The Emergence of Cryptocurrency Lending
For long-term cryptocurrency investors, accessing liquid currency represents something of a paradox. Cryptocurrency cannot yet be used in many non-digital transactions, nor can it be leveraged within the traditional financial system to securitize a bank loan in the same way that other investible assets can be (e.g. stocks or real estate). Thus, cryptocurrency investors face the dilemma of having to sell off their tokens at current market prices in order to make additional investments or to simply pay off real-world expenses. For investors who are bullish and long on their tokens, the expectation that the price of cryptocurrency will rise means that it will become increasingly expensive to repurchase the tokens that they sold as time passes1.
To address this problem, a number of cryptocurrency lending services have emerged. These services, such as SALT2, Nexo3, ETHLend4, and BlockFi5, allow users to use their cryptocurrency as collateral in exchange for a loan. There are some notable differences between these platforms and how they implement lending. SALT, Nexo, and BlockFi are centralized lending platforms that operate similarly to a traditional bank – they deliver fiat currency directly to a real-world bank account upon the deposition of cryptocurrency in an escrow account. ETHLend, on the other hand, operates a more democratic platform that matches lenders and debtors directly and allows them to exchange Ethereum-based tokens.
These platforms have for the most part been quite successful. SALT, one of the first major players in the cryptocurrency lending space, has over 70,000 active members and over $50 million in issued loans6. Meanwhile, BlockFi grew its revenue ten-fold in 2018 as long-term cryptocurrency investors and cryptocurrency bears alike weathered through the recent market dip7. More important, the pullback in the cryptocurrency market while the stock and real estate markets largely soared in 2018 demonstrated the potential profitability of loaning against cryptocurrency assets in exchange for fiat currency to investors, broadly validating the business model of cryptocurrency lending.
Part of the reason for the success of these companies, especially during the recent drawback in the cryptocurrency market, is that they only accept Bitcoin, Ethereum, and other major tokens such as Ripple and Litecoin. Importantly, these are large-cap cryptocurrencies with relatively high market liquidity. Liquid cryptocurrencies are easier to buy and sell8, meaning that these lending platforms have the ability to sell of collateralized tokens if a debtor is unable to repay their loan. This is especially important for SALT, Nexo, and BlockFi, since these platforms are themselves the lenders for all loans that they issue.
In addition, liquid large-cap cryptocurrencies such as Bitcoin and Ethereum have less price volatility than illiquid small-cap cryptocurrencies. This contributes to relative price stability, even during period when the cryptocurrency market is experiencing a broad sell-off as occurred recently. Price stability is another important financial consideration for these centralized lenders, as they require that loans be leveraged to a specific degree.
For example, SALT issues loans at a as much as a 50% loan-to-value ratio9 – meaning that for every $10,000 of fiat currency loaned, $20,000 worth of Bitcoin or Ethereum must be collateralized. Since the price of Bitcoin and Ethereum relative to US dollars is constantly fluctuating, debtors must keep the market value of their collateral account above that $20,000 minimum. For more volatile cryptocurrencies, ensuring that debtors keep their collateral accounts above the minimum requires more computational effort and there is a greater chance that the collateral account value can drop precipitously with little warning.
Unrealized Value in Cryptocurrency Lending
However, by limiting themselves to accepting only a few major cryptocurrencies as collateral for loans, the major cryptocurrency lending platforms have prevented themselves from fully saturating the market sector. Bitcoin, Ethereum, Ripple, and Litecoin together make up only about 70% of the total cryptocurrency market capitalization10, meaning that these lenders are effectively shutting out as much as 30% of cryptocurrency value from their platforms. All told, that represents more than $40 billion in value that the cryptocurrency lending industry has not yet serviced.
That leaves open a significant opportunity for the Joos platform. In addition to accepting major cryptocurrencies on the distributed peer-to-peer Joos network, Joos is seeking to enter into the remaining 30% of the cryptocurrency market by accepting small- and micro-cap cryptocurrencies as collateral for lending.
Lending Against Small-cap Cryptocurrencies on Joos
The primary challenge in allowing debtors to stake small- and micro-cap cryptocurrency tokens at loan collateral on Joos, or any other cryptocurrency lending platform, is managing risk. However, Joos has identified several ways in which the platform can limit the potential downside of these cryptocurrencies.
First, Joos is making an effort to evaluate small-cap cryptocurrencies that have until now been ignored by the cryptocurrency lending market. This evaluation will consider the history of a particular token and its projected direction in order to ensure that Joos is not accepting coins that may cease development in the foreseeable future or that could be subject to pump-and-dump schemes11. Joos’ evaluation will also consider the historical volatility and liquidity of individual tokens, which provide objective measures of the risk that different cryptocurrencies bring to the platform. Although this stringent vetting process will exclude some microcap cryptocurrencies from being listed on Joos, the majority of the hundreds of tokens currently inadmissible in cryptocurrency lending will become eligible for use.
