With cryptosphere veterans joining the globetrotting elite in Davos and punters having sleepless nights in the crypto crash, it is time for regulators to reflect on the real-world impact of the next boom-and-bust crypto cycle. Fintech and crypto apps have already expanded into digital cash, loans and complex products that may seem as simple as e-mails to credit cards. This has created financial channels for far more than just one-off bets on bitcoin or bored apps: decentralized-finance (DeFi) platforms offer investors crypto yields of 8-10%; Some even fund startups around the world without even touching the banks. Tulip Mania meets the real economy at whatnot speed.
In this time of market tension, rewards that appear as volatile have given way to a cascade of losses – highlighting the challenge facing policymakers, some of whom believe they dropped the ball on crypto. Is.
Crypto funds are being sourced from lending platforms, even those backed by real-world assets. A project offering an 8% return on tokenized loans issued by French payday lender Bling has been hit with massive redemptions in excess of its available cash and a credit line from venture-capital backers. For one investor I spoke to, this meant waiting months to potentially get their money back. Their main motivation for investing in the first place was the free token rewards which have since vanished.
Meanwhile, on the other end of the chain, lending to the end-consumer has also hit a brick wall. Bling suspended its cash-advance service in April, as regulators cracked down on the sector. A consumer advocacy group has estimated the cost of Bling’s immediate one-month advance at a 128% annual interest rate when service charges are included.
Such a small collateral-backed project to sell assets is apparently nothing on the scale of the $60 billion terra collapse that has seen desperate Koreans beat a path to founder Do Kwon’s door. But it shows why regulators are nervous about future risks to the financial system.
Those free rewards and high returns are rolling in to those who might be least able to afford it. Data from the European Central Bank (ECB) shows that crypto ownership is a U-shaped affair, with top- and bottom-income households more likely to own crypto than people in the middle.
Crypto links with the financial system are on the rise as venture funds and banks seek to capitalize on the disruptive potential of crypto; Societe Generale is tinkering with DeFi loans, while others are keen to launch stablecoins. “There is a very widespread feeling within the investor community that one has to dip one’s toes in,” says economist Ishwar Prasad, author of The Future of Money.
Crypto markets today are modest in size—the current total value locked in DeFi is about $100 billion, or about one-sixth of total venture-capital investment last year—but what a dozen crypto lending blowups could look like in the future if the sector continues to grow. Is? The race to sell assets to complete crypto redemptions can have huge spillover effects, especially if managed algorithmically through smart contracts.
Parallels with the subprime mortgage market, which triggered the global financial meltdown in 2008, are being drawn more frequently.
“While the risks are currently small, they could increase significantly if the platform starts providing services to the real economy,” the ECB said last week. Out of 14 in 2021.
The founders and financiers of DeFi platforms like Centrifuge or Goldfinch say that serving real-world businesses is still a good news for crypto. Algorithmically managing projects and cutting down on paper-shuffling means unlocking efficiency gains and access to capital, they argue, and the past market bubbles creating useful infrastructure in building railroads and the Internet.
Perhaps. But these are also bank-like activities that can be done with more bank-like oversight. They often involve the complex financial structures that plague many Delaware-based LLCs with little legal recourse and high counterparty risk. And they are part of a broader explosive proliferation of fintech lending that has yet to be properly tested in a recession. Instead of a high-speed train, it could look like a “shadow banking square,” says fintech investor Peter Lugli.
Expect some of this activity to be drawn more in light as a result of the institutional and regulatory focus. Maybe the likes of Bling will behave more like regular banks and the DeFi lending platform will have more centralized big-name funds due diligence. But given the way animal spirits tend to return, regulators will know that risk management will only get tougher from here on out.
Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies