After the Bitcoin flash crash, is the cryptocurrency lending business still viable?

On March 12, Bitcoin experienced a flash crash, with the price falling from a high of $7,980 to $5,555. On March 13, Bitcoin continued to fall, from a high of $6,230 to a direct break through $4,000, and a low of $3,800.

On March 14, the cryptocurrency lending institution Genesis Capital asked borrowers to provide more collateral. Almost at the same time, the Gate.io exchange announced that the annualized interest rate of USDT in its financial lending market had been reduced to 10%.

Affected by the flash crash of Bitcoin, the cryptocurrency lending business is facing a crisis.

On March 16, Guosheng Securities released a research report stating that in 2019, financial institutions began to appear in the market to engage in digital currency pledge lending. Driven by leverage, the currency market presented a certain false "prosperity". The current drop in currency prices is a process of market deleveraging.

Coincidentally, some media pointed out that under extreme market conditions, lending in the OTC market will incur a higher risk of default, and believed that the crypto lending industry may be reshuffled.

A series of opinions have successively downplayed the future development prospects of cryptocurrency lending.

What impact does this Bitcoin flash crash have on the cryptocurrency lending business?

Cryptocurrency lending during Bitcoin flash crash

As a derivative industry of cryptocurrency, the development of lending business is closely related to the rise and fall of currency prices.

Graychain, a crypto credit rating startup, recently released a report on cryptocurrency lending in 2019. The report pointed out that overall, the cryptocurrency lending business developed healthily in 2019, but it can also be clearly seen that in the third quarter when the price of the currency was low, the development of the lending business also shrank.

"It is inevitable that bear markets will be difficult to do business in, not to mention the big dive this year."

RenrenBit CMO Zi Cen told DeepChain that when the market is bullish and the demand for loans is strong, the annualized interest rate for loans can even reach 24~48%. There are even cases where the annualized interest rate of some exchanges has skyrocketed to 50% and it is still impossible to borrow USDT.

“In a bear market, it’s the exact opposite.”

According to data from the RenrenBit platform, from July 2019 until the Bitcoin flash crash, RenrenBit's reserve amount had been steadily increasing, and after the Bitcoin flash crash, it began to fall sharply.

If we say that during the bull market, the cryptocurrency lending sector has always been in short supply, then in the current cold winter, there are more idle cryptocurrencies with no one to borrow.

“In a bear market, everyone is in danger. Who would be willing to borrow money on a large scale? Moreover, after the flash crash of Bitcoin, the mentality of the entire cryptocurrency circle has been shaken.” Liu Liang told DeepChain.

Sun Kun (pseudonym) is one of the typical representatives.

According to Sun Kun, he had previously been a large deposit and loan demander on a certain trading platform. However, affected by the collapse of FCoin and the flash crash of Bitcoin, he took out and cashed out his Bitcoin after his deposit certificate expired.

“If the FCoin crash shook my confidence in exchanges, then the halving of Bitcoin has shaken my confidence in the entire market.”

As funds leave the market, the demand for borrowing money within the industry also declines.

"If no one is willing to borrow money, then users who deposit coins for lending can only lower the interest rate," said Liu Liang.

Gate.io is a good example.

In addition, the field of cryptocurrency lending is also accompanied by the situation that money is more difficult to borrow.

On March 14, Genesis Capital added $100 million in collateral to contracts of about 40 of its clients. Its CEO Michael Moro said that Genesis Capital plans not to provide services to any user with less than 100% collateral until the market calms down.

In addition to the difficulty in borrowing money, the cryptocurrency lending business has also encountered other development difficulties in the bear market.

On March 18, cryptocurrency lending service provider BlockFi announced that it would increase the holding interest rates for Bitcoin and ETH from April 1.

In Liu Liang's view, BlockFi's move is to retain users on the platform and prevent more funds from flowing out of the platform.

In addition, another cryptocurrency lending platform, Morecoin, chose to use subsidies to offset the series of negative effects caused by the Bitcoin flash crash.

Affected by the plummeting currency prices, decentralized lending products such as MakerDAO are also facing challenges.

Since last week, the price of Ethereum has also plunged significantly, which has triggered a rapid increase in gas fees on Ethereum, causing tremendous pressure on the Maker protocol, community, Maker Foundation and the entire Ethereum ecosystem.

On Ethereum, a large number of loans fell below the collateral threshold, triggering the liquidation process. Due to the abnormality of the liquidation mechanism, about 33.6% of liquidators won the auction of the Ethereum collateral liquidation process with a bid of $0 DAI (that is, the auction was completed for free).

