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 This article was originally published in FinTecBuzz, 14 July 2022, and can be found here

Lending platforms are integral to the crypto market

Manoj Mistry, Managing Director, IBOS Association

Crypto currencies have had a rollercoaster year: record high valuations followed by precipitous falls mixed with intervals of stagnation as the market pauses for breath before deciding where to go next. This volatile performance has made big headlines, allowing bullish and bearish commentators to push their respective arguments – from the crypto bubble has burst to this is a huge buying opportunity.

The substance behind the hype is sobering, as the crypto bull market of 2021 morphed into a full-on crypto bear market in 2022: crypto asset values have consistently fallen by significant margins across the board. After a huge spike in valuations that peaked last autumn, the retrenchment was equally sharp. Bitcoin, the best-known crypto, has fallen by 70% since its November 2021 peak. Meanwhile, the aggregate value of the crypto market has tanked from $3trn+ to under $1trn.

Collectively looking for a tabloid phrase to describe this remarkable asset squeeze of falling crypto prices that have remained low, global media quickly settled on crypto winter – a sustained bear market that is now eight months old, creating problems for both crypto investors and the crypto platforms they use. During that time, the most prominent victim yet to emerge is the crypto lending platform, Celsius Network.

On 12 June, citing “extreme market conditions”, Celsius announced that it had immediately blocked its 1.7 m clients from making withdrawals, and undertaking swaps and transfers. Notwithstanding these restrictions, Celsius has continued to take some new client deposits.

In total, Celsius had lent out more than $8bn to these clients while it held nearly $12bn in assets under management. The New Jersey-based company recently hired Kirkland & Ellis for restructuring advice as it considers the various options, according to the Wall Street Journal. This contrasts with reported advice from its previous law firm, Akin Gump, which had suggested a potential bankruptcy filing instead.

On 13 July, the Celsius board announced that it had filed for Chapter 11 protection which might enable the company to survive by restructuring its debts and obligations under supervision from the court while it continues to operate. Inevitably, much attention will now be focused on a much wider group of crypto lending platforms which are an important engine in driving the growth of cutting-edge industry projects.

Although market contagion is unlikely to ensue, the Celsius difficulties will inevitably serve to undermine the embryonic crypto sector. The knock-on effect on lending platforms is concerning since they are essential to the development and evolving maturity of the wider crypto market.

Whatever Celsius’ fate, crypto lending platforms are critical for the long-term future of the digital asset market. The essential core business model of these lenders is similar to traditional consumer banks: the platforms take deposits from customers and then lend money out, primarily to institutional borrowers.

To entice consumers, platforms have offered attractive interest rates – typically, in the 7 to 15 per cent range – which are much higher than those offered by conventional banks and traditional investment vehicles. Potential high yields is another factor which has drawn millions of new investors into the crypto market, particularly over the past two years.

Crypto platforms use some of the deposits to finance new developments in the crypto sector. These include decentralised finance (DeFi) projects that replicate structures in the financial system, but without centralised authority or approval from a third party.

Blockchain technology that underpins smart contracts allows maintenance margins and interest rates to be programmed directly into a borrowing agreement. Liquidations are automatically generated in the event that an account balance fall below a collateral ratio specified by the smart contract.

Celsius’ difficulties and the broad-based decline in crypto asset values have brought renewed focus on the widespread absence of specific crypto regulation across multiple

jurisdictions, and where it does exist under current legislation, a lack of consistent application.

The constant refrain from global regulators is that more regulation is needed. Most recently, Bank of England deputy governor Jon Cunliffe, gave a speech in Singapore stating that regulators need to “get on with the job” of bringing the use of crypto technologies within the “regulatory perimeter.” In the US, no continuity yet exists between regulators: diverse laws are applied at a state level, although progress is being made towards developing federal crypto legislation.

Cryptos are not regarded as legal tender by The Financial Crimes Enforcement Network (FinCEN), but crypto exchanges are seen as money transmitters on the basis that crypto tokens provide “other value that substitutes for currency.” Notably, the Internal Revenue Service (IRS) defines crypto as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value” – the commonly used characteristics of money.

Despite a dearth of crypto-specific regulation, compliance still applies using a broad range of definitions. US crypto exchanges, which fall under the scope of the Bank Secrecy Act (BSA), have to register with FinCEN, implement an AML/CFT programme, keep appropriate records, and submit relevant information to the authorities. Meanwhile, the US Securities and Exchange Commission (SEC) which regards cryptocurrencies as securities, applies relevant securities laws to digital exchanges and digital wallets, whereas the Commodities Futures Trading Commission (CFTC) defines Bitcoin as a commodity and allows cryptocurrency derivatives to trade publicly.

The absence of crypto-specific regulation and continuity between different jurisdictions may be seen as an impediment, but it seems likely that robust regulations will soon arrive on both sides of the Atlantic. In the meantime, investors have other risks to consider, such as hacking, fraud and design faults. Once regulators, lawyers and cyber security experts deal with the assorted challenges, lending platforms will remain integral to developing the crypto and DeFi markets that will be critical to our digital future.