Remember “Blockchain technology represents a potential 3%-10% cost savings on every good that uses it as a medium of exchange”
Blockchain technology is often described as a destructive force to the banking system. To most, this doesn’t translate. There are too many facets to the banking system. Probably the most common and understandable function of a bank is lending. Most people are familiar with debt in the form of a mortgage, student loans, or credit cards.
For lending to work effectively, the bank needs to have access to an asset that can be leveraged as collateral. Collateral is generally something of value that is not as liquid (easily sold for cash) as the funds the bank is lending. With home ownership, most people use the title to their property as the collateral for the loan to purchase the property. Property values are fairly stable and easily appraised, so most home loans are highly collateralized. Lenders typically require a borrower to put down 20% of the total value of the home in cash and the lender will lend out the rest.
A loan has another major component, interest rates. Interest rates represent the time value of money, the return on the funds given to the borrower for the contractual period of time. The interest is the fee on the money that is lent. Often, interest rates account for some of the risk that is borne by the lender. If the loan is riskier for the lender, they may choose to increase the interest rate to offset those risks. Since home values are very stable, the interest rate on a mortgage is usually quite low.
What does lending have to do with cryptocurrency?
Lending is one way the blockchain ecosystem is bridging into the traditional financial markets. Savvy lenders can lend on any asset that has an underlying value. For cryptocurrencies, value fluctuates often, making them a risky asset to lend on, but there are ways to account for those risks – by increasing interest rates and collateral required for the loan. Leveraging cryptocurrency as the collateral for personal loans is the cutting edge for some lending companies. Through intensive underwriting and actuarial work, a few groups have figured out profitable ways to account for the risks associated with the volatility inherent in today’s Bitcoin value. These companies are starting to lend on Bitcoin and other cryptocurrencies so that holders can use cryptocurrency holdings as collateral to fund personal loans.
One such company is BlockFi. BlockFi has been lending USD to Bitcoin and Ether investors since the beginning of 2018. They require 35% loan to value rate in their loans to account for market fluctuations. For example, if a user wants $3,500 in the form of a cash loan, they would have to offer BlockFi $10,000 worth of Bitcoin. This ensures that BlockFi can cope with volatility in a way that minimizes the risks associated this type of lending. Extensive risk analysis has been performed by BlockFi. The analysis as been so comprehensive that none of their customers have defaulted on a loan due to the 2018 downturn that we are witnessing. Incredible. BlockFi also charges a 12% interest rate. These two measures enable BlockFi to efficiently lend out dollars on BTC and ETH. They are currently looking toward integrating more cryptocurrencies and other methods of lending. Check them out.
The lending space is going to be forever changed by the adoption of cryptocurrencies. Companies are exploring different ways to make lending more efficient and visible through blockchain tech. I am excited to see where these two industries collide and collaborate.