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Are Crypto Lending Platforms Safe?

Are Crypto Lending Platforms Safe? Let's compare them to each other and let's compare them to the traditional banking. Which is more safe?
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Crypto lending has emerged as a part of the blockchain-based financial system, but is crypto lending safe?

The yearly crypto lending volume exceeded 40 billion USD in 2019, The market is growing 25%-35% quarter to quarter. 

Following key questions are analyzed in this webinar:

  • What are the key segments of this market?
  • How do these key segments work?
  • Are crypto lending platforms safe?

Our Webinar Series

We started with the regular webinar series with the focus on the blockchain, crypto lending, and coronavirus economic crisis. We host the webinar every Sunday, 15:00 CET (Central European Time):

Webinar

Here is the recording of the webinar:

Takeaways

Key use cases in the Crypto Lending

  1. 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
  2. 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 10%-15% of the market
  3. Crypto economy – borrowing crypto for using it in the crypto- sphere – 5% -10% of the market

Market segments

There are 3 main channels for crypto lending:

  1. Crypto Borrowing / Lending via the Crypto Exchanges for margin trading
  2. Custodial Lending Platforms (Nexo, Celsius, Genesis Capital) – they control your private keys (i.e. they control your assets)
  3. Non-Custodial Lending Platforms (Maker, Compound, Ethlend, SmartCredit.io) – the do no control your private keys (i.e. they do not control your assets)

Crypto exchanges are the biggest player in this market. They are offering 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.

Crypto lending market size

The estimated market size is the following.

Crypto Loan Originations in 2019
Crypto Loan Originations in 2019

The market size for the crypto exchanges is based on the Bitfinex lending statistics (which is publicly available), it’s circa 500 million USD loan originations at the moment. Let’s calculate with 20 biggest exchanges offering the margin borrowing/lending, let’s calculate with their active loans of 300 million USD and let’s calculate with 4 originations per year. This would result in the 4 x 20 x 300 = 24 billion USD originations per year.

The market size for the custodial solutions is based on the self-declared numbers.

The market size for the non-custodial solutions is based on the loanscan.io statistics.

Risks in the platforms

Crypto exchanges based lending is facing general hacking risks (MtGox, Bitfinex, …). They are responding with using the hot wallet / cold wallet strategies.  90%-95% of the crypto assets will be kept in the cold wallets, where the access is possible only with operational procedures. In the hot wallets, the multi-signature technologies will be used. Additionally, they do have operational risks, mainly the “employee risks”, where the employees might use the private keys or other data for their advantage.

Custodial lending platforms are with their risks similar to the crypto exchanges – they face the hacking risks and operational risks. The hacking risks will be mitigated with the multi-signature wallets (BitGo has established himself as a standard in this sector). The risks are smaller in case of the fiat lending – the crypto assets would not leave the platform in this case. In the case of crypto-to-crypto lending, the risks are higher, because the coins are just moving more around.

Custodial lending platforms do not face operational risk because the assets will be kept in the smart contracts, where the entry and exit criteria are described via the source code. There is the hacking risk for these smart contracts, but, as there is a multitude of security scanning systems available, and the experience of the developers is growing, then the respective risk is continuously reducing.

Risks in the next best alternative

The next best alternative to crypto lending is to use good old traditional banking. However, how safe is the traditional banking? The Credit Default Swaps (CDS) might give a clue. Here is a table with the CDS prices for the European banks (before the coronavirus crisis started):

Bank CDS prices
Bank CDS prices

Let’s think here on the UniCredit – the CDS price is 2.35% per year. This means the CDS buyer has to buy every year 2.35% to protect from the credit-events. CDS price is similar to the default probability. This results in the UniCredit 2.35% default probability within one year, however, within the five years it will be 11% (just some probability calculus). However, these CDS prices are from the pre-coronavirus crisis. See more about our forecast on how the coronavirus crisis will play out.  The CDS prices will skyrocket and the probabilities of the bank failures will skyrocket too.

This leads to the question – is the crypto lending safer than bank lending? Our viewpoint is that when we factor in the coronavirus crisis, then yes, the bank lending risk is higher than the crypto lending risk.

Summary

The Crypto lending market has developed to the size of 40 billion USD loan originations in 2019. Several subtypes exist and all of them have developed their security and operational procedures. The development of these procedures has significantly reduced platform risks. In parallel, the risks in the traditional banking sector are increasing, especially because of the coronavirus economic crash.

To answer the question from the beginning – are the crypto lending platforms safe? Yes, they are now.

Additional information

For more information check out the related articles from the SmartCredit.io blog:

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