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Genesis Capital’s fall might transform crypto lending — not bury it
TradFi firms with expertise in risk management may soon “fill the void” left by bankrupt crypto lenders, a Duke finance professor predicts.
Is crypto lending dead, or does it just need better execution? That’s a question asked with more urgency in the wake of Genesis Global Capital Jan. 19 bankruptcy filing. That, in turn, followed the demise of other prominent 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, like banks, cryptocurrency lenders aren’t required to have capital or liquidity buffers to help them weather hard times. The collateral they hold — cryptocurrencies — typically suffer from high volatility; thus, when markets plunge, it can hit crypto lenders like an avalanche.
Edward Moya, a senior market analyst at Oanda, told Cointelegraph, “The demise of crypto lender Genesis reminded traders that there still needs to be a lot more cleaning up in the cryptoverse. You don’t need exposure to FTX to go under and that theme might continue for a while for many distressed crypto companies.”
Echoing those comments, Francesco Melpignano, CEO of Kadena Eco, a layer-1 blockchain, expects to see “contagion from these meltdowns continue to reverberate this year and maybe the next few.”
Is crypto lending kaputt? It’s a question Duke University finance professor Campbell Harvey was asked lately. His answer: “I don’t think so.” He believes the business model remains sound and there is a place for it in future finance.
Many traditional loans today are overcollateralized, after all. That is, the collateral provided may be worth more than the loan, which is unnecessary from a borrower’s point of view and makes for a less efficient financial system. Of course, the problem with many crypto lending transactions is the opposite — they are undercollateralized.
However, a safe middle ground could be reached if one applies professional risk management practices to crypto lending, said Harvey, co-author of the book, DeFi and the Future of Finance.
He believes that those bankrupt crypto firms failed to plan for worst-case market scenarios and it wasn’t for lack of knowledge. “Those people knew crypto’s history,” Harvey told Cointelegraph. Bitcoin has fallen more than 50% at least a half-dozen times in its short history and lenders should have made provisions for significant drawdowns — and then some. “It’s a failure of risk management,” said Harvey.
Genesis is part of the Digital Currency Group (DCG), a venture capital company founded by Barry Silbert in 2015. It’s the closest thing that the crypto industry has to a conglomerate. Its portfolio includes Grayscale Investments, the world’s largest digital asset manager; CoinDesk, a crypto media platform; Foundry, a Bitcoin mining operation; and Luno, a London-based crypto exchange. “One big question mark on everyone’s mind is what will be DCG’s fate?” said Moya.
DCG aside, the crypto lending sector can probably expect some changes before the end of 2023. Harvey anticipates a new wave of crypto lenders emerging, spearheaded by traditional finance (TradFi) firms, including banks, to replace the now depleted ranks of crypto lenders. “Traditional firms with expertise in risk management will enter the space and fill the void,” Harvey predicted.
SALT Lending built one of the earliest centralized platforms to allow borrowers to use crypto assets as collateral for fiat loans. It has registered with the United States Financial Crimes Enforcement Network and has a history of third-party audits. While it doesn’t conduct credit checks on borrowers, it performs full Anti-Money Laundering and Know Your Customer verification, among other screenings. Still, SALT Lending hasn’t come out unscathed from the recent turmoil.
Looking ahead, Owen expects more regulation of the cryptocurrency lending sector, including measures “such as the implementation of capital and liquidity buffers, similar to those required of traditional banks,” he told Cointelegraph.
Some practices like rehypothecation, where a lender re-uses collateral to secure other loans, may come in for closer scrutiny. Owen also expects to see more interest in “cold storage” lending, “where borrowers are able to monitor their funds throughout the duration of their loan.”
Others agree that regulation will be on the table. “DCG’s debacle has [had] an incredibly detrimental effect on institutional investors, which also means that retail investors will feel the brunt of it,” Melpignano of Kadena Eco told Cointelegraph. “I would liken it to a one-two punch that will give regulators the ammunition they need to move aggressively against the industry.”