Since we run both a Crypto Fund, and a Lending Fund, I’ve spent a bit of time thinking through the opportunities and risks around lending against Crypto as a secured asset.
It fits within our thesis of “investing in new asset classes build on the back of emerging technology.” Crypto is a new asset class developed almost entirely in the last twelve months. And the credit originated, secured by it, is by definition new and likely miss-priced. The trick is figuring out if it’s miss-priced in the good way, or the bad way.
Some thoughts are below in no particular order:
(1) What are people borrowing capital for? In some cases it may be to make an investment or a purchase without triggering ordinary income. This seems like a reasonable use-case, but depending on the liquidity of the new investment I’d be nervous that borrowers catch themselves in a liquidity mis-match in the event that they have to pay back the loan/re-collateralize during a crash.
(2) I think that ultimately, lenders will realize that they’ll want to attach their loans not just to Crypto Assets, but also to whatever assets/investments purchased with the loan. I can imagine the loans becoming a bit predatory because people will end up getting caught in a dip, not being able to sell their illiquid asset, and finding their assets liquidated much faster than they could have anticipated. These loans may become abusive less because of their rate, but because of the nature of the collateral and the speed of the collections.
(3) The duration of the loans would likely have to be short term. BTC crashed 60% in the last 30 days, implying that an LTV of 40% (at most) for a 30 day loan would make sense (especially considering rates of returns will be capped by usury laws). So what LTV would you need to price at for a 1 year term, or 3 year term loan? It’s a hard model to run with a very small amount of data to test against.
(4) The collections process may end up being a lot easier than other asset backed lending products. Typically, when making a loan secured against an asset, in the event of a default the lender has to go find the asset (in the case of an auto loan, for example, that’s not so easy). And then there is the process of selling the asset, which is often sold at a discount due to the nature of the auction, and is an expensive process. So the “Salvage value” on the foreclosed asset ends up often being below the amount necessary to recover full principal plus income. I can imagine the collections process of Crypto and the re-selling process to be a lot faster, and cheaper.
(5) The cost of capital to originators will likely stay high, meaning lenders will likely capture the value, not the originators. And that means the liquidity of the originators will be important. Traditional banks won’t be able to make loans secured against Crypto Assets for a long time — meaning non-traditional lenders will likely make up a majority of the capital available. These lenders will likely charge at least 12% (or more) on their capital — meaning even in the event that loans are made at 15–18% APR — there is not a lot of spread for the originator to capture. This means the equity capital of the originator may evaporate quickly if their burn is too high. And I don’t think lenders will be good at servicing loans originated to Crypto holders (both the servicing and collections process will likely be nuanced and full of fraud). So making sure a company has enough cash to extend through the terms of the loans originated would be important.
(6) Borrowers may be less likely to pay back their loans because they are secured against an asset they care less about than a car. Don’t get me wrong, people love their BTC, but they probably need their car more, or their house.
(7) The borrowers may be, in some cases, irresponsible with their financial health. People who come into new wealth very quickly are notorious for spending it unwisely, and many “BTC millionaires” are newly rich, and may fall into this trap.
(8) I think barriers to entry will come down, and the loan products will become commoditized. It’s hard for me to imagine proprietary origination channels (proprietary ways of customer acquisition) that would make customers use anything other than price when evaluating which loans to take out.
These are some, not so formally baked out thoughts, on a 5:30 am flight, but it’s something we’ll likely keep thinking about. Would appreciate thoughts.
