Cryptocurrency lending teeters on the brink of extinction after the collapse of Genesis

The bankruptcy of major cryptocurrency lender, Genesis Global Capital, could be another blow than the industry can handle, at least in its current form.

The list of bull market stars now includes nearly every major player who has captured the public’s attention by offering market-beating returns for the simple act of depositing tokens. Genesis joins BlockFi Inc., Celsius Network and Voyager Digital among companies whose collapse has left countless customers angry and unlikely to risk more money for their daring exploits.

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Acting as de facto banks, these firms acquired assets which they then lent freely on the market, often to hedge funds who used the borrowed funds to leverage their bets on uncertain tokens.

Genesis issued $130.6 billion in loans in 2021 alone, part of a complex web of interconnected risky deals and toxic lending that helped turbocharge the market, only to trigger a cascade of crashes as cryptocurrency prices kicked in to plummet last year.

Even day-to-day investors around the world have been left to take care of billions of dollars in cumulative losses, and now regulators are forcing lenders to meet the stricter standards required in traditional financial markets or face huge repercussions. Either way, the heyday is over.

“Genesis going belly up is further highlighting the contagion that is spreading in the cryptocurrency lending industry, with its risks becoming a real domino effect,” said Hirander Misra, CEO of market infrastructure firm GMEX group. “Due to the lack of counterparty risk management and control, the current market structure is fundamentally undermined.”

Loan volumes had already declined significantly before the Genesis crash. While aggregate market figures for centralized platform lending are hard to come by, the company’s disclosures offer a barometer of the health of the overall market. Genesis originated a peak of $50 billion in loans in the last quarter of 2021, around the same time that the broader cryptocurrency market was at its peak. That figure dropped to just $8.4 billion in the third quarter of last year.

But low volumes are just one of the problems facing the industry, which now also faces increased scrutiny from regulators.

Just hours before Genesis filed for bankruptcy, London-based lenders Nexo said it had agreed to pay $45 million in penalties to US state and federal regulators over allegations it broke securities rules with its own fruitful product.

The Securities and Exchange Commission had already imposed $100 million in fines against BlockFi for its lending activities in February.

Earlier this month, the regulator sued Genesis over its deal with cryptocurrency exchange Gemini, under which Gemini customers could invest their cryptocurrencies with Genesis for returns of up to 8% through a product called Earn. The Genesis deal now makes Gemini’s customers collectively the largest creditors on Genesis’ books, with a claim of $900 million.

Also in 2021, the SEC had signaled its intention to further investigate cryptocurrency lending as part of a crackdown on illegal securities offerings. It issued a Wells notice — a way of telling a company it’s going to sue them — to Coinbase in September of that year, over a proposed lending product that the cryptocurrency exchange was exploring. Coinbase said at the time it didn’t know why the regulator was unhappy.

Future models

Being targeted by the SEC is likely to lead to yet another shock to what little is left of the lending industry.

“There will be two different models in the future,” said Campbell Harvey, a finance professor at Duke University. “First, some organizations will register with the SEC and sell these products as securities. Second, investors can do it themselves by placing their cryptocurrencies in decentralized liquidity pools and earning a fee for that.”

In decentralized finance, or DeFi, investors use software to automatically borrow and lend tokens, with positions automatically liquidating if prices fall too low or miss repayment deadlines. Some platforms such as Maple Finance set up pools where a trader can manage incoming investor funds and choose who to lend them to, using due diligence to assess a borrower’s creditworthiness rather than asking for collateral. This approach has already led to some defaults during the current crisis, as well as plummeting volumes.

Because these types of lending are conducted on public blockchains, the lending slump is more visible. The total amount of value locked up on DeFi networks peaked at $181 billion in early December, according to data from DeFiLlama, and is now hovering around $45 billion, overshadowed by fluctuating demand, falling cryptocurrency prices and several spectacular bankruptcies.
Some investors still believe the sector could make a comeback, though not in its pre-crash form. For those willing to go through the process, a regulated version of cryptocurrency lending can foster a higher level of investor safety, using 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 to provide and how to manage it, experts said.

Fees could also be higher as lenders will not be able to recoup through risky trades and would have to open their books to much more invasive supervision.

“The loan market will recover, and when it does, it will be built in a way that helps prevent this type of crisis,” said Taylor Cable, European chief executive of Cowen Digital, the digital assets arm of US investment bank Coven Inc.

Read more: Dubai’s crypto investors are cautiously optimistic as confidence recovers from FTX fiasco

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