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What does the crypto credit market look like to Wall Street's elite?

Nakamao

21-04-07 11:16

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Title: Crypto Credit Market Breakdown

Original source: Jump Capital, Peter Johnson

Original compilation: 0x26

Peter Johnson is Head of Investments at Jump Capital. Since joining Jump Capital as its first employee in 2013, he has invested in over 50 companies, including many of the leading cryptocurrency companies. Jump Capital is owned by the Jump Trading Group, one of the largest private Trading firms in the traditional and crypto markets.

After reading this article, the translator feels that the crypto market is evolving, and that there is a degree of fragmentation between "coin fry" retail investors, miners, developers, trading platforms, market makers, and professional financial services institutions. This paper not only combs out the development of crypto credit market, but also explains, to some extent, the reasons for the large number of stablecoin issuance and the large influx of WBTC into the DEFI market.

Looking around the whole industry, no matter what Angle you approach the market from, you can't deny that the crypto market has become more and more mature. We are no longer living in the era of "100 times pull". There are not only Hodler who adhere to ideals and are full of passion, but also Suits from traditional finance who only squeeze 0.1% interest rate difference.

The crypto credit market has grown exponentially over the past few years, with assets on the BlockFi platform reaching $15 billion, Genesis generating $7.6 billion in loans in Q4 2020 alone, and Compound's current loan inventory reaching $5 billion. In Jump Capital's view, we believe that the crypto credit market will continue to expand rapidly and that the next generation of iconic global financial systems will be built on the crypto market.

We are also proud to be an investor in several innovators in this space, including BlockFi, Voyager, Bitgo, Zipmex, and CoindCX. In this three-part article, we describe why the crypto credit market offers high interest rates, attracts tens of billions of dollars in deposits (compared to traditional financial markets), who the major players are, and how we expect the market to evolve over time.

Part 1: How do BlockFi and Voyager maintain annual interest rates above 8%?

Almost every day, we get messages from friends asking about savings rates offered by companies like BlockFi and Voyager. These annual interest rates are typically more than 8% in US dollars (in cryptocurrencies) and more than 5% in Bitcoin, with the average savings account yielding 0.05%. In the real world, this is hard to believe. Oh, and if you haven't heard, you can actually earn more than 8% annually.

Unsurprisingly, these high yields have attracted a lot of customers and assets.To understand how these yields are achieved, we have to understand who is willing to borrow at these rates.

If deposits can earn more than 8 per cent, then someone must be willing to pay at least 8 per cent (plus some spread) to borrow the capital. Who is willing to pay such a high interest rate? There are, in fact, some groups, in particular:

Traders,

· Retail borrowers with special needs

· Companies in the crypto industry

Traders are easily the biggest borrowers in the crypto credit market.They borrow at such high interest rates because they believe they can earn more from their trading activities than the interest rate.Some of the ways traders earn these returns come from exploitationA tried-and-true strategy for market inefficiency"Or some other more speculative approach. Traders are a huge demand side in the crypto credit market because:

· Unique markets create huge profit opportunities;

· The crypto market requires a large amount of capital due to the need for pre-deposit on the trading platform;

· Traditional financial institutions generally do not lend to cryptocurrency traders.

Further, traders can use two common strategies to raise capital.

One type of trade is the "carry" trade, which is based on market inefficiencies or dynamic changes in market structure to provide a positive expected return to the trader.

We refer to the three most famous of these trades as the underlying trade, the cross-trade arbitrage and the grayscale trade.

Underlying trading takes advantage of the industry phenomenon that bitcoin (and other crypto assets) futures typically trade at a much higher price than spot prices (and a similar situation for other crypto assets). In this trading model, traders buy a spot and sell a futures contract, earning the difference between the current and future prices when the contract matures.

Cross-trading platform arbitrage is a simple arbitrage of price differences between trading platforms. For example, if Bitcoin trades at $50,000 on Coinbase and $50,005 on Bitstamp, the trader will make a purchase on Coinbase and sell on Bitstamp at the same time, and net $5 risk-free (minus transaction fees). A few years ago, price differentials between trading platforms were common. Today, as markets have evolved, the returns from ordinary spread trades rarely exceed the costs, so the opportunities for such trades are diminishing.

