Remember in my previous piece criticizing Ray Dalio’s stance on the eventual regulatory ban of competing with fiat currencies cryptos we discussed how important it is for the latter to grow its all-inclusive financial infrastructure? The basics of that infrastructure must entail a self-sufficient and self-reliant remittance, acceptance and extensive shopping and payment networks with clear and straightforward interfaces. But the contemporary rapid pace of blockchain and blockchain product development witness the existence of even a more ramified and overlapping client-oriented network. In particular, blockchain P2P solutions virtually eliminated competition from all sorts of crowdfunding and C2C loans and credits.

Busy people are increasingly unwilling to file so much familiar to everyone, but increasingly pointless in contemporary digital world financial paperwork, familiar requests for pay-per-view credit histories and other costly and time-consuming standard compliance procedures. Instead, more and more people prefer to take some risk in exchange for saving hours of their time, and this is exactly how crypto financial infrastructure is being developed on its own. On top of that, investors become more and more frustrated by the low profitability of brick-and-mortar bank deposits. And, finally, people just don’t want to build their credit histories – they simply want to borrow and lend. Period. The newly introduced so-called crypto-credit accounts offer interest rates of 9% and higher, which is unheard of in the contemporary ultralow-percentage-rate environment.

Crypto lending is a brand new segment. It enables traders and ordinary cryptowallet holders to obtain cash by utilizing their crypto holdings as collateral, without having to sell their coins. As a result, individuals may secure loans against their crypto assets, expecting the value of the assets to increase during the period of the loan. This business is cool, clean and free of any gimmicks.

Crypto lending started to grow at the time when economies faced a brutal hit from Covid-19 pandemic, around the beginning of 2020. That saw the interest rates around the world get slashed, and lending for big-ticket items took a nosedive. Many people were looking for other ways to make their assets work for them. Crypto loans became a quick and easy way to gain access to crypto – and, hence, fiat currencies almost instantly, all without selling the underlying funds. All of a sudden, the days of Bitcoin and Litecoin gathering dust in an exchange or cold storage were numbered. Unlike personal loans or credit cards, collateralized loans looked much more secure for a lender, on one hand, and enabled the borrowers to take advantage of competitive interest rates, on the other.

Another important consideration. One of the most frequently cited disadvantages of Bitcoin and other cryptos has been their elevated volatility. Expressed in percentage terms, rather than in a more commonplace standard deviation, it grew to an excess of 30%. Being reduced by the above-mentioned average lending rate of 9%, a crypto investor effectively gets just slightly over 20% volatility risk, which significantly improves overall risk-reward metrics.

According to Bloomberg, Celsius Network and BlockFi believe that such accounts will become a popular digital product that will attract many cryptocurrency investors. Bitcoin trading is considered volatile and risky, so online companies offering pseudo-crypto interest-bearing accounts claim that they offer a more stable source of income for passive investors. Celsius, BlockFi and Gemini interact directly with their clients and pay them interest, calling it “centralized financing”. Some investors get similar returns on deposits in «decentralized finance» or DeFi protocols, where the interest payments are controlled by computer code rather than an intermediary. Lending in cryptocurrencies for interest through DeFi is sometimes referred to as “profitable farming”.

Pic.1. Total Value Locked USD in DeFi 2021 (source: Statista)

Aspiring crypto firms said they have already collected more than $35 million in crypto deposits. But watchful eyes of many traditional lenders and regulators were saying they are unhappy. They claimed that crypto-credit accounts are much riskier than they seem to be. Also they hinted that such accounts are being offered illegally. That rising conflict added oxygen to the fire of already raging regulatory tightening and raised questions about the place of cryptocurrencies in the U.S. financial system.

At first glance, crypto credit accounts are very similar to savings accounts offered by banks. But instead of traditional money, they accumulate cryptocurrencies. An investor opens such an account, deposits cryptocurrency, and starts getting interest payments. Many deposits are nominated in Bitcoins. Also widely used are stablecoins and the lesser known cryptocurrencies with higher volatilities. Some accounts offer a daily rate revision, while others are featured by fixed interest, implying money being locked for a certain period of time. For example, as is the case with a certificate of deposit.

As we mentioned earlier, crypto credit accounts usually provide yields that outperform traditional banking. The average bank savings rate at the end of August in the U.S. was 0.06%. The Celsius network, for example, says it can pay 8.88% on deposits in some stablecoins.

Let’s see how it works, at Binance, just as an instance. Binance offers crypto loans to their users that want to borrow stablecoins like BUSD and USDT, blue chip cryptocurrencies like BTC and ETH, and many more. Loan collateral can be BTC, ETH, BNB and other permitted cryptos assets. The initial LTV (loan-to-value, the ratio of a loan to the value of an asset purchased) is 65%. The automated margin call occurs at 75% drawdown, and LTV liquidation begins at 83%. Loan terms are 7, 14, 30, 90 and 180 days, with relevant interest being calculated hourly. Binance users can choose to repay the loan in advance, however, interest will be rounded to account for the nearest full hour. The interest rate can be calculated not only monthly or daily but also hourly. The current hourly interest rate stands for slightly less than 0.002%, and accumulates on the hour once the user successfully borrows the crypto asset.

This new area of the crypto business is already big and growing rapidly. The above-mentioned Celcius, one of the largest in the industry, recently pointed out that its total deposits are valued at more than $20 billion. In its turn, BlockFi claims to have over $10 billion in deposits. Gemini Trust started opening accounts in February and says it now has over $3 billion in customer deposits.

The account providers say they use customer deposits to lend to institutional investors at even higher rates. The latter sometimes have to borrow a cryptocurrency to make their own transactions – for example, for short selling or arbitrage.

Now, let’s discuss, are there any valid concerns behind the banking industry regulators’ unwillingness to accept the existence of crypto lending as a new phenomenon. In particular, they noted that some crypto lending firms may have been using the received funds for “other activities”. The bottom line is that there is no uniform information about what exactly deposits can and cannot be used for, which remains the main and most valid concern to date (it is a well-known fact that banks themselves often use deposited funds to underwrite credits or issue certain high-grade bonds). Also, regulators do have a point saying if a bank fails, the government would compensate for a tangible amount of such loss – up to $100,000 per account. But on DeFi platforms, if a person loses all his or her assets in some unexpected way, a person won’t have an opportunity to apply to a third party for a conflict resolution. But this is how things look right now. Once again, the industry is at the early development stage, while it is readily self-correctable and self-adjustable. But before crypto lending gets some sort of regulatory approval (or, at least, guidelines), public crypto lenders will likely experience certain difficulties. Thus, well-known U.S. public cryptocurrency exchange Coinbase was forced to suspend its in-house crypto lending operations because of “failure to comply with SEC securities law”. However, that episode didn’t do much harm to the overall emerging crypto lending business.