Happy uptoper! In today’s Crypto for Advisors newsletter, Gregory Mall, Chief Investment Officer of Lionsoul Global, explains the evolution of Bitcoin-assisted loans in both decentralized and centralized financial systems.
Saros CEO Lynn Nguyen then answers questions about tokenized stocks in “Ask an Expert.”
Thank you to the sponsors of this week’s newsletter, Grayscale. For financial advisors near San Francisco, Grayscale is holding its exclusive event, Crypto Connect, on Thursday, October 9th. learn more.
– Sarah Morton
Cryptocurrency as collateral: What Wealth Managers Should Know About the Revival of the Institutional Loan Market
Lending and borrowing have long been the heart of the financial market. And ciphers are no exception. In fact, before the decentralized financial (DEFI) protocol became prominent, secured loans emerged in the digital assets sector. The practice itself has deep historical roots. Lombard lending – using financial instruments as collateral for loans – dates back when Lombard merchants became famous across the continent, and became famous across the continent to expand their credit protected by mobile goods, precious metals and ultimately securities. In comparison, it took only a short time for this centuries-old model to conquer the digital asset market.
One of the loans for crypto collateral is that it is very persuasive. A unique liquidity profile for the asset class. Top Coins are available for sale 24/7 at Deep Market. The speculative nature of cryptos drives the demand for leverage, but in some jurisdictions, Lombard-style loans offer tax benefits by allowing liquidity generation without causing taxable disposals. Another important use case is the behavior of Bitcoin Maximalists. Bitcoin maximaists are often deeply obsessed with holding BTC and are reluctant to reduce the overall stack. These long-term holders usually prefer to borrow at a low-value ratio, hoping that the price of Bitcoin will be highly valued over time.
History of the secured lending market
The first unofficial Bitcoin lender appeared in 2013. However, it was during the ICO boom of 2016 and 2017 that institution-style players such as Genesis and Blockfi emerged. Despite the 2018 code winter, the centralized finance (CEFI) market has expanded, with retail-centric companies like celsius and Nexo joining the fight.
The rise of Defi between 2020 and 2021 was followed by additional supercharged loans. Both the CEFI and Defi platforms have multiplied and competed actively for depositors. However, as competition grew, the quality of the balance sheet deteriorated. Several major CEFI players operate in mismatches of potential LA on key assets, leaning heavily towards their own governance tokens to strengthen their balance sheets, relaxing their underwriting criteria, particularly in regards to haircuts and LTV (loan-to-value ratio).
The vulnerability came to light in the second quarter of 2022 when the collapse of Stablecoin Terrausd (UST) and Hedge Fund Three Arrows Capital (3AC) caused widespread losses. Prominent Seffi lenders, including celsius, Voyager, Hodlnaut, Babel and Blockfi, were unable to meet the demand for withdrawal and entered bankruptcy. Billions of customer assets have been wiped out in the process. Regulatory and court-led postmortem pointed out familiar failures: thin collateral, reduced risk management, and opacity regarding business-to-business exposure. The 2023 Examiner’s report on celsius actually described the business that issued large, unsecured, low-cost loans, masked losses, and sold them as safe and transparent while the examiner operated on something “like Ponzi” fashion.
The market has since undergone a reset. Surviving CEFI lenders generally focus on strengthening risk management, implementing stricter collateral requirements, and tightening policies regarding relocation and business-to-business exposure. Still, the sector is only a small portion of its previous size, earning loan volumes around 40% of its 2021 peak. In contrast, the Defi credit market has made a stronger comeback. On-chain transparency regarding relocation, loan-to-value ratios, and credit terms have restored trust more quickly, pushing up the locked total value (TVL) back to record levels in 2021.
Source: Galaxy Research
Does Cefi have a role next to Defi?
Cryptocurrency has always been driven by the spirit of on-chain transparency and decentralization. However, it is unlikely that Cefi will disappear. Following the crisis, a small number of companies, such as Galaxy, Falconx and LEDN, are now more concentrated in space, taking into account more outstanding loans. Importantly, borrowers at many institutions continue to prefer to deal with licensed, established financial counterparts. For these players, concerns about anti-money laundering (AML), knowledge of customers (KYC), and the exposure and regulatory risks of the Bureau of Foreign Assets Control (OFAC) do not realize or tolerate direct borrowing from a particular debt pool.
For these reasons, CEFI lending is expected to grow in the coming years, although at a slower pace than defi. The two markets could evolve in parallel: Defi, offering transparency and complexity, and CEFI offers regulatory clarity and institutional comfort.
-Gregory Mall, Chief Investment Officer of Lionsoul Global
Ask the expert
Q. How will NASDAQ integration of tokenized securities into the existing national market system and associated investor protection benefits investors?
This step immediately brings back three thoughts – distribution, efficiency, and transparency. It is a game changer for everyday investors who are less involved in traditional finance. Blockchain is becoming more scalable every year, and I love the idea of efficient, configurable, decentralized finance (DEFI) use cases for tokenized securities. Confining these assets to the industry means they also have much more transparency compared to legacy systems.
Statistics bring this back – the global tokenized asset market has reached around $300 billion, up from just $6 billion in 2022. This means wider distribution. Imagine a small rural investor who wins 5-7% yields on tokenized stocks without requiring broker blessings. We have also seen that when we move from traditional finance to defi, blockchain is optimized, transparent and inclusive. This is more than just hype. It’s about helping more people build wealth through smart, digitalized tools that level the arena.
Q. What challenges could investors face if the Securities and Exchange Commission (SEC) approves NASDAQ’s proposal to trade tokenized securities?
It’s not all a mediocre voyage. First, there are technical hurdles that need to be overcome, which affect not only the investor’s user experience, but also the time frame. Mixing blockchain infrastructure with legacy systems is not easy, and this can affect early adopters and early prevalence of liquidity.
Early investors also need clearer guidance on regulations. Transparent guidance on token rights is needed as investors can face issues related to events such as dividends and voting. When introducing new technologies, it is also essential to take security very seriously. Cyberattacks have skyrocketed 25% year-on-year, and we have all seen famous cases related to blockchain. Though you’ll assume this is a priority for the Nasdaq.
All of these issues are solved as far as I am concerned. So I’m not too worried.
Q. NASDAQ says trading of European tokenized stocks in tokenized stocks “stimulates concerns” because investors can access to tokenized US stocks without the actual stocks of the company. “How will NASDAQ’s proposal to provide the same important rights and privileges as a comparable class of traditional securities benefit investors?
Here we talk about benefits including voting, dividends and equity stakes, including access to the same rights as traditional securities. In Europe, investors were able to acquire securities without full rights. We consider this to be similar to holding exclusive inappropriate tokens (NFTs) without gaining the merits of membership that belongs to. Imagine you own Cryptopunk but don’t have access to the venture opportunities available to Punkdao and its holders.
Nasdaq is basically trying to make sure investors aren’t shortened. This is a huge advantage as you get all the perks, not only are you able to access a more dynamic but limited version of the assets. When I consider the possibilities here, it’s exciting – imagine a completely run-through stock with 24/7 trading, lower fees, and much shorter settlement times.
-Lynn Nguyen, CEO, SAROS