To this end, on March 16, the Maker Foundation launched an executive vote to add a collateral auction circuit breaker mechanism on March 17, and reduce the DAI deposit rate from the current 4% to 0%, while the borrowing rate will be reduced from the current 4% to 0.5%. In addition, the security response time will be extended to 4 hours to be able to respond to emergencies more calmly.

“DeFi needs to go through multiple baptisms before it can get better,” Yang Zhou, co-founder of PayPal Finance, told DeepChain. “DeFi has been hit hard by the liquidation mechanism this time, but it will also allow DeFi to grow further.”

In addition to the DeFi field, Yang Zhou also believes that for the lending business, an important revelation of this decline is the importance of risk control.

"This includes introducing professional financial trading talent and using hedging tools in the market to manage the risk of a sudden and sharp drop in asset prices."

Where does the cryptocurrency lending trend come from?

Cryptocurrency lending emerged in 2017. It refers to the practice of users pledging their cryptocurrencies to lending platforms, which then issue cryptocurrencies or legal currencies to users in a certain proportion and charge interest.

Liu Liang said that generally speaking, cryptocurrency players may encounter a shortage of funds and sell their cryptocurrencies. However, due to the huge fluctuations in the cryptocurrency market, these people often have to pay a higher price when they want to buy back cryptocurrencies.

The cryptocurrency lending business has therefore emerged.

From foreign BlockFi, Salt Lending and Genesis Capital to domestic PayPal Finance and RenrenBit, as well as decentralized lending platforms such as MakerDAO, DYDX and Compound.

In addition, various exchanges such as Huobi, OKEx, and MXC have also launched cryptocurrency lending businesses.

Liu Liang said that in the past two years, a new project was born almost every day. The reason why the cryptocurrency lending business has gained popularity is largely due to its unique advantages compared to traditional lending.

Generally speaking, in the traditional lending field, if a user defaults, there will be high execution costs.

Crypto lending can use smart contracts to make the entire process open and transparent, which is not only convenient but also highly secure. In addition, the collateral is cryptocurrency, so even if the user defaults, the platform can still obtain profit protection by selling cryptocurrency.

As a result, cryptocurrency lending has been favored by many users in the industry, especially high-net-worth customers such as miners.

However, although cryptocurrency lending is a good business, there are always hidden problems and risks.

Risks and Challenges of Cryptocurrency Lending

In addition to being affected by market conditions, the security and stability of centralized cryptocurrency lending businesses have also been questioned because investors cannot be sure whether the platform will run away in extreme circumstances.

Decentralized lending products such as MakerDAO have, to some extent, solved some of the pain points of centralized lending business, but they are not perfect.

As the most mainstream decentralized stablecoin issuance method in the DeFi field, the biggest problem with the MakerDAO model may be that it will accelerate the bubble when the currency price rises, and it is very easy to fall into a liquidity crisis when it falls.

Another point is that due to the limitations of the basic performance of the Ethereum network and the high probability of on-chain congestion in extreme market conditions, the execution efficiency of MakerDao smart contracts is greatly limited, and black swan risks are very easy to accumulate.

In addition, from a legal perspective, there are also some controversial points in the cryptocurrency lending business.

Zhang Ling, a partner at Hanyi Law Firm, once wrote that in the legal context of my country, only things that are defined as "things" by law can be pledged. Whether cryptocurrencies are "things" is still undecided.

In addition, for cryptocurrency staking, lending companies often take some risk control measures, and forced liquidation is one of them.

According to Article 211 of the Property Law, before the expiration of the debt repayment period, the pledgee shall not agree with the pledgor that the pledged property will belong to the creditor if the debtor fails to repay the due debt.

However, forced liquidation, a risk control measure, often occurs before the debt term agreed upon by the borrower and the lender is reached. Therefore, whether there is legal support for forced liquidation is still unclear.

“Don’t be completely pessimistic.”

In Zi Cen's view, all problems existing in the blockchain's business model will be solved after the industry welcomes a larger user scale, higher liquidity, and higher performance and more robust blockchain infrastructure.

Yang Zhou believes that the future cryptocurrency lending sector will shift from basic price competition to scenario competition, and further move towards differentiation.

In addition, Yang Zhou also said that the U.S. stock market circuit breakers will indeed have an impact on the price of Bitcoin, but as the number of circuit breakers increases, the impact on Bitcoin will also decrease. Now it can only be said that it is a big test for Bitcoin, not a cold winter.

As the cryptocurrency industry recovers, the cryptocurrency lending business will also usher in a new spring.