By Elizabeth Howcroft and Hannah Lang
LONDON/WASHINGTON (Reuters) – On May 11, Scott Odell, an analyst at British cryptocurrency lender Blockchain.com, sent an instant message to Edward Zhao of Three Arrows Capital requesting that the Singapore hedge fund withdraw at least a portion of a $$ loan. 270 million repayments.
Three Arrows had just been dealt a blow by the collapse of cryptocurrency Terra, raising doubts about its ability to repay. That was a concern for Blockchain.com as it had not taken any collateral to secure the loan, court records show.
“This is time sensitive, so let’s find out if you’re available,” Odell said of the refund.
Zhao seemed lost for words.
“Yo,” he replied.
Three Arrows filed for bankruptcy in July, and Blockchain.com told Reuters it had yet to recover one cent of its loan. The text exchange is one of the sworn documents filed by liquidators as part of the hedge fund liquidation process.
Three Arrows did not respond to requests for comment. Odell declined to comment, while Reuters could not reach Zhao.
The loan was part of an opaque web of unsecured loans between crypto firms that exposed the industry when cryptocurrency prices crashed by 50% earlier this year, according to a Reuters review of bankruptcy court and regulatory filings, and interviews with about 20 executives and experts.
Institutional crypto lending involves lending cryptocurrencies and cash in exchange for a return. By waiving the requirement for the borrower to provide collateral – such as stocks, bonds or, more commonly, other crypto tokens – lenders can charge higher rates and increase profits, while borrowers can generate cash quickly.
Blockchain.com has since largely shut down its unsecured loans, which accounted for 10% of its revenue, chief business officer Lane Kasselman told Reuters. “We’re not willing to take the same risk,” he said, although he added that the company would still offer “extremely limited” unsecured loans to top clients under certain conditions.
Unsecured loans have become common in the crypto industry, according to the review of the files submitted and the interviews. Despite the recent shakeout, many industry insiders said the practice would likely continue and could even grow.
Alex Birry, chief analytics officer for financial institutions at S&P Global Ratings, said the crypto industry has in fact broadly seen a trend toward unsecured lending. The fact that crypto was a “concentrated ecosystem” increased the risk of contagion across the industry, he added.
“So if you’re only lending to people who are active in this ecosystem, and especially if the number of these counterparties is relatively limited, yes, then you’re going to see events like the ones we’ve just seen,” he said of the collapse of the summer of lenders.
CRYPTO TREE AND BUST
Crypto lenders, the de facto banks of the crypto world, boomed during the pandemic, attracting double-digit retail customers in exchange for their cryptocurrency deposits. On the other hand, institutional investors, such as hedge funds that wanted to bet with leverage, paid higher rates to borrow the money from the lenders, who took advantage of the difference.
Crypto lenders are not required to hold capital or liquidity buffers like traditional lenders and some were exposed when a shortage of collateral forced them – and their customers – to bear large losses.
Voyager Digital, which became one of the biggest victims of the summer when it filed for bankruptcy in July, offers a window into the rapid growth of unsecured crypto loans.
The New Jersey-based lender’s crypto loan book grew from $380 million in March 2021 to about $2 billion in March 2022, and it took collateral for just 11% of that $2 billion, the company’s regulatory filings show. .
The lender collapsed after Three Arrows defaulted on a crypto loan worth more than $650 million at the time. While neither party said whether this loan was unsecured, Voyager made no mention of liquidating collateral due to the default, while Three Arrows listed its collateral status with Voyager as “unknown,” the companies’ bankruptcy filings show.
Voyager declined to comment on this article.
Rival lender Celsius Network, which also filed for bankruptcy in July, also offered unsecured loans, court records show, though Reuters could not pinpoint the size.
Since most loans are private, the amount of unsecured loans in the industry is unknown, and even those involved in the business give completely different estimates.
For example, crypto research firm Arkham Intelligence estimated the figure at close to $10 billion, while cryptocurrency lender TrueFi said at least $25 billion.
Antoni Trenchev, co-founder of cryptocurrency lender Nexo, said his company had rejected requests from funds and traders asking for unsecured loans. He estimated that unsecured lending across the industry was “probably in the hundreds of billions of dollars.”
BULLISH ABOUT LOAN
While Blockchain.com has largely withdrawn from unsecured lending, many cryptocurrency lenders remain convinced of the practice.
Most of the 11 lenders interviewed by Reuters said they would still provide unsecured loans, although they didn’t specify how much of their loan book this would be.
Joe Hickey, global head of trading at BlockFi, a major cryptocurrency lender, said it would continue its practice of offering unsecured loans only to top clients it had seen audited financial data for.
A third of BlockFi’s $1.8 billion loans were unsecured as of June 30, according to the company, which was bailed out by crypto exchange FTX in July, as it cited loan losses and increased customer withdrawals.
“I think our risk management process was one of the things that saved us from bigger credit events,” Hickey said.
In addition, a growing number of smaller, peer-to-peer lending platforms are trying to fill the gap left by the departure of centralized players like Voyager and Celsius.
Sid Powell, co-founder and CEO of unsecured crypto lending platform Maple, said institutional crypto borrowers were more cautious following the Three Arrows insolvency, but conditions have since normalized and lenders are now comfortable borrowing unsecured loans.
Executives at two other peer-to-peer lenders, TrueFi and Atlendis, said they had seen an increase in demand as market makers continue to seek unsecured loans.
Brent Xu, CEO of Umee, another peer-to-peer platform, said the crypto industry would learn from its mistakes, and lenders would do better by expanding lending to a more diversified range of crypto firms.
That would include, for example, companies looking to make acquisitions or fund expansion, he added, rather than focusing on those trading with leverage on crypto prices.
“I am very optimistic about the future of unsecured borrowing and lending,” said Xu.
MILLION DOLLAR BITCOIN
To be sure, many crypto loans are secured. But even then, the collateral is often in the form of volatile tokens that can quickly lose value.
BlockFi over-collateralised a loan to Three Arrows but still lost $80 million on it, the lender’s CEO Zac Prince said in a July tweet. BlockFi said its loans to the hedge fund were secured with a basket of crypto tokens and shares in a bitcoin trust.
“A more traditional lender would probably want more than full collateral coverage for a loan backed by crypto, as the value of the collateral can fluctuate by 20% or more on any given day,” said Daniel Besikof, a partner at Loeb & Loeb who works in bankruptcy.
“Borrowing a million dollars against a million dollars in bitcoin is riskier than borrowing against more traditional, stable collateral.”
(Reporting by Elizabeth Howcroft in London and Hannah Lang in Washington; editing by Michelle Price and Pravin Char)