Money Markets meet Crypto – Part III

Telegram chats and excel spreadsheets 

The crypto lending industry today functions like the banking sector in the 1960ties. Lending and borrowing were happening in a rather messy, scattered way. Lender and borrowers found themselves calling each other up and agreeing on the terms via telephone or fax machines. Back then, there was no institutionalized money market for banks and other entities to go to.  

The same is the case for crypto with voice brokering being today’s norm. Crypto businesses that either want to lend or borrow don’t have a consolidated marketplace in the form of an electronic trading system to either get or grand short-term loans. They find themselves constrained to use either Bloomberg terminal or Telegram to connect to and settle a deal with a potential counterparty. Trades are carried out through voice calls, using instant messengers or emails. Besides not having organized communication channels, there is also no unified reporting. Right now, each company must keep track of its deals in a separate excel spreadsheet.  

Consequently, short-term crypto debt markets are riddled with unpredictable risks, market opaqueness, and inefficiencies that lead to low liquidity flows. Serious crypto entities that have no other choice than jump in at the deep end feel anxiety every time they engage in crypto borrowing or lending services.  And more traditional institutional lenders and borrowers don’t even feel like tipping their toes in. 

CLST: The first professional money market for crypto 

These circumstances call for improvement. At CLST, we are establishing a network of lenders and borrowers to become the institutional gateway for uncollateralized lending. In order words, CLST is building the necessary new money markets for this newly emerging money.  

Through an all-in-one platform, CLST strives to get rid of handling individual excel spreadsheets. By becoming the center hub of crypto lending and borrowing institutions have a consolidated venue that directly connects lenders and borrowers – be it crypto banks, investment firms, market makers, hedge funds, trading firms, asset managers, fiduciary lending firms, crypto mining companies or treasuries. 

One of CLST’s key achievements is standardization and professionalization. An easy-to-handle interface lets counterparties seamlessly find one another. Terms and conditions regarding either lending or borrowing can be pre-defined and set for all platform users to see. Thanks to automated requests for quotes (RFQs), counterparties can directly place quotes with each other and then accept if an agreement is reached. CLST’s platform also allows users to connect their wallets for peer-to-peer settlement and be a custodial and non-custodial wallet. This means that counterparties cannot only lend and borrow their crypto assets are customized terms but also have them settled in an automated fashion.  

CLST’s platform keeps track of all the crypto lending and borrowing deals that its users have ever performed. This way, credit histories exist and can be consulted by individual counterparties to better assess each other. And the in-built chat function helps counterparties to seamlessly communicate. Both features build trust and foster long-term engagement. Because of more effective communication and reporting that occurs in one place only, excel spreadsheets are no longer needed. This seriously reduces opaqueness. 

Mitigate Risks 

The automation of bilateral price negotiation and settlement on a consolidated platform also helps diminish credit and counterparty risks. The safekeeping and the provision of insurance through established triparty collateral management systems between borrowers and lenders is paramount to traditional money markets. Such triparty solutions are not present with crypto assets yet. CLST however is providing a one-stop-shop platform that allows borrowers and lenders to conduct their credit risk assessment and choose their counterparties carefully.   

This marks a crucial difference to decentralized finance. DeFi protocols offer a wide array of lending and borrowing possibilities. Contemporarily though, they are more of a retail phenomenon. They neither provide the trust nor the regulatory requirements that would make them deployable in a wider institutional context. For one thing, smart contract lending and borrowing protocols have technical risks that are difficult to calculate. For another thing, they lack transparency into counterparties. Since DeFi protocols gather funds from various unknown entities, an institution cannot reliably know, who it is interacting with. Such realities make borrowing or lending through decentralized finance projects commonly inaccessible for most institutions at present. 

Therefore, CLST is working towards the institutionalization of crypto money markets. With promissory notes provided by FQX, counterparty risk in uncollateralized lending is reduced through a legal framework represented on-chain. Because risks are mitigated, and trust is established, already a reasonable amount of institutional entities – crypto-native as well as traditional – are using CLST’s all-in-one platform. Through the ever-growing number of users on CLST’s platform, better pricing for crypto lending and borrowing ensues as more liquidity leads to better price quotes. The dawn of professional crypto money markets is upon us.  

Money Markets meet Crypto – Part II

Crypto needs a money market 

By now, the crucial importance of money markets should be obvious. And just as today’s traditional world of finance is dependent on money markets, the newly emerging asset class around crypto assets will need one too. After all, within the crypto industry, as institutions of all sorts are maturing, they are developing the same set of sophisticated market financing needs that traditional companies have had for decades.   

Consequently, the crypto lending market has grown significantly. According to a research report from Arcane, from Q3 2019 to Q4 2020, the total active collateral in the crypto lending market grew by 1170 percent3. And the most recent numbers from Q4 2021 show that one of the biggest crypto lending providers Genesis saw its loan originations reach $50 billion, an increase of 565% year-on-year comparison4.  