Grayscale trades take advantage of the premium on their net asset value (NAV) of trust products such as Grayscale's Bitcoin Trust (GBTC), which often (or at least they used to) trade at a spot premium. This trading dynamic applies not only to GBTC, but also to grayscale trust products such as Ethereum, Litecoin and large-cap indexes, as well as to trust products created by Bitwise and others. In this transaction (in the case of GBTC), the trader borrows bitcoin, uses that bitcoin as net asset value to create GBTC, waits for 6 months until GBTC can be sold on the open market, and sells GBTC for a premium.

These carry trades exist mainly because of investment access issues.Many investors want crypto assets but are unable or unwilling to own them directly. For example, many individual investors want to invest in crypto assets from their traditional broker or IRA accounts, and many institutional investors are restricted by investment mandates to invest only in products that are traded on traditional established exchanges and have CUSIP*. These investor groups are limited to products such as CME Bitcoin Futures and GBTC. Because of the high demand for these products, they tend to trade at a premium to the underlying asset price. This creates arbitrage opportunities for traders - and this arbitrage trade creates a demand for funds - so traders are willing to pay high interest rates to finance these trades.

CUSIP (Committee on Uniform Securities Identification Procedures) Number, Chinese Name: CUSIP (Committee on Uniform Securities Identification Procedures) Number. The CUSIP system, administered by the Committee on Uniform Securities Identification Procedures, is used in the United States and Canada to identify all stocks and registered bonds.

The other type of trade is speculative trading, where a trader uses leverage to become a net long or net short in the market.

For investors who want to magnify gains (and losses), using leverage is one way. Leverage may come from borrowing from third-party lenders or using margin to borrow money on an exchange platform. At present,A very large part of the crypto credit market ultimately drives leveraged trading, including the bulk of loans on decentralized loan agreements such as Compound and AVE. As people always say,"Leverage is poison" -- and the cryptocurrency market sometimes becomes very disruptive because of leverage(Originally called Scarface, an action movie starring Al Pacino). We expect that,The crypto market will continue to be a bull market, leverage will continue to increase, the scene will continue to be spectacular, of course, large-scale continuous liquidation of the highly leveraged market impact, is bound to occur.

Another speculative trading situation is shorting. The classic way to short an asset is to borrow an asset, sell it in the market, wait for the asset to fall, buy it back, and then pay back the loan. There are still some traders brave enough to bet short in today's market, so good luck to them.

This leads to the second reason why traders have a strong demand for cryptocurrency borrowing -- cryptocurrency transactions can require large amounts of capital. That's because crypto trading platforms require upfront deposits, and there are hundreds of them across the industry.For market makers and traders who need to trade across platforms to take advantage of price discrepancies or best strike prices, the issue of trading platforms needing upfront capital is particularly acute.That means coins and cash are needed on every platform that wants to trade, which may seem normal to retail investors but is not the case in traditional markets. In traditional markets, traders only need to have money at their prime broker, which they can then use to trade in a number of places.

For a very simplified example, let's say a trader wants to buy or sell $1 million of assets on multiple trading platforms on the go. In a traditional market, traders contribute $1 million to their primary broker, which trades directly across multiple trading platforms (in fact, the broker is likely to provide leverage, so traders don't even have to pay the full $1 million). In the crypto market, by contrast, if a trader wants to buy or sell $1 million worth of Bitcoins instantly across 10 exchanges, they need to contribute $1 million in cash and $1 million worth of Bitcoins to each of the 10 exchanges, with an initial capital requirement of $20 million. In this case, the crypto market requires at least 20 times as much capital as the traditional market.

This brings us to the final reason why traders are such a big part of crypto lending -- the market is not as well served as traditional finance. In the example above, the problem with the crypto market is not only the need to pre-fund the trading platform, but also the absence of a prime broker to pre-finance and leverage the traders. For years, banks have avoided providing services to crypto companies because of regulatory issues caused by authenticity or bias. This bias still exists today, with some notable exceptions such as Silvergate and Signature. Since traditional banks are not interested in lending to crypto traders (except for some of the largest market makers), this has led to a very high demand from crypto lenders.

As mentioned above, traders are not the only borrowers in the crypto market. Other borrowers include retail investors and crypto companies.

Retail investors want to avoid the tax consequences of making a big purchase, such as a house, if they intend to do so. In this case, borrowing against their cryptocurrency can get a very high tax benefit compared to selling their cryptocurrency holdings.

Another type of borrower is crypto companies. These can be companies that need to borrow for capital spending (such as mining companies), or sometimes just corporate borrowing to fuel growth. The crypto credit market could provide the capital these companies need.

In short,BlockFi, Voyager and the like can pay high rates of return on assets because there are borrowers willing to pay high rates of return.These borrowers include traders, individuals, and crypto companies, with traders making up the largest segment of the market. These traders are willing to pay high interest rates for their borrowings as they deploy these funds into arbitrage and speculative strategies earning high returns. The crypto market is very capital intensive, but these traders are not well served by traditional lenders.

Part II: Crypto Credit Market Participants

Now that we know what's driving high interest rates and growth in the cryptocurrency credit market, let's take a look at who the "big players" are. The following market chart lists the categories of companies and major players. Notably, we exclude actual lenders/depositors and borrowers of last resort, focusing instead on intermediaries and technology providers that enable this market.

Major players in this market include:

Cryptoasset native savings and loan company

When we refer to these companies as "savings and loans," we use the term in the most literal sense (without any regulatory connotation) that these companies offer interest-bearing savings accounts for crypto assets and lend them out to earn an income. These companies often start with crypto loans and interest-bearing accounts for retail investors. Some, such as BlockFi, have branched out into transactions, payments and institutional lending.

A broker that offers interest-bearing accounts

A company that started as a crypto brokerage/trading platform and added interest-bearing accounts to its offerings.

Non-native encrypted interest-bearing account

Some companies offer high interest rates to savers by lending to the crypto sector, either directly or through lending agreements, but they are taking crypto out of the hands of users in order to appeal to a wider audience.

DeFi agreement

Peer-to-peer smart contract lending agreements.

DeFi interface

Third-party interfaces where people can interact with the DEFI lending protocol (and other DEFI protocols).

A trading platform with leverage

An trading platform that enables savers (lenders) to earn profits by providing margin loans to traders on the trading platform.

Leveraged Lending Robot

Automatically deploys funds into margin loans on the trading platform to optimize returns.

Agency intermediary

Focus on serving institutional clients to meet their borrowing/interest needs. This includes companies like Genesis that focus purely on lending, as well as custodians like BitGo that offer lending products, innovative banks that serve the crypto ecosystem -- like Seba and Sygnum -- and companies with interest-bearing corporate accounts, like Circle.

Loan Technology Provider

A company that provides technology to other crypto lenders.

Traditional Banks

Actively collecting deposits from crypto companies and providing loans to them.

At Jump Capital, we have been active investors in several of these categories, including crypto asset native savings and loan institutions (BlockFi), broker and interest-yielding accounts (Voyager, CoindCX, Zipmex), and institutional intermediaries (BitGo).

Going forward, we continue to be interested in making more investments in these categories, as well as in other areas, including lending technology and the DEFI protocol lending interface.

We like crypto native savings and loan companies such as BlockFi as they are leading the way in attracting large numbers of customers and assets with their interest-bearing accounts, and often have developed large lending businesses with strong risk management practices. We believe that some of these companies are uniquely positioned to be the leading global financial institutions of the next era.

In the Broker category with interest-bearing accounts, we seek to invest in the world's best fiat/cryptocurrency upwardly mobile companies. We plan to continue to invest in the best trading platforms/brokers in all major regions of the world and work with these companies to add interest-bearing accounts if they don't already offer such products.

The reason intermediaries are attractive,It is because we believe that many interest-bearing account providers will not establish full lending operations to generate yields.Most people use intermediaries that specialize in borrowing and generating yields.

Non-cryptocurrency interest-bearing accounts are interesting because they expand the range of customers who can benefit from the high interest rates in the crypto credit market. While other crypto income accounts are primarily aimed at customers who have adapted to encryption, these companies are targeting the larger non-crypto market.

