Throughout history, lending is as old as money, and no matter what form of money there is, there needs to be a market for lending and borrowing. Now, Bitcoin occupies the leading position in the crypto space due to its decentralized and transparent nature.
Like currencies before it, Bitcoin needs a strong lending market for it to truly thrive. So far, however, most attempts to create a Bitcoin credit market have failed spectacularly, with disastrous consequences.
In 2020, demand for Bitcoin and digital asset lending services surged, with 1 billion customer assets flowing to centralized and decentralized lending platforms. Due in part to loose macroeconomic monetary policies and the explosive growth of the crypto industry, this environment allows bad actors to operate recklessly and mislead consumers without facing significant checks and balances.
This lack of oversight ultimately led to the collapse of the digital asset lending industry starting in 2022, including the cascading bankruptcies of lenders including BlockFi, Celsius, and a division of Genesis. Here’s a look at why these companies failed to help better understand the events of 2022 and the systemic risks faced by crypto credit providers.
First, crypto credit providers often combine customer assets with the company’s yield products, which creates a situation where risks are intertwined. If a company's revenue plan fails and results in bankruptcy, customers' loans may be affected.
Second, the concentration risk of loan counterparties is another issue worthy of concern. These platforms partner with other companies to generate revenue for their customers, however over-reliance on a few partners can create concentration risks. If a partner encounters problems or gets into trouble, this could have a negative impact on a customer's loan. Finally, lenders did not provide customers with the transparency they needed to understand the concentration of risks in their credit underwriting processes or lending activities.
While fraud charges in some of these cases will be decided by the courts, the sudden domino collapse of dozens of digital asset lending companies highlights an underlying flaw: The operating structures of crypto credit providers are inherently unsustainable, and this Outdated structures coupled with inadequate risk management are like dry wood eagerly awaiting a spark - while Terra/Luna, Three Arrows Capital (3AC) and FTX are a full box of matches.
Historically, lending models without ring risk were only feasible where there was a lender of last resort, such as the Federal Reserve in a traditional banking context, acting as a stabilizer and regulator of the financial system. However, the decentralized nature of Bitcoin and other cryptocurrencies prevents traditional lending models from being directly applicable, meaning the industry needs to develop a new model – one that does not rely on governments or state agencies.
Today, digital lending platforms are trying to create a new model to adapt to the characteristics of this blockchain technology. The dual-account system is one such attempt, which divides funds into safety accounts and income accounts, providing customers with more choices and flexibility.
Under this new model, the safety of funds is guaranteed, while customers can choose to invest part of their funds in the lending market to pursue returns. Under this model, the returns and risks of loan funds are segregated into the income account, and customers who do not participate in the loan will not face the risk of loss of the loans in the income account. In addition, transparency is also a focus of these platform improvements, with regular, easy-to-read reports giving customers a clear understanding of where their funds are being used and the status of their loans.
Drawing on past lessons, digital lending platforms are more prudent and diversified in their lending strategies. By lending small amounts of money to multiple people, risk is spread, avoiding the potential risk of over-concentration on a single borrower or project. In short, digital lending platforms are working hard to develop a new model that adapts to the characteristics of decentralization and make improvements in transparency and lending strategies to provide better services and customer experience.
Summarize
The “Wild West” era has passed, and the digital asset lending industry is entering a new period of development. Past challenges and bankruptcies have allowed platforms and industries to learn valuable lessons and begin to rebuild in a more sustainable and responsible direction. Through these efforts and improvements, the digital asset lending industry is gradually growing, and the industry is also moving in a healthier and sustainable direction.