Where Joos plans to break from existing cryptocurrency lenders is in designating coin-specific loan-to-value ratios. Currently, since SALT, BlockFi, and Nexo only accept major coins with relatively stable pricing, they either designate a single loan-to-value ration across the platform regardless of the coin used as loan security or, as in the case of SALT, set the loan-to-value ratio according to a subscription tier9. Joos will instead use the objective risk measures – volatility, liquidity, and other token-specific risk factors – to determine the loan-to-value ratio to be assigned to each cryptocurrency accepted on the platform.
The advantage of this approach is that Joos retains full control over the amount of risk being introduced to the platform with each new cryptocurrency. For example, a micro-cap cryptocurrency that is highly illiquid and volatile may be assigned a loan-to-value ratio of just 10%, meaning that the debtor must put 10 times the value of the loan up as collateral based on the current market value of that coin, and to keep their collateral account above that level as the price of the coin changes. This means that even if the market price of the coin were to suddenly swing downward by as much as 90%, the lender would be able to recover the value of the principal loan by liquidizing the collateral.
The relatively low loan-to-value ratios that will be assigned to microcap cryptocurrencies may be a limiting factor on the sizes of loans that long-term investors can take on, since large loans will require a significant amount of coin to be staked as collateral. This can be partially alleviated by allowing debtors to use multiple types of accepted tokens – each with their own loan-to-value ratios – to meet the necessary collateral requirements.
It is also worth noting that the vast majority of long-term bullish investors in small- and micro-cap cryptocurrencies are incentivized to keep their collateral accounts above the required margin. These investors believe in the long-term growth potential of the currency they are holding and do not want to see it sold off to re-balance a collateral account – hence the reason for taking out a cryptocurrency loan rather than simply selling off their assets. Thus, debtors themselves can help to manage the risk of these tokens by buying more during dips in value and adding those newly purchased coins to their collateral accounts.
Growing Joos’ Lending Potential
There is a significant incentive for cryptocurrency investors to flock to the Joos platform as their cryptocurrency lending service of choice as more tokens are accepted on the platform. Importantly, Joos will be the first and only cryptocurrency lending platform to accept the hundreds of popular, high-value tokens that are not among the top five cryptocurrencies by market cap. For users who hold these tokens, then, Joos will be the only option available to hold those coins while using them to securitize a loan in fiat currency.
Since Joos also accepts major currencies such as Bitcoin and Ethereum, it is easy for investors to remain within the Joos network once they begin using it – the platform will serve as a one-stop network for lending using any cryptocurrency. Furthermore, because Joos is a peer-to-peer lending platform in which lenders must compete against one another, average interest rates on the platform are likely to be significantly lower compared to centralized lending platforms such as SALT, Nexo, and BlockFi.
Ultimately, this means that by expanding the types of cryptocurrencies accepted on Joos, the platform could both carve out a niche for lending to small- and micro-cap cryptocurrency investors as well as poach market share from more established cryptocurrency lenders.
Joos will be the first cryptocurrency lending platform to make lending available to investors holding small- and micro-cap cryptocurrencies. While accepting potentially volatile cryptocurrencies with low liquidity does present some inherent risk for lenders operating on Joos, the platform plans to thoroughly evaluate each token to objectively assign a loan-to-value ratio. This individually assigned value, combined with the natural desire of bullish cryptocurrency investors to keep their coins from being sold, will help to minimize risk across the Joos network.
All told, small- and micro-cap cryptocurrencies make up roughly 30% of the cryptocurrency marketplace and represent around $40 billion in value that is currently not being targeted by existing cryptocurrency lenders. Accepting a wider range of cryptocurrencies than any other cryptocurrency lending platform gives Joos both a major competitive advantage relative to more established industry players as well as a high-value niche that caters to the needs of an underserved cryptocurrency investing population.
1Crosman P. 2018. Crypto Lending May be Risky, But These Firms Say They’ve Solved the Riddle. American Banker. https://www.americanbanker.com/news/crypto-lending-may-be-risky-but-these-firms-say-theyve-solved-the-riddle.
6SALT. 2018. The Upgraded SALT Borrow Experience is Here. Medium. https://blog.saltlending.com/the-upgraded-salt-borrower-experience-is-here-53991a2d6d3.
7Kharif O. 2019. Lenders are Thriving on Bitcoin’s Bust by Aiding Both Fanatics and Shorts. Bloomberg. https://www.bloomberg.com/news/articles/2019-01-02/thriving-on-bitcoin-s-bust-lenders-aid-both-fanatics-and-shorts.
8Guide to Cryptocurrency Liquidity: Understanding Liquidity & Its Importance. Master the Crypto. https://masterthecrypto.com/cryptocurrency-liquidity-understanding-liquidity-importance/.
9SALT. Loan to Value (LTV) Explained. Medium. https://blog.saltlending.com/loan-to-value-ltv-explained-9ff7182d446f.
10Top 100 Cryptocurrencies by Market Capitalization. CoinMarketCap. https://coinmarketcap.com/ (Accessed March 27, 2019).
11 Kamps J, Kleinberg B. 2018. To the moon: Defining and detecting cryptocurrency pump and dumps. Crime Science 7:18.