Loan technology providers have grown rapidly, and now almost every company in the space is building its own loan and interest-bearing account technology. There is a great opportunity for third-party technology providers to quickly enter this space by building best-in-class software for a large number of companies.

Finally, we are interested in the DEFI lending connection because the DEFI protocol is increasingly accessed through the best interfaces that provide portfolio management, trading, lending, yield, transfer, and more.

Overall, we believe there are significant opportunities across the crypto credit ecosystem and are excited to continue investing in these areas.

Part III: The future of crypto credit

When we invested in the crypto credit market at Jump Capital, one of the key questions we thought about was how the market would evolve over the next few years. Specifically, what we're thinking about is,What will happen when the inefficiencies of the current crypto trading market are corrected? How and when will interest rates in the market fall, and when they do, will the market become less attractive to savers/lenders?

Over time, we think many of the inefficiencies in the crypto trading market will be corrected and interest rates will come down. However, we expect lending demand in the crypto credit market to continue to expand dramatically and the interest rates available to savers to remain very attractive.

We are confident in the continued growth of the crypto credit market for the following reasons:

· The crypto trading market is still in its infancy and its growth will more than offset the decline in borrowing demand as the exchange market becomes more efficient.

· The crypto credit market has structural advantages over traditional credit markets and will attract a significant amount of non-transactional use case borrowing.

The first reason is straightforward --Crypto trading is still a relatively small market.The sector is still dominated by retail traders with early backers and users and a few innovative deals. Few institutional traders enter the market. If the market develops the way we think it will --Bitcoin will be an asset in most investors' portfolios, crypto dollars are a new trajectory for global money flows, and DEFI is giving the world a new way to access financial services -- then the crypto trading market will grow exponentially in the coming years.Such exponential growth would stimulate demand for lending, making the reduction in lending from the exchange market more efficient.

The second reason is more important --The crypto credit market has structural advantages over the traditional credit market.These structural advantages include:

The crypto credit market is extremely flat.The market is globally connected, cutting out traditional intermediaries and allowing money to flow freely from those who have money and want to earn it to those who need it and are willing to pay for it. It is a market where savers' money can flow seamlessly to borrowers on the other side of the world, without the need to go through a network of intermediaries as in traditional markets. In extreme cases, if depositors and borrowers use decentralized lending agreements directly, there is no need for any company or intermediary to participate in the transaction.

Cryptocurrencies are near perfect collateral.Cryptocurrencies can be ideal collateral for a global lending business. It can be transferred instantly, held directly, hosted in a smart contract if needed, and sold instantly into a highly liquid market if needed. The biggest drawback of crypto collateral is that it can fluctuate in price, which crypto dollars have overcome. Because of this, we expect crypto mortgages to continue to grow explosively in the coming years.

In the crypto credit market, anyone can hold, earn interest and borrow in dollars.The thirst around the world for dollars and dollar-denominated debt is insatiable, as dollar credit from non-bank borrowers outside the United States has been one$12 trillion market and growing by 6% a yearYou can see that. This market is currently limited to governments and large institutions. Crypto dollars and credit based on crypto technology have opened up the market to everyone around the world.

These structural advantages have allowed BlockFi and Compound to build a global multi-billion dollar lending business in less than five years. Over the next few years, we expect these advantages to enable the crypto credit market to gain significant share from the traditional lending market.

Part of the expansion of this market will come from the current use cases across crypto exchanges, with individual crypto owners borrowing to buy, and crypto companies borrowing to finance development. But these will not be the biggest growth. The largest segment of the crypto credit market expansion will come from non-crypto companies and individuals who have borrowing needs and may not even know that crypto technology is being used to meet those needs on the back end.

In the future, many users who use cryptocurrency technology on the back end will be obscured. Users will deposit their savings into an interest-bearing account on their favorite fintech app, while the company will keep their cash in an interest-bearing company account. At the back end, these cash deposits would be converted into USDCs and lent directly around the world, or deployed into DEFI lending agreements where the funds could flow to borrowers anywhere. These borrowers will be individuals borrowing from their favorite fintech apps, or companies borrowing from the next generation of corporate lenders that tap into the crypto ecosystem. Neither the lender nor the borrower has to consider the details of facilitating the transaction.