We are excited to give you a sneak peek into our upcoming comprehensive piece - "Credit Lending Mechanisms for Crypto Trading Firms (A Risk Management Perspective for Capital Allocators)." The full article will be available in the coming weeks, but for now, we are pleased to share the Executive Summary.
Having experienced firsthand the limitations of the (unsecured) lending/borrowing environment in the previous cycle, we have returned to the drawing board to design a more robust framework. Our aim was to create a setup that effectively combines risk management, proper legal frameworks, and liquidity with competitive yields. This initiative is part of our ongoing commitment to elevate industry standards. Our extensive research focuses on educating Capital Allocators in the space and addressing the various nuances of lending mechanisms for trading firms in the digital assets arena.
Introducing our new product
Reflecting on our research, we have identified a tremendous opportunity to capitalize on the increasing demand for capital from crypto-native trading firms. We plan to leverage the existing over-collateralized Prime Brokerage ecosystem and their sophisticated risk/liquidation-engine through a de-facto "CLO setup." Over the past few months, we have dedicated ourselves to developing the optimal legal structure for this endeavor. We are thrilled to announce that we are on track to issue our first loan next month to our launching partner, a leading Digital Assets Prime Broker. Please don’t hesitate to reach out if you would like to go over the offering in more detail including target yield, the PB risk approach, collateralization, and the SPV structure strategy.
Executive Summary "Credit Lending Mechanisms for Crypto Trading Firms"
The research article "Credit Lending Mechanisms for Crypto Trading Firms" presents a detailed examination of credit lending dynamics within the digital asset sector, with a particular focus on trading entities. The study delves into various lending paradigms prevalent in the cryptocurrency market, including over-collateralized, under-collateralized, and prime brokerage financing, each distinguished by its risk profile and capital efficiency.
Against the backdrop of the cryptocurrency credit market's nascent stage and ongoing evolution, recent developments, such as the collapse of centralized finance (CeFi) lenders, underscore the necessity of establishing robust credit frameworks. The sector's inherent volatility has been compounded by challenges such as lack of transparency, trust deficits, and structural issues within the credit landscape. Notably, the predominance of retail capital in the market, combined with the prior misuse of credit-only underwriting methodologies to extend leverage to trading firms, underscores the urgency of transitioning to more robust lending practices tailored to the specific needs of these entities.
This evolution towards transparent and established financial principles is pivotal in fostering a more stable and secure cryptocurrency financial ecosystem in the long term.
The article highlights key insights, including the potential of prime brokerage models to enhance safety and capital efficiency in the crypto space. Addressing systemic challenges in the crypto credit market, such as the establishment of price discovery mechanisms, diversification of funding sources and adherence to professional reporting standards, is crucial in fostering market stability and transparency.
Looking ahead, the study envisions the integration of traditional prime brokerage model strengths with digital asset innovations, such as DeFi Capital Market Platforms acting as Capital Formation Layers. This convergence has the potential to catalyze the development of more sophisticated services in the crypto credit market, catering to the evolving needs of trading firms and capital allocators, and contributing to the maturation of the digital asset ecosystem.
Market Pulse Commentary: Digital Asset Lending Landscape
Following a consolidation period in January, the total crypto market cap successfully broke out of its range in the first week of February with an increase of over 48%, sitting around $2.2 trillion. Historically, this marks the second-largest monthly increase in market capitalization.
It goes without saying that the approval of the first Bitcoin spot ETF nearly two months ago has played a significant role in Bitcoin's price trend, contributing to a steady uptrend throughout February. This pivotal event continues to influence major market movements, primarily due to the substantial inflows and outflows associated with these ETFs. According to CoinShares' report on February 26, the past week alone saw ETF inflows of $598 million, bringing the year-to-date total to a remarkable $5.7 billion.
This surge in inflows has coincided with record-breaking trading volumes, pushing the cumulative trading volume to surpass $54 billion. Leading the charge, BlackRock's spot Bitcoin ETF reported a daily trading volume of $1.3 billion. Consequently, Bitcoin prices soared, reaching a new two-year peak of $59,000 in the last week of February.
Expectations from Lenders:
Our current insights into lender rate expectations reveal a noticeable increase in anticipated returns across the board. This uptrend is primarily driven by a surge in demand from trading firms and the emergence of high-yielding opportunities for deploying funds in DeFi and benefits from elevated funding rates. Despite the strong demand for undercollateralized borrowing in the market, lenders continue to strongly favor the overcollateralized spectrum in institutional lending. This underscores the need for a pivotal shift in a market still characterized by a lack of transparency, trust issues, and challenges within the credit ecosystem.
As highlighted in our last market update, our analysis and insights indicate that the number of eligible counterparties for unsecured deals remains quite limited, with only a few large, top-tier counterparties meeting the necessary profile, information disclosure standards, and capacity to engage in such transactions. In light of these market conditions, we recommend a transition towards a prime brokerage lending model, the benefits of which were outlined in our last market pulse as well as below. Additionally, to offer lenders and quality borrowers an alternative means of engaging in the un(der)collateralized market segment, while addressing transparency issues, we are actively using a privacy-preserving live monitoring platform, Accountable. This tool provides live verification of a borrower's assets, trading exposure and various (customisable) performance and risk metrics, benefiting both lenders and borrowers from increased transparency and better pricing. For any parties interested in the solution, feel free to contact us for an introduction to the Accountable team.
Our recent market analysis has revealed that in the undercollateralized segment, lender rate expectations are converging within specific ranges:
USDC(T): 15%+ for undercollateralized options
BTC: 6%+ for undercollