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Block by Block

Block by Block: Crypto Lending

Quick Take

  • Crypto-secured lending is a nascent lending market that has seen significant uptake in both growth and innovation over the prior 12 months
  • Lending on crypto (both centralized and decentralized) provides a unique opportunity for both lenders and borrowers that is hard to find with current lending products in the market
  • In December, total decentralized lending originations (on Ethereum) grew by over 25%, driven by +30% growth in Maker origination volumes (Maker originates +90% of total DeFi volumes)
  • Competition is fragmented at the moment, with the main lever driven by rates

Block by Block is a series where we dive into different industries and examine the entry-points for decentralization. This issue is an introduction to crypto-secured credit markets, exploring: market/product segmentation, lender and borrower opportunities, competition across both custodial and decentralized lending protocols, and more.


The market for crypto lending may be small relative to other credit products, but the sector is still worth attention given its recent growth, pace of innovation, and ability to provide lifeblood for companies in the broader ecosystem. 

Crypto-secured loans require borrowers to offer cryptocurrency (typically Bitcoin) as collateral, often times significantly overcollateralized, in exchange for another asset (usually USD or stablecoin). Loans can be originated centrally with a custodian/counterparty, or originated through a decentralized non-custodial lending protocol. The core market and product offerings can be segmented as:

  • Borrowing USD secured by crypto: Personal or Business loans originated by custodial lenders against crypto, with USD wired directly to bank accounts. Loans can be used for additional liquidity, and offer tax benefits on potential capital gains. Some of the larger players include: BlockFi, Unchained Capital, and Coventure. 
  • Margin lending on exchanges: The ability to use leverage via derivatives or direct margin from the exchange itself. Protocols like dYdX and Dharma offer decentralized open-source platforms for margin and derivative trading.
  • Lending crypto borrowing crypto: Origination volumes are largely demanded by fund trading, as the loans can be used to go short a position or run various other trading strategies where the fund would rather not own all the crypto. Genesis Capital is the major player in this bucket, but also plays within other segments (eg. USD – Crypto). Outside of OTC desks, the funding of Bitcoin ATMs is another use case for crypto-to-crypto borrowing.
  • Decentralized Lending Protocols (Non-custodial): Non-custodial lending protocols offer a similar collateralized loan as custodians, only in a decentralized way. The protocols leverage smart-contracts to minimize counterparty risk and reduce the cost to originate and borrow. Considering the today’s core lending protocols are native to Ethereum, non-custodial loans today are predominately against Ether rather than Bitcoin (however, this is expected to change in time). Most likely users of the protocols include traders, ICO treasuries, and borrowers looking to experiment with alternative low-cost credit.
  • Token-based platforms: A catch-all bucket for any lending platform or protocol that may push custody to a third-party provider like Bitgo—and also comes with a token model attached to the hip. Large players here include Nexo, Celsius, and Salt.

 

The lending opportunity impacts both lenders and borrowers
Lending on crypto (both centralized and decentralized) provides a unique opportunity for both lenders and borrowers that is hard to find with current lending products in the market.

For Lenders:

  • Unique collateral characteristics that can be favorable to alternatives. Currently, the predominant secured cryptocurrency loan is against Bitcoin. Bitcoin, and other cryptocurrencies like Ether, offer unique collateral characteristics that make it quite favorable to lend against, assuming the loan is over-collateralized in order to mitigate underlying price volatility. Some of these characteristics include: 1) asset is received instantly (little to zero clearing friction),  2) efficient storage, 3) can be liquidated 24/7, and 4) is constantly marked-to-market. Contrast that to a more common secured auto loan where the collateral (the car) can face unexpected decline in value (not constantly marked-to-market, and doesn’t face upside appreciation), and can be tricky to repossess and store upon default.
  • Entry for new lending growth. Considering the crypto lending market is still nascent, there aren’t a lot of players funding loans in the space. It’s not that big of a stretch, however, to imagine more traditional banks and credit funds starting to explore the market given that overcollateralization leads to relatively lower LTV (Loan to Value i.e., lower risk vs. other secured loans), while lower costs to underwrite/monitor the borrower and less competition lead to higher premiums.

To be sure, these higher premiums and returns will compress overtime as more players enter the space, similar to how “alternative lending 1.0” products (e.g. Lending Club) have matured over time. The latter will be an interesting trend to watch, as weaker returns (and performance) on these products, combined with a new differentiated lending pond to fish in, could push investors to explore alternative credit opportunities like custodial lending of bitcoin or non-custodial lending through protocols.

Lending Club loans’ Net Annualized Returns have compressed across the prior 5-year vintages

Source: Lending Club, The Block

The creation of non-custodial lending protocols offers an evolved alternative lending opportunity

For Borrowers:

  • Potential to open up wider credit access to developing markets. For borrowers in countries with little access to low cost credit (in Argentina, 180-day personal loans topped out at ~65% APR in November), consumers that own BTC or ETH can receive significantly lower financing costs vs. competing products. There is a wide variety in interest rates being offered from both custodial and non-custodial crypto-secured lenders. Currently, lending protocols offer significantly lower costs to borrow (and true border-less access), starting with Maker at ~.50% and ranging upwards to ~12% for Compound (borrowing DAI). However, even custodial crypto-secured lenders like BlockFi and Unchained Capital can offer loans at better rates than typically seen on a secured loan in the U.S. for borrowers with weaker credit profiles. 
  • Access to credit for crypto-native businesses and funds. Credit markets are the lifeblood of industries. For crypto-native business (exchanges, funds, ICO treasuries, BTC ATMs, etc.) access to credit that can be lent against the predominant asset on the balance sheet allows for greater capital management capabilities.
  • Tax advantages. Ability to generate liquidity without realized capital gains on crypto holdings, allowing for tax arbitrage. However, given the sharp decline in underlying price Y/Y, fewer borrowers will be able to leverage this advantage than before.

Estimated average APRs across various lending products

*Sourced from Project/Company websites. Argentina Data from CEIC Data, latest reported #’s from November 2018
https://www.ceicdata.com/en/argentina/lending-rate-non-financial-private-sector/lending-rate-domestic-currency-fixed–renegotiable-mortgage-loans-5-to-10-years

Origination Volumes

One of the advantages of lending protocols is the transparency and real-time granularity of lending data that is publicly available on-chain. In December, total decentralized lending originations (on Ethereum) grew by over 25%, driven by +30% growth in Maker origination volumes (Maker originates +90% of total DeFi volumes).

Source: Bloqboard, Loanscan.io, Compound smart contracts, dYdX smart contracts, The Block

Maker origination volumes highlight that volumes spiked during the third week of December (while the price of Ether moved ~40% from December 21 – 25th), and tapered off shortly thereafter. Cumulative origination volumes are currently running at ~$14 million so far through January, with over $40 million originated over the last 30 days.

Source: Loanscan.io, The Block

Meanwhile, Maker originated ~5,700 loans during the prior 30 days, with an average and median loan value of ~$7k and ~$400, respectively.

Source: Loanscan.io, The Block

Unfortunately, the same can’t be said for origination volumes coming from custodial lenders. Based on our conversations with some of the major players in the space, it’s hard to say what true originations currently are. Genesis Capital has reported over $500 million in originations from March to October, with ~$130 million active loans outstanding, however this number is stale, with 4Q data missing (set to release January 28th) and can include a mixture of lending BTC, USD, as well as the collateral. Moreover, the reported originations from other players are fragmented or not publicly available at this time, however we received estimates for total capital outstanding against these loans to be anywhere from “a little more than $50 million to upwards of $200 million.”


Source: Genesis Capital 3Q Lending Snapshot

Competition 

  • Competition on rates, rather than duration and LTV. Loan terms (duration, collateral limits, etc.) are largely standardized across the space outside of the disparity of rates. The variance in the cost to borrow is dependent on the degree of directional exposure the underwriter is comfortable with, as well as jurisdiction and regulatory classifications. Over time the expectation is for rates to continue to compress, eventually pricing similarly to a stock portfolio loan (LIBOR + 2-3%).
  • Non-custodial lending protocols vs. traditional custodial lenders. There are few notable advantages and disadvantages that lending protocols offer compared to traditional custodial lending. Some of the advantages of non-custodial lending allow for minimized counterparty risk, global 24/7 access to credit, and greater real-time transparency into outstanding loan books. Alternatively, lending protocols may not be suitable for all borrowers, as the UI/UX can introduce greater friction with limited product offerings, and the public nature of the data on-chain can weaken borrowing privacy. While the narrative of crypto lending has recently focused more on the growth in utility of non-custodial lending protocols (predominantly MakerDAO), custodial crypto-backed lending is an important trend to follow as well — and is able to compete against more efficient protocols by offering strong fiat rails, dollar funding direct to bank accounts, and the flexibility to iterate and diversify product offerings.

Correction: a previous version of this story misstated BlockFi average APR rates. The post has been updated to reflect the correct figures, and the inclusion of Genesis Capital’s 4Q Lending Snapshot release date.