Genesis is only one of many companies that have emerged in the crypto lending space. Others are BlockFi, Unchained Capital, Ledn, Nexo, Celsius, Coinloan, or Salt Lending. There are also entities like Binance or other exchanges that act as lenders and borrowers of crypto assets. And even traditional players like Fidelity or Silvergate have ventured into crypto lending.  

Lending services play a crucial role in today’s crypto asset trading ecosystem. They are providing essential access to liquidity for various actors. Among them are firms with crypto-denominated liquidity requirements, actors that are looking for leverage, proprietary trading firms, or arbitrage funds. One of the biggest demanders of crypto lending services is market makers that make use of these crypto lending facilities as they borrow different cryptocurrencies and stablecoins for liquidity provision elsewhere. And even exchanges that do crypto lending themselves can act as borrowers if – for example – they don’t want to deplete cold storage funds to honor withdrawal requests. The same goes for miners that have Bitcoin-denominated cash flows and don’t want to sell their Bitcoin but borrow them to cover their operational costs. Last but not least, there are ever more companies that hold Bitcoin and other cryptocurrencies on their balance sheet. But instead of just keeping them idle, these companies want their Bitcoin to work for them. Hence, they lend them out for interest. This is a natural development as crypto gets bigger and bigger.

Crypto lending is highly tailored to the mechanics of money markets. Because Bitcoin is a fundamentally deflationary asset, not many businesses are interested in acquiring longer-term liabilities denominated in Bitcoin. Therefore, crypto lending has more in common with short-term securities lending and is thus a good match for money market operations. But there is just one problem today: No money market exists for crypto assets yet.  

Money Markets meet Crypto – Part I

Humans almost universally love to have money and interact on markets virtually every day. The money markets though – a place where money is being borrowed and lent continuously – are hardly known. If it were not for the global financial crisis of 2008, this part of our financial system wouldn’t even be known to wider circles within the financial industry itself.  

However, money markets are not just any part of today’s vastly complex financial system. Total money market funds make up $4.51 trillion1 in assets with a daily turnover of about $1.5 to 2 trillion. In terms of volume, this puts worldwide money markets just behind the global foreign exchange market, which is said2 to do up to almost $7 trillion in volume per day.  

This enormous size begs the question: What are money markets? They represent an essential component of financial markets as they allow for short-term financing. This means that money on money markets is usually lent and borrowed for up to two years in duration. On average though, the length of a money market trade is about one week to one month. Furthermore, money market trades can either be unsecured or collateralized with the latter commonly being referred to as repurchase or repo agreements. And in terms of assets, the most important ones within money markets are government bills, commercial papers, deposits, federal funds as well as short-lived mortgage- and asset-backed securities. Especially for short-term papers, it is due to money markets that short-term securities were commoditized and became an integral financing tool within financial markets.   

Functions of the money markets 

The borrowers and lenders on money markets are entities that have access to such wholesale markets. It’s institutions like banks, big corporate treasuries, or public authorities. Money markets today serve three main functions: 

  • Financing trade 
  • Financing industry
  • Financing banks  

Financing trade is one of the most important roles money markets play today and this is also how they emerged a long time ago. It already started with companies like the Dutch East India Company that needed to raise money for ships, so merchants and tradesmen could sail to foreign continents hunting for spices and other types of commodities. With ships financed through credit, these commodities were transferred back to Europe and sold for profits that would pay for the principal and interest. Up to this day, money markets still play a vital role in financing domestic as well as international trade.

Another important function of the money markets is to serve as a place for all sorts of industry actors to finance themselves. Through money markets, companies can secure short-term loans to meet their working capital requirements. Additionally, borrowing and lending conditions on money markets also influence conditions as well as the interest of long-term loans that are typically provided by the capital markets.  

The third pillar is the financing of commercial banks. Be it a regional bank or an international bank, they all tap into the money markets to finance or refinance themselves. This way, they can keep their liquidity levels at the required legal levels. When it comes to banks acting in the money markets, it usually boils down to one bank lending to another bank.  

The importance of money markets 

It cannot be understated: Money markets provide the necessary liquidity for the global financial system including capital markets. They make the world go round. Through a chain of agreements domestic banks – and almost any bank for that matter – are connected to the big money markets in the world. While they could theoretically tap into global money markets directly, in practice these so-called tier-2 banks go through other international tier-1 banks. The latter are globally spread out and have a direct connection to different money markets all over the world. As systemically relevant banks, these big banks generally act as liquidity providers for smaller banks, domestic corporates, and local public authorities.  

One can say that if money markets break down, the entire world would come to a standstill as liquidity would freeze up rather quickly. This has been particularly obvious with the great financial crisis of 2008 when central banks had to step in and backstop money markets because borrowing and lending among different banks – due to trust issues – dried up. The money markets truly are the cardiovascular system of finance and if they stop, blood circulation in this cardiovascular system stops with detrimental consequences.