Crypto Lending Platforms Hit Hard as Contagion Spreads

The crypto lending industry, which handed borrowers billions of dollars in just the past few years, faces its biggest crisis yet as some of its leading firms implode.

Genesis Global Capital, which doled out $130 billion in 2021, filed for bankruptcy last week and joined BlockFi Inc., Celsius Network, and Voyager Digital among companies that have collapsed, leaving investors frustrated and regulators scrambling.

Crypto Lending Industry Faces Challenges

Genesis was the biggest unsecured creditor of failed trading platform FTX, whose former CEO, Sam Bankman-Fried, faces fraud charges. Due to FTX's collapse, Genesis went into financial trouble, forcing crypto exchange Gemini to terminate its lending product in which Genesis was a lending partner.

''I won't be surprised if this is the end of the types of [lending] programs we saw throughout the past few years,'' said prominent crypto critic and computer scientist Molly White. ''They promised high returns for relatively low risk, and ultimately proved that that wasn't sustainable.''

It's not the first time that critics have engaged in a bit of schadenfreude at the expense of the crypto industry. Some analysts have practically built careers predicting the imminent demise of a system that was deliberately built on existing outside the traditional banking system. Yet this time seems different because it's not just the investors who are hurting but the quasi-bank firms that provided the rocket fuel to spark growth.

Moreover, the SEC has been cracking down on crypto lending products by calling them securities. The financial watchdog even fined BlockFi to pay $100 million in penalties and forced Coinbase to cancel its crypto lending program. Most recently, it fined crypto lender Nexo for launching its product.

What Investors Need to Understand?

The crypto lending platforms offer attractive returns, and investors pour their capital into them. Typically, the interest rates on crypto lending platforms can go up to 20% APY. In comparison, the national average yield for savings accounts is 0.23% annual percentage yield (APY). 

Crypto assets have both pros and cons. They are ideal collateral because they can be liquidated at any time (unlike real estate or yachts). However, they carry a high level of volatility, which is why the collateral amount must be higher than the amount one wants to borrow. Crypto lenders didn't follow the rule, and ''a lot of crypto lenders were lending from one another,'' said White.

If the loan-to-value ratio (the amount of collateral relative to the amount loaned) is not high enough, the collateral value can go below the loan value faster than it can be sold, said crypto expert and editor of the "Crypto is Macro Now" newsletter, Noelle Acheson. 

''When loans are not fully collateralized (with less than 100% collateral deposited), the risk is obviously much higher,'' she said.

The Bottom Line

The crypto lending industry is facing challenges, but it doesn't mean that decentralized finance, or DeFi, will go extinct as developers are working on making crypto lending more risk-averse and efficient. Acheson believes that trust has been hurt but not totally wiped out, and it will recover as new processes are put in place, and new players come into the market. 

Regulators will play a crucial role in determining where checks and balances should be placed. ''The growing regulatory scrutiny will imbue the new market leaders in this segment with strong disclosures and risk management practices,'' she said. 

(Vinamrata Chaturvedi contributed to this article.)