Bear markets are very harsh for crypto lenders compared to companies that do not employ leverage on deposits, explains one Bitcoin analyst.
Crypto Lending Allows People to Use Digital Assets as Collateral for Loans
The crypto bear market is very harmful to the industry lenders, but the concept can still survive the on-going bloodbath, according to industry experts.
Crypto lending is a type of digital finance service that allows borrowers to use crypto assets as collateral to get loans in fiat money, such as US Dollars or stable coins like tether (USDT). This means that they are able to repay loans without having to sell their coins.
In his view, Josef Tetek, a Bitcoin analyst at crypto wallet firm Trezor, digital asset companies that operate their firms on a fractional-reserve basis are faced with more risks during the bear markets. In the traditional banking system, the fractional reserve model means that only a small amount of the deposit is backed with actual cash. Therefore, crypto lending firms are operating “a fractional-reserve business” to provide yields to clients.
“Exchanges and custodians that run on a fractional-reserve model are playing with fire. This practice may work fine during bull markets when such companies experience net inflows and grow their customer base,” the executive stated,” expressed Tetek.
If you are using leverage when trading with borrowed funds, the losses are higher and more painful when the price moves against the predicted trend.
Tetek argues that sharp market declines are more bearable for companies that do not offer lending services or leverage deposits. This means that they can survive the domino effect of dropping prices and firms going under. “If you throw in leverage — trading with borrowed funds — the losses are often much more painful, especially with sudden price moves,” Tětek emphasised.
Solutions to Current Bear Market is Getting Rid of Maturity Mismatch Issue
To survive the current crypto lending quagmire, crypto lenders should address the challenge of short-term liabilities and short-term assets. “Crypto lending as a concept can survive this crisis, but the sector needs to get rid of the maturity mismatch problem: if someone else borrowed my assets and I get a yield as a return, then I have to wait for the borrower to repay before I can withdraw,” explained Tetek.
As far as lenders promise full liquidity on lent assets at the same time, liquidity issues will always remain. “Every participant needs to respect the risks involved and the fact that there are no bailouts in the space, so if a borrower fails to repay, a lender has to accept their loss. There is no risk-free yield, and often the yield is not worth the risks,” he added.
The crypto industry is facing a major crisis after the price of digital assets dropped to 2020 levels, hiving off over USD1 trillion in market cap. On 13th June, Celsius, one of the lending platforms, suspended all withdrawals because of “extreme market conditions.” Babel Finance also temporarily stopped withdrawals and redemptions because of liquidity pressures.
