Learn about the encrypted credit market in one article

Odaily资深作者

2020-08-18 15:35 (UTC+8)

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Just as we have witnessed the financialization of Bitcoin, the exponential growth of the Bitcoin derivatives market - including synthetic cash settlement instruments as well as digital settlement instruments, the Bitcoin lending space continues to grow e

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Author: Blockchain Robin

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Debt and Technology Power the Modern Economy

The world loves leverage. Debt is the magic that has driven economic growth since time immemorial, and while we are far from the days of the Iron Bank - as you Game of Thrones fans should know - global debt is by far the largest asset class and investment class . Whether it's government debt, corporate debt, derivatives, consumer debt, or some combination thereof, leverage is the lubricant that keeps the bearings of the global machine turning.

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Bitcoin is often touted as a hedge against debasement of fiat currencies by governments and their central banks. Watching Chairman Powell work with the money printing presses (brrr) certainly highlights the stark contrast between bitcoin and fiat currencies. Bitcoin is digitally scarce, so among the global assets in the table above, we expect it to behave more like gold, appreciating as demand rises, rather than like non-monetary and some other cryptocurrencies, in order to meet demand and expand the supply.

However, investors who hold Bitcoin are just rational people. Just as we have witnessed the financialization of Bitcoin, the exponential growth of the Bitcoin derivatives market - including synthetic cash settlement instruments as well as digital settlement instruments, the Bitcoin lending space continues to grow exponentially quarter after quarter .

Please step into our amazing time machine and let us transport you to 2017... (seriously, that's like... 2 crypto epochs ago)MM63Crypto Finance History Lessons

If you're a fan of modern economics, you're bound to be familiar with the Capital Asset Pricing Model, maybe the notion that WACC sucks, and the work that Miller and Modigliani have done. we only mention

, the purpose of which is to introduce the cost of debt, or r(d), which affects how firms make financing decisions.

Figure 2: Are Equity and Debt Equal? The vagaries of CAPM"income"So why is WACC being proposed? Historically, companies in the crypto ecosystem have been funded purely through equity. As one of the few crypto investors in 2015, we can confidently say that the idea of debt financing doesn't really exist. The cost of equity is variable, but generally, the cost is quite high. The average dilution rate for a round is between 20-40%, depending on your business model, your jurisdiction, and your ability to sell valuations to investors. Therefore, for most companies, access to capital is basically limited to E, equity, and r(e) is expensive.

Given that the price of Bitcoin has fluctuated between $200 and $300 for a long time, but because the price has reached $1,200, the founders are not willing to sell coins to cash out to finance their operations. In fact, some of the related companies invested by the fund also committed a big taboo. They used part of the financing to buy more bitcoins and held bitcoins on their balance sheets, thinking that the value of bitcoins would rise. In 2017 and 2018, many companies started with

income

In 2017, investors began to think about how to finance companies with short-term working capital needs. It doesn't make sense to raise highly diluted, very expensive equity capital to finance short-term needs that stem from cash flow timing mismatches. Some companies already have cryptocurrency on their balance sheets, so lending against that crypto collateral offers a low-risk way to extend credit at modest interest rates to finance growth opportunities. Dealers with cash on their balance sheets are in a good position to start providing short-term capital to these companies, especially if they are already investors through their venture strategies.

The crypto-backed debt market grew dramatically as Bitcoin went from $700 to $1,200 to $10,000 within half a year. Early-stage companies in portfolios with limited cash on their balance sheets were able to finance their operations in a new way, effectively creating a debt market. Thus, a crypto debt market was born and r(d) was created. And more importantly, because the loan is collateralized by a highly liquid, ready-to-sell asset like Bitcoin, the required level of risk is very low. It’s no surprise that today crypto mortgage rates aren’t much higher than other types of corporate debt, and in some cases crypto companies can actually get debt at better rates than other types of tech startups.

One final point here - the introduction of a robust asset-backed debt market is a game changer for the crypto ecosystem and many of the companies within it.

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lower cost of capital

The average cost of capital has fallen significantly, thanks in large part to this growing debt market. Interest rates for borrowing USD by posting Bitcoin collateral are between 8-12%, which is much more attractive than 20-40% through equity dilution. And don't forget the important tax advantages of financing with debt, which further adds to the attractiveness of the deal. As more venues pop up to cater to this debt market, the availability of capital in this industry has greatly increased."In terms of risk, the vast majority of institutional crypto loans today are fully collateralized, usually with a collateral ratio ranging from 1.25-3 times the loan amount, depending on the volatility of the underlying object. If the price of the collateral is going to fluctuate wildly, you have to post margin calls 24 hours a day."Effectively risk-free borrowing through crypto-backed loans can still earn 8-12% APY today. Whereas lending in traditional markets is done at LIBOR+1, or zero if you have access to a printing press. We expect crypto lending rates to drop as more capital chases yield.

yield farming

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In a world where capital is plentiful but yields are scarce, investors are willing to look for yield further down the risk curve. We'll get to that in a moment!

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Enter Mooninites, the Crypto Lending Index"Let's hop aboard the Delorean car (Back to the Future) and travel back to July 2019. At this point, crypto lending has been around for almost two years. While crypto lending has started making its way to brokers and existing trading desks, the crypto community quickly realized that you don’t need an expensive team of traders to match buyers and sellers. You can use the magic of the internet to match this market, you can use the financial primitives that are being built on top of Ethereum to build new types of debt instruments. The first such product was a margin loan product offered by Maker."Borrowing with an on-chain margin loan is simple, where the borrower will lock up Ethereum as collateral and borrow USD (synthetic USD, so to speak) in the form of the stablecoin Dai. Borrowers will not be subject to margin calls as long as the locked Ether value remains above 150% of the USD-denominated loan balance. If it falls below this threshold, the locked ether will be liquidated to repay the loan, ensuring that the lender has no credit loss, and any excess will be returned to the borrower's ether wallet. The Maker system is a huge proof-of-concept for an open financial ecosystem, and demonstrates how financial incentives and programmable money built on top of the Ethereum network can facilitate an automated lending market following programmed rules, with no manual work required at all.

By offering a dollar-pegged stablecoin to the willingness to spend its existing