There are more, but these once-highly respected firms represent some of the most embarrassing upsets of this year. They all have something in common: loans against digital assets. What went wrong? And can centralized crypto lenders ever regain market share and trust?
Crypto lending is the process of linking people who have excess crypto and want to earn yield on their money by depositing it on a platform, which lends those funds out to people who want to borrow crypto and are willing to leave collateral and pay interest to take out a loan.
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In other words? “Crypto lending is essentially banking – for the crypto world,” as Reuters put it early this year. And as Lisa of “The Simpsons” once said, most comparisons are problematic.
Before the market downturn, lending was big business for the crypto industry. Celsius, sometimes called a “neobank,” accrued over $11 billion assets on its platform. BlockFi, which recently filed for Chapter 11 bankruptcy protection, had been valued at $3 billion just last year. Genesis, a Wall Street-facing firm owned by CoinDesk’s parent company, Digital Currency Group, had $2.8 billion in active loans at the end of the third quarter of this year (down from $11.1 billion the same quarter a year earlier).
Crypto lenders grew so large, in part, by offering high yields to depositors. While a bank account may earn less than 1% in interest, some crypto lenders offered returns as high as 20%. Even at the frothiest moment of the bull run, people were curious about where those returns came from.
Like banks, crypto lenders were supposed to generate profits from deposits by loaning that money out. Borrowers would pay typically between 5%-10% in fees, and crypto lenders like Celsius were supposed to make profit on the spread between interest payments paid to depositors and fees earned by borrowers.
As we learned this year, even when things go well for crypto lenders they can quickly turn south. Volatility in the markets put pressure on crypto lenders’ normal businesses – including shrinking the number of depositors and borrowers. Faced with increasing withdrawals, many were found to have been illiquid or insolvent.
But we also learned that lenders were engaging in potentially illegal behavior by re-loaning (or rehypothicating) funds they shouldn’t have, or making generally ill-advised bets. In a filing, Vermont’s securities regulator said Celsius at times resembled a Ponzi scheme in that it relied on attracting new investors to pay out old ones. It did that by offering rewards programs tied to its CEL token and using its marketing budget to pay yields well above standard. (The latter practice also happened at FTX’s “earn” program and the Anchor protocol, a decentralized lender built on Terra, another of 2022’s big failures.)
Of course, not all crypto lenders are created equal and not all of these firms went broke for the same reasons. Nor is there any reason to suspect other crypto lenders necessarily abused client funds. Because these are private companies by and large, it’s also not totally clear as to what went wrong.
There are increasing calls to regulate crypto, which could be a good thing for the industry. Although Federal Deposit Insurance Corporation (FDIC) insurance (which guarantees up to $250,000 in bank deposits) is unlikely to be approved for crypto lenders, there could be increased regulatory supervision to make sure these companies better manage deposits to stay solvent.
It’s worth also noting that the crypto lenders grouped under the decentralized finance (DeFi) sub-economy fared better. These platforms generally require users to overcollateralize their loans, and they prevent human actors from taking possession of deposits because they’re non-custodial. While crypto lenders can make sweetheart deals with supposedly trustworthy individuals, in DeFi everyone plays by the same rules.
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