits in this area, including ‘new forms of collateral such as real-world assets, viability through transparent protectors and new account abstraction primitives’.
Overall, crypto lending remains a useful financial innovation. But its practitioners need to adopt some cutting-edge risk management practices developed by traditional financial firms. Harvey of Duke University said, “The idea is good, but the implementation has failed. The second wave will be better prepared,” he summarizes.
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