Pitfalls of Crypto Lending III - Counterparty and Collateral Risk
  • Company
    • About Us
      Who and Why
    • Media & Press
      Media & Press
    • Contact Us
      Reach Out
  • Insights
    • Blog
      Inform
  • Request Demo
  • Sign In

Getting access usually takes 5 minutes to complete.
Please note you will need a few business documents on hand to complete the KYB process.
Start Now Request a Demo instead

Crypto lending pitfalls Part III

July 21, 2022

Pitfalls of conventional crypto lending

Continued from Crypto lending pitfalls Part I and Part II and covering the topics of counterparty and collateral risk.

Be aware of counterparty and collateral risk

Apart from the fact that the general concept of yield is on rather shaky ground when it comes to DeFi, there are other tangible risks with crypto lending. For one, there is undetectable counterparty risk. When lending to a DeFi protocol, the lender does not know his counterparty because the DeFi’s asset pool represents a sort of omnibus account any party can borrow from. For a lender that needs to know his counterparties – not least because of regulation – not knowing one’s counterparty is an unacceptable risk.

Another elevated risk is that of collateral availability. Some crypto lending is collateralized lending. Borrowers need to over-collateralize the loan they are taking out. In the event the borrower defaults on his loan, the collateral provided acts as a cushion and security fallback for the lender. When it comes to DeFi protocols though, the question is: Collateral that winds up being locked in protocol, what mechanisms make sure the lender has access the collateral?

In the case of BlockFi, such collateral availability seems to have been the problem. It appears that the lending company had  a substantial amount of collateral from 3AC, which was itself invested in DeFi protocols. Although the collateral was above 100% it was mainly illiquid and hard to sell. So, while BlockFi managed to liquidate 3AC’s $1 billion of collateral, the lender still incurred a small loss.

Crypto lending risks reconsidered

We now have unfortunate but corroborating proof that crypto lending with DeFi protocols – as it is done by some CeDeFi players – is not only unsustainable but carries extreme tail risk. In the case of Terra, its demise can ultimately be traced back to its DeFi lending and borrowing protocol Anchor. By guaranteeing an astonishing APY of 20% during times of collapsing market yields, the DeFi protocol gradually but inevitably morphed into a Ponzi scheme.

As a matter of fact, UST barely had any other use case apart from serving as depository asset on Anchor. At its height, Anchor held more than $14B of UST, and became the sink for almost all of the UST in existence. This entailed circularity on the part of UST and Anchor. Once the high yields could not be sustained any longer, the house of cards would collapse as it did.

The existence of collateral risk the other hand was manifested in the case of Celsius. With its operations halted, it is very much the case that the collateral backing outstanding loans on Celsius is inaccessible. The issue is: what does collateral help if it cannot be accessed properly?

Furthermore, the Celsius case also highlighted the liquidity risk that is present in any crypto lending activity. As a major source of yield, the CeDeFi company staked their customers’ ETH as stETH on Lido Finance, Ethereum’s most prominent staking platform. With ETH being locked, whenever Celsius customers withdraw ETH from their accounts, the crypto lending company had to sell stETH on the open market for the corresponding amount of ETH.

When the stETH/ETH pair depegged, liquidity began to cease and Celsius was not able anymore to use their stETH to buy ETH because of a lack of market demand for stETH. This caused concerns about Celsius turning illiquid as the company could be unable to meet its Eth redemption demands. With funds being withdrawn from the platform, the CeDeFi company recently halted withdrawals altogether.

Professional crypto money markets to the rescue

As these last few weeks and their tangible problematic instances show, the crypto lending will have to change. For one thing, the introduction of a more clear-cut and binding regulation will do its part. Beyond regulation, it is time for professional crypto money markets to stand up.

CLST is building the necessary new money markets for this newly emerging money. The company was established a year ago based on the fundamental principle to establish a peer-to-peer institutional lending and borrowing venue for crypto market participants.

CLST addresses the inherent risks of counterparty invisibility in which lenders and borrowers directly face the counterparties. This fact forces risk management departments to assess their financial situation. It is CLST’s foremost goal to establish a money market for the new money in collateralized and uncollateralized transactions.

To read more about what professional crypto money markets look like, check out this previous post.


Welcome to CLST

At CLST, we are establishing a network of lenders and borrowers to become the institutional gateway for uncollateralized lending.

Related articles

Blog

Weekly Insights: January 9th-13th 2023

January 16, 2023
Blog

Key lessons from the retail crypto crisis of…

October 25, 2022
Blog

The Ultimate Guide to Stablecoins

September 26, 2022

NEW MONEY MARKETS

We create markets for the new money.

At CLST, we are establishing a network of lenders and borrowers to become the institutional gateway for collateralized and uncollateralized lending.

Company

  • About Us
  • Media & Press
  • Contact Us
Request Demo

Insights

  • FAQ
  • Glossary
  • Blog

Legal

  • Terms & Conditions
  • Privacy Policy
  • Cookie Policy
©2022 CLST. All Rights Reserved.
Get Access
  • Company
    • About Us
      Who and Why
    • Media & Press
      Media & Press
    • Contact Us
      Reach Out
  • Insights
    • Blog
      Inform
  • Request Demo
  • Sign In
Privacy and Cookies Policy
We use cookies on our website to give you the most relevant experience by remembering your preferences and repeat visits. By clicking “Accept All”, you consent to the use of ALL the cookies. However, you may visit "Cookie Settings" to provide a controlled consent.

Read More
Cookie SettingsAccept All
Manage consent

Privacy Overview

This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
Necessary
Always Enabled
Necessary cookies are absolutely essential for the website to function properly. These cookies ensure basic functionalities and security features of the website, anonymously.
CookieDurationDescription
cookielawinfo-checkbox-analytics11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Analytics".
cookielawinfo-checkbox-functional11 monthsThe cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional".
cookielawinfo-checkbox-necessary11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookies is used to store the user consent for the cookies in the category "Necessary".
cookielawinfo-checkbox-others11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Other.
cookielawinfo-checkbox-performance11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Performance".
viewed_cookie_policy11 monthsThe cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. It does not store any personal data.
Functional
Functional cookies help to perform certain functionalities like sharing the content of the website on social media platforms, collect feedbacks, and other third-party features.
Performance
Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors.
Analytics
Analytical cookies are used to understand how visitors interact with the website. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc.
Advertisement
Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. These cookies track visitors across websites and collect information to provide customized ads.
Others
Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet.
SAVE & ACCEPT
CLST logo.
  • Company
    • About Us
      Who and Why
    • Media & Press
      Media & Press
    • Contact Us
      Reach Out
  • Insights
    • Blog
      Inform
  • Request Demo
  • Sign In