CRYPTO INDUSTRY SECRETS: Shadow Debt Market
Cryptocurrency & Blockchain
Hidden behind the public view is one of crypto industry’s biggest secrets, the Shadow Debt Market, where cryptos worth billions of dollars are borrowed & lent on an un-collateralized basis, between some of the industry’s biggest names. Given the huge amounts of money involved, one would assume that the technology behind the Shadow Debt Market is state-of-the-art, but it is shocking to find out that is in fact not the case.
Most people would be surprised by the unsophisticated ways entities borrow & lend cryptos on a large scale. In the chat groups on Telegram, borrowers and lenders haggle over interest rates & durations of loans, as we are in an ancient bazaar and not part of the cutting-edge industry. There is no transparent price discovery of interest rates, be that an interest rate exchange or a public ledger with terms (interest rate, tenor, and risks) of all loans.
Moreover, it is then not surprising, that the opaque & bilateral negotiations, lead to wildly different interest rates, for loans of literally the same terms. After striking an interest rate, the lender ships those cryptos to large borrowers, with little to no oversight or understanding of how they are further deployed. Lenders are left to pray to see those assets back when the maturity is due…in most cases not asking for a full repayment at maturity, but rolling over the loan.
With the promise of high interest rates, many platforms (Genesis, Celsius, BlockFi & FTX) managed to attract billions of AUM from professional and retail investors. As a result, creating a massive supply of capital.
The demand for debt was infinite during the crypto bull run, and all those crypots got lent out further to the world’s biggest crypto companies (3AC, Alameda etc). In the beginnings of Shadow Debt Market, it was not easy to understand the capital flows that are today obvious. Or as one Swiss crypto legend stated to me in a private conversation back in 2020: “I see everyone lending out at high rates and making a killing, but nobody can tell where those cryptos are actually ending up”.
The above-described Shadow Debt Market is in stark contrast to TradFi, where prime brokers monitor positions in real-time & stop-out loans when there is too much risk. The terms are recorded, albeit in private & centralized databases, available for audit or review by the regulatory bodies.
TradFi has learned its lessons the hard way (Enron, Bernie Madoff’s Ponzi-scheme, Financial Crisis of 2008), hence the financial industry players & regulators have put in place rules, processes & laws that try to mitigate risks that cause disruptions in the financial system, but also real economy. The young and rapidly growing crypto industry has an opportunity to embrace those important & painful learnings from TradFi (but also its own learnings), and integrate them into the decentralized infrastructure that will support the world’s economy in the decades to come.
Written by Anton Golub
Anton is a Strategic Advisor of Pazar, decentralized OTC marketplace. Anton founded & served as CEO of flovtec, Swiss market-maker providing liquidity solutions to digital asset exchanges, token issuers & protocols and offering investment products for professional & institutional investors. In addition, Anton is also a co-founder of Trust Square AG, a pre-eminent blockchain technology hub located in Zurich’s financial district. Furthermore, Anton co-founded Lykke Corp, a blockchain-powered exchange to trade all assets with zero fees, where he served as a Chief Science Officer. Prior to Lykke, he worked as a quantitative researcher at Olsen Ltd (successor to Olsen & Associates, founded in 1985), a boutique investment firm that pioneered the field of high-frequency trading.
As a Marie Curie Research Fellow at the Alliance Manchester Business School, Anton worked on high-frequency trading, market microstructure and flash crashes. In 2011, he was invited to participate in the Foresight Project – The Future of Computer Trading in Financial Markets, an international project on algorithmic trading funded by HM Treasury in the UK. Anton has also been involved in several research projects backed by the European Union (EU) and was on the Supervisory Board for the BigDataFinance project funded through Horizon 2020. He has co-authored 13 academic papers and two books.
CRYPTO INDUSTRY SECRETS: Shadow Debt Market
