The focus of this article is the Nexo review. In our previous blog article, we analyzed the crypto lending market. This article here will review Nexo based on our crypto lending analysis framework from this previous article. Nexo is the first product to be analyzed, other crypto lending products will follow.
- Gives an overview of the crypto lending market
- Nexo review will follow
- After that, we focus on the Nexo regulatory analysis
- In the end, we look at the difference between Nexo and SmartCredit.io
What is the crypto lending market?
We look in the following on the market dynamics.
Crypto lending market segmentation
There are 3 main channels for crypto lending:
- Crypto Exchanges margin lending/borrowing. Crypto exchanges are the biggest player in the lending market. They offer the margin lending – that’s for the traders, which can leverage their positions via the margin lending. For example, the trader puts down 1 Bitcoin as collateral, he borrows 3 Bitcoins against this collateral and he has to pay daily interest for these 3 Bitcoins. This will take a long position with these 3 Bitcoins. When the market goes up, then the trader will earn a profit. However, when the market goes against his trades, then the traders’ positions can be liquidated.
- Custodial Lending Platforms (Nexo, Celsius, Genesis Capital) – they control your private keys (i.e. they control your assets). Some of them lend fiat (Nexo) and the others lend crypto (Celsius)
- Non-Custodial Lending Platforms (Maker, Compound, Ethlend, SmartCredit.io) – they do no control your private keys (i.e. they do not control your assets). The assets are kept in the smart contracts, which are un-accessible for the platforms. These smart contracts define when the collateral is moving back to the borrower or not. That’s the huge difference to the segment (1) and segment (2), which both control client assets.
Key use cases for crypto lending
- Using loans for trading – ca 80% of the market will feed into the crypto exchanges. Traders use their collateral to get the loans, because either the crypto exchanges do not support these collaterals or traders get better terms via crypto lending
- Liquidity creation – instead of selling crypto, which in most countries would be a taxable event, the users would rather monetize their crypto-assets via using them as collateral for the loans. This is approximately 15% of the market
- Crypto economy – borrowing crypto for using it in the crypto- sphere – 5% of the market
We estimate the market size of custodial and non-custodial lending platforms ca 20 Billion USD.
- Graychain estimated in Q2 2019 the crypto lending market size as 4.7 Billion USD (Source: https://reports.graychain.net/TheCryptoCreditReport-q2-2019.pdf)
- Celsius has originated loans for 4.25 Billion USD in 2019 (Source: https://www.prnewswire.com/news-releases/celsius-hits-4-25-billion-in-originated-crypto-loans-setting-the-bar-for-crypto-lending-industry-300956493.html)
- Genesis Capital did loans of 3.1 Billion USD in 2019 (Source: https://genesiscap.co/insights/q4-insights-2019/)
This results approximately in 20 Billion USD market size.
Nexo Review – Statistics
Here are some statistics from the Nexo website:
- 1.5 Billion USD loan volume
- 200+ jurisdictions supported
- 45+ fiat currencies supported
Nexo review – Platform Analysis
Here are the key parameters for the classification of the crypto lending platforms:
Here is how Nexo fits into this framework:
Custodial Crypto Lending – Nexo is a custodial platform, it controls client assets. Additionally, it manages client assets actively – it lends them out to earn the interest. It is not clear is Nexo doing re-hypothecation or not (lending as well the collateral of the loans for earning the extra interest). However, some indicators show that Nexo is doing re-hypothecation – the rate for the lenders is sometimes higher than the rate the borrowers are paying.
Risk Analysis – The key risks are related to the custodial assets (see later) and the regulatory situation (see later)
Fiat loans – Nexo is providing fiat loans against crypto collateral. These fiat loans are provided just in time, which means Nexo must have the fiat pool behind.
Crypto loans – Nexo is providing crypto loans against crypto collateral
Crypto Credit Score – There is no evidence of credit scoring, the credit risk management is based on the collaterals
Money Market Fund – Nexo offer’s kind of money market fund functionality, where the crypto depositors will earn interest on their holdings.
Fixed Income Fund – Not available
Variable interest rate daily loans – interest rates are fixed
Low collateral ratio – collateral ratio is rather high. crypto lending is collateralized lending. If the borrower has low collateral ration, then the borrower can borrow more on his given asset basis. See more in “Why borrowers need low collateral ratio?“. A low collateral ratio makes the crypto loans more attractive for the borrowers. As the market is driven by the borrowers, then this is the key feature for the borrowers. See more in the “Why is the collateral ratio so high in DeFi?”
Large choice of collateral – Nexo offers more choice than the DeFi platforms. It is focussing on the key crypto assets.
API – Custodial platforms are not able to provide Credit As A Service API’s – because all assets have to be transferred into their platforms first …
Loan Transferability – Custodial platforms do not offer loan transferability. The alternative would be a bond-like structure of the loans, which would make the fixed term loans transferable. This offers then the possibility to package the loans into Fixed Income Funds. Additionally, it allows transferring the defaulted loans to the loan liquidators, which would deal with the legal side of defaulted loans.
Regulations – below is a further analysis of Nexo and different regulations
Nexo Business Model
Nexo Business Model can be summarized as follows:
Here is the summary:
- Crypto Lenders deposit their crypto into the platform
- Fiat Lenders deposit their fiat into the platform
- We assume Credissimo fiat pool is included for providing instant fiat loans
- Crypto Borrowers can borrow from the Crypto Investment Pool. It’s possible that OTC contracts are used with institutional investors
- We suspect that Crypto Collateral is lent out as well to earn the extra interest to the lenders (lending rates are higher than the borrowing rates)
This business model means the following:
- Nexo is pooling client assets into Investment Fund and actively managing this Investment Fund
- The Lenders (often retail investors) can be looked like investors into this Investment Fund
Nexo review – Risk analysis
We did a general risk analysis of crypto lending platforms in our blog article Risk Analysis of Crypto Lending Platforms. Following risks should be mentioned by Nexo:
- Risks related to the custody of Crypto Assets
- Risks related to the regulatory setup of Nexo
- Re-hypothecation of the assets
Custody of Assets
Nexo is using BitGo multi-signature wallets. BitGo has insurance of 100 mUSD on the assets, which are managed via BitGo. Let’s look on this in detail:
- Nexo says it has 100 mUSD assets insured. However, this insurance is not per BitGo client, but for all BitGo clients. If for example, the BitGo client A is getting hacked for 30 mUSD, and let’s assume after that client B is getting hacked for 120 mUSD the next day, then client B will receive only 70 mUSD (100 – 30)
- The assets above 100 mUSD are not insured as Nexo has not ordered any additional insurance from BitGo (BitGo clients can do so)
- BitGo insurance applies only if:
- Assets are kept in the BitGo cold wallet, insurance does not apply on the hot wallet
- All private keys are controlled by the BitGo team (Nexo shall not have any keys to the cold wallet)
- Transfer transactions from cold wallet to other addresses take ca 24 hours – these transactions are executed by following special operating procedures by BitGo team
The lending business is inherently connected with the transfer of the assets (of underlying and collateral). Nexo is custodial, but he cannot keep all assets in the cold wallet:
- If Nexo is providing fiat loans against crypto, then these crypto-assets can be in the cold wallet
- Assets sitting idle in the Nexo wallet can be in the cold wallet
- But crypto assets used for earning interest on crypto cannot be in the cold wallet – because these assets will be lent out to someone else and will be transferred to someone else
As a summary – the insurance is cumulative over all BitGo clients and applies only for the assets kept in the BitGo cold wallets.
Re-hypothecation of the assets
Re-hypothecation means that the service provider is using the client’s assets for earning additional revenues. BlockFi crypto lending platform states for example that it uses re-hypothecation. For example, BlockFi can use the borrower’s collateral and lend it further.
Re-hypothecation works fine in a positive scenario. The issues will appear when something in the chain fails. If BlockFi is lending collateral to the next borrower, which will default – what will happen then?
Nexo has not made any statements about the use of re-hypothecation. However, as the lender interest rates are sometimes higher than the borrower interest rates, then it looks like re-hypothecation is used.
Nexo Review – Regulatory Analysis
Nexo legal entity
Nexo “Terms and Conditions” are not stating under rules of which jurisdiction is it acting, it only refers to the “Nexo jurisdiction“, which refers again to “Nexo jurisdiction“. This means the jurisdiction is not defined.
Crypto Wallet license in Estonia – Nexo Services OÜ
Nexo is controlling the client’s virtual assets and falls therefore under the European Anti Money Laundry Directive 5 (AMLD5) and will need a crypto wallet license. There is no reference on the Nexo website to the crypto wallet license.
However, there is a company Nexo Services OÜ, incorporated in Estonia and the possession of the crypto wallet and crypto exchange license. However, there is no reference to this company on the Nexo website.
Nexo is not authorized in Estonia
Although Nexo has a crypto wallet license in Estonia, the Estonian regulator has not authorized Nexo services in Estonia.
Practically the regulator is stating that the Credissimo (the partner company of Nexo) does not have a license to grant credit and Nexo does not have a license to intermediate the credit (Nexo would intermediate the P2P fiat loans from the Credissimo against the crypto collateral).
Nexo services are disabled in Estonia – it’s not possible to access Nexo with Estonian IP address.
Nexo is not authorized in Bulgaria
Nexo and Credissimo share the same owners. Credissimo developed his business in Bulgaria. Nexo has a development and operations center in Bulgaria. However, the “Terms and Conditions” state that Bulgarian residents are not allowed to use the Nexo services. If looking on the website of Bulgarian National Bank, then one can see, that Nexo or Credissimo are not listed in the list of financial institutions or credit intermediaries.
Nexo AG in Switzerland
Nexo AG is registered in Switzerland, but it’s not a FINMA (Swiss regulator) regulated entity and it’s not a member of self-regulatory organizations.
Nexo dividend-paying token
Nexo token is dividend-paying. Although a good idea, it has several side-effects.
- One of them is that dividend buying tokens are securities by the SEC definition and by the EU regulators definition. Additionally, it requires that exchanges, which will list the Nexo token, will have the broker-dealer-license. This is not the requirement for the utility tokens, where dividend or token buybacks are not allowed.
- Another side-effect is that financial institution license needs clear ownership structure (and KYC plus AML of all the holders), however, this might be quite challenging with so widely distributed Nexo token.
We suspect that the dividend-paying token is behind the regulatory cat-and-mouse game (i.e. fuzzy regulatory structure). We hypothesize that by fixing the issue with the Nexo token, i.e. by converting it into the utility token, one could create a more robust legal setup of the company.
Financial Institution Licence
Nexo states on the website that they do have a European Financial Institution Licence. However, there no reference to the country where the license has been acquired. Neither is it clear which license is acquired.
However, as Nexo and Nexo’s partner Credissimo should be incorporated in the EU, then we looked at the ECB financial institutions database. We couldn’t find any references to “Nexo” or “Credissimo” in this European Central Bank database (as per 29.06.2020).
There are three types of credit institutions:
- Credit institutions, also known as banks – they can take the deposits from the consumers and they can issue the credit-money
- Credit Providers – they can give credit with their own money (for example via bond issuing) or from pooled client money
- Credit Intermediaries – they intermediate the credit from the Credit Institutions and Creditor Providers to the consumers
As Nexo is issuing fiat loans against the crypto assets, then they need to be licensed at least as Credit Intermediary if not Credit Provider. Additionally, when providing services to other European Countries, they should register (passport) in every EU country, where their clients are located. However, this registration might be challenged, as there is no jurisdiction or no legal entity visible on the Nexo website.
Requirements to Financial Institution Licence
Nexo lists on the web page several requirements for the Financial Institution Licence:
- Adequate operational capital
- An internal and external auditor
- AML policies and procedures
- Data protection and security
It is unclear why does Nexo lists these requirements because Nexo or Credissimo are not included in the ECB financial institutions database at the moment of writing this article.
Summary of required licenses
Nexo would require following licenses for his business:
It looks like Nexo is accepting crypto and fiat deposits (both need licenses). It looks like Nexo is running an Investment Fund by actively managing pooled client assets (the Investment Fund and Investment Fund Operator need licenses). It looks as well that an additional license for Credit Intermediary or Credit Provider is required.
Providing cross-border services to 200 countries
Nexo claims to provide services to 200 countries. However, it’s not so easy. Providing credit is regulated business, but doing marketing and onboarding the clients for the credit providers is regulated in most jurisdictions as well.
That’s the topic of cross-border banking services. Every jurisdiction has rules for:
- Can credit providers from other jurisdictions do marketing for their services? Usually, they cannot …
- Can credit providers from other jurisdictions onboard consumers for their services? Usually, they cannot …
- Can credit providers from other jurisdictions offer services to the consumers? Usually, they cannot …
Strictly speaking – Nexo should register in every jurisdiction for providing credit services to the consumers. But as Nexo’s legal entity is unclear at the moment and it’s not clear in which jurisdiction it operates, then this registration might be challenging.
Difference Nexo and SmartCredit.io
Here are the key differences:
- Nexo is a custodial solution, where SmartCredit.io is a non-custodial solution
- Nexo offers fiat against crypto, SmartCredit.io does is only for crypto-to-crypto borrowing and lending
- Nexo offers crypto deposit accounts with interest, SmartCredit.io offers Fixed Income Funds
- Nexo offers a wide choice of classic blockchains as deposits/collateral, SmartCredit.io focuses on the Ethereum based tokens
- Nexo offers rather high collateral ratio for the borrowers, SmartCredit.io offers a rather low collateral ratio
- Nexo loans are not transferable (but Nexo deposits can be canceled ad hoc), SmartCredit.io loans are transferable
- SmartCredit.io has as well the Fixed Income Fund functionality, which will invest based on the investment rules
We looked in this article on the Nexo crypto lending platform review. Nexo platform provides many good features to their clients, however, we identified as well some risks. These risks are especially in the regulatory side of the business.
Our view is that many of these risks are caused by the custodial business model, and especially by lending fiat against the crypto collateral. Both of them cause many regulatory issues, which are challenging to be solved. The impacts of this challenge are visible in Nexo’s regulatory challenges.
SmartCredit.io, on the other hand, is fully non-custodial and has no access to the client’s funds. This results in much simplified regulatory requirements.
For more information check out the related articles from the SmartCredit.io blog:
Top Crypto Lending Platforms for Fixed Income (Guide)
Why Borrowers need Low Collateral Ratio?
Blockchain-based financial system – Are we ready?
Why is Collateral Ratio so high in Defi?
Risk analysis of crypto lending platforms
Why is DAI interest rate 10% in Defi
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