The bankruptcy of Genesis Global Capital, crypto’s top lender, could be another blow the industry, at least in its current form, can withstand.
The list of downed bull market stars now includes almost every major player that has captured the public’s attention by offering market-beating returns for simple token escrow. Genesis joins BlockFi Inc., Celsius Network and Voyager Digital in companies whose collapse has infuriated countless customers and are unlikely to risk more money on their daring exploits.
Acting as de facto banks, these firms took on assets which they then lent freely in the market, often to hedge funds, which used the borrowed funds to capitalize on their bets on dubious tokens. Genesis lent $130.6 billion in 2021 alone, part of a complex web of interconnected risky deals and toxic loans that helped boost the market, only to trigger a cascade of collapses when crypto prices started falling over the past year.
Everyday investors around the world have also suffered billions of dollars in cumulative losses, and now regulators are forcing lenders to either meet the stricter standards required in traditional financial markets or face massive repercussions. Anyway, the heyday is over.
“The collapse of Genesis further underscores the contagion spreading in the crypto lending industry as its risks become a domino effect,” said Hirander Misra, CEO of market infrastructure firm GMEX Group. “Due to a lack of counterparty risk management and control, the current market structure is essentially at risk.”
Lending volume had already declined significantly before Genesis collapsed. While aggregate market numbers for lending through centralized platforms are hard to come by, the company’s disclosures provide a barometer of the health of the overall market. Genesis issued a peak of $50 billion in loans in the final quarter of 2021, around the same time the broader crypto market was peaking. That number fell to just $8.4 billion in the third quarter of last year.
But low volumes are just one of the sector’s problems as the industry also now faces increased scrutiny from regulators. Just hours before Genesis filed for bankruptcy, London-based lending firm Nexo said it agreed to pay $45 million in penalties to state and federal US regulators over allegations that it violated securities rules with its own interest-bearing product have violated. The Securities and Exchange Commission previously fined BlockFi $100 million for its lending activities in February. Earlier this month, regulators sued Genesis over its arrangement with crypto exchange Gemini, which allowed Gemini clients to invest their crypto with Genesis for returns of up to 8% through a product called Earn. The agreement with Genesis now makes Gemini’s customers, collectively, the largest creditors on Genesis’ books with a claim of $900 million.
Even in 2021, the SEC had signaled its intention to further investigate crypto-mining as part of a crackdown on illicit securities offerings. It issued a notice from Wells to Coinbase in September of that year — a way of telling a company it was going to sue — over a proposed lending product the crypto exchange had been investigating. Coinbase said at the time it didn’t know why regulators were unhappy.
Future models
Being in the SEC’s crosshairs is likely to result in another shake up of what’s left of the credit sector.
“In the future, there will be two different models,” says Campbell Harvey, a finance professor at Duke University. “First, certain organizations will register with the SEC and sell these products as securities. Second, investors can do this themselves by placing their cryptos in decentralized liquidity pools and earning a fee for doing so.”
In decentralized finance, or DeFi, investors use software to borrow and lend tokens automatically, liquidating positions automatically if prices fall too low or they miss redemption deadlines. Some platforms, such as Maple Finance, organize pools where an operator can manage incoming investor funds and choose who to lend them to, using due diligence to assess a borrower’s creditworthiness, rather than requiring collateral. In the current crisis, such an approach has already led to a number of payment defaults in addition to collapsing volumes.
As these types of lending are processed on public blockchains, the collapse in lending is more visible. The total amount of value locked in DeFi networks peaked at $181 billion in early December, according to data from DeFiLlama, and is now around $45 billion — marred by faltering demand, plummeting crypto prices, and several spectacular outages.
Bloomberg
Some investors still believe the industry could make a comeback — albeit not in its pre-crash form. For those willing to undergo the process, a regulated version of crypto lending can promote a higher level of investor safety by leveraging existing securities laws to keep companies in check.
This will make the market and its practices more similar to lending in traditional markets, including rules on how much collateral must be posted and how this is managed, experts said. Fees could also be higher as lenders won’t be able to repay through risky deals and would have to open their books to much more invasive oversight.
“The credit market will recover and when it does it will be set up to help prevent this type of crisis from occurring,” said Taylor Cable, European Managing Director at Cowen Digital, the digital asset division of the US investment bank Cowen Inc.
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