Bear markets are much more brutal for crypto lenders than cryptocurrency firms that don’t leverage users’ deposits, according to one Bitcoin analyst.
The ongoing bear market on cryptocurrency markets is too harmful to industry lenders but the concept of crypto lending can still survive the bloodbath, according to some industry experts.
Cryptocurrency lending is a type of crypto services allowing borrowers to use their crypto assets as collateral to get loans in fiat currencies like the U.S. dollar or stablecoins like Tether (USDT). The practice allows users to get money without having to sell their coins and repay the loan at a later date.
According to Josef Tětek, Bitcoin (BTC) analyst at the crypto cold wallet firm Trezor, crypto firms that run their business on a fractional-reserve basis are exposed to greater risks during bear markets.
In traditional banking, the fractional-reserve model is a system where only a fraction of deposits are backed by actual cash. Crypto lending companies are “definitely running a fractional-reserve business” to provide yields to their customers, according to Tětek.
“Exchanges and custodians that run on a fractional-reserve model are playing with fire. This practice may work fine during bull markets when such companies experience net inflows and grow their customer base,” the executive stated.
According to Tětek, sharp declines in cryptocurrency prices are more bearable for crypto businesses that do not provide lending services and do not leverage users’ deposits. This allows them to survive the domino effect of falling prices and companies going under.
“If you throw in leverage — trading with borrowed funds — the losses are often much more painful, especially with sudden price moves,” Tětek noted.
In order to survive the ongoing crypto lending crisis, cryptocurrency lenders need to solve a major issue related to short-term assets and short-term liabilities, the analyst argued, stating:
“Crypto lending as a concept can survive this crisis, but the sector needs to get rid of the maturity mismatch problem: if someone else borrowed my assets and I get a yield as a return, then I have to wait for the borrower to repay before I can withdraw.”
Tětek went on to say that liquidity issues are inevitable for lenders that promise full liquidity on assets that are lent out at the same time.
“Every participant needs to respect the risks involved and the fact that there are no bailouts in the space, so if a borrower fails to repay, a lender has to accept their loss. There is no risk-free yield, and often the yield is not worth the risks,” he added.
The crypto lending industry has been facing one of its biggest historical crises amid cryptocurrency prices dropping to 2020 levels, with the total market cap shrinking more than $1 trillion since the beginning of the year.
Celsius, a major global crypto lending platform, suspended all withdrawals on its platform on June 13, citing “extreme market conditions” as its native CEL token lost about 50% of its value. Hong Kong-based asset manager and crypto lender Babel Finance also temporarily suspended redemptions and withdrawals from its products on June 17 due to “unusual liquidity pressures.”