Crypto Lending’s Dangers Highlighted | PYMNTS.com

Despite receiving a $500 million backstop line of credit on June 21, teetering crypto broker Voyager Digital announced today that it was cutting its daily withdrawal limit to $10,000 from $25,000.

Voyager has been in trouble since it revealed exposure to potentially insolvent crypto hedge fund Three Arrows Capital, which took huge losses when the terraUSD stablecoin and its partner cryptocurrency, Luna, collapsed in a $48 billion run in early May.

But the amount it had loaned Three Arrows, $720 million in bitcoins and stablecoins, shocked investors, who tore away 60% of its share value on June 22.

While the support from FTX exchange CEO Sam Bankman-Frieds Alameda Research, a trading firm, appears to be keeping Voyager on its feet, with its stock stabilized around $0.58 versus $1.23 on June 21 the withdrawal limit cut could have been far worse.

See more: Is Cryptos Richest Billionaire Becoming its Lender of Last Resort?

Another firm clobbered by Three Arrows reported insolvency, lending firm Celsius, halted all withdrawals by its 1.7 million customers on June 12 and is reportedly struggling to find liquidity.

It isnt alone. Crypto lender BlockFi was also hit by Three Arrows and was also provided support by Bankman-Fried, with a $250 million line of credit from FTX.

Dearth of Regulation

Its a sign of the growing problem the largely unregulated cryptocurrency industry has with lending.

Both BlockFi and Celsius are centralized versions of decentralized finances (DeFis) bread-and-butter crypto lending and borrowing platforms, which act in some ways like banks. They solicit deposits from investors seeking interest very, very high interest on their money. They loan it out to others who put up crypto collateral that is typically 150% of the amount borrowed.

While much of the regulatory and political attention has focused on the risk to small investors that might shift, or at least expand, to the bigger investors. In this case, the failure of one big borrower, Three Arrows, has endangered the funds of a large number of small investors.

While these cases involved centralized firms, many lending and borrowing platforms are DeFi operations, meaning regulating will be far more difficult as there is not, in theory, any person or organization to regulate. While thats debatable a number of international financial regulatory organizations think they arent as decentralized as they claim itll certainly be a heavier lift.

Another question is who will regulate these lenders.

The U.S. Securities and Exchange Commission (SEC) has claimed some regulatory authority over the business, warning crypto exchange Coinbase not to start a lending/borrowing service and getting BlockFi to pay a $100 million fine to it and a group of state securities regulators, as well as registering with the SEC. It and the state agencies call these lending operations unlicensed securities offerings a designation that gets quite a bit of pushback from the crypto industry.

Read more: BlockFis $100 Million Settlement With SEC Raises Internal Discussion

But there is a move in Congress to define most cryptocurrencies as commodities regulated by the Commodity Futures Trading Commission (CFTC), which would certainly cloud jurisdictional questions.

See more: Senate Crypto Bill Debuts, and Crypto Industry Gets Big Wins

Less than Transparent

Back in February, Fitch Ratings predicted the BlockFi settlement would accelerate the regulatory process, adding that it could accelerate the industry segments growth.

The crypto lending industry operated not unlike savings accounts at commercial banks that pay APRs on customer deposits but at much higher rates, Fitch said. These can run as high as 20% or even more.

It added that the liquidity lock-up and the risks faced are significantly different. Crypto interest accounts are not FDIC-insured and have increased risk of loss from cybercrime or crypto lenders being hacked.

More importantly, it noted that despite industry claims that loans are overcollateralized, that isnt always the case.

BlockFis crypto deposits, which [were] around $10 billion, were lent out to institutional counterparties, with only 17% of loans being over-collateralized despite representations that such loans were typically over-collateralized.

See also: SECs New Top Cop: No Free Pass For Unregistered Crypto Lenders

While much of the loans Three Arrows took out were reportedly overcollateralized, bitcoins roughly 60% price crash this year highlighted that crypto collateral is always risky.

The whole industry operates in a grey area, Perianne Boring, founder and CEO of the Chamber of Digital Commerce, told Reuters after Celsius cut off withdrawals.

We are now seeing the consequences of regulators failing to provide clarity,” she said. “I am hopeful that recent events will accelerate efforts to deliver clearer policies to the industry and certainty to those who invest in digital assets.

But the whole thing raises a fairly simple question: If it looks like a bank, acts like a bank and lends like a bank, wouldnt it make sense to regulate it like a bank?

And as there are plenty of bank regulators, why go looking for a new regulator for crypto?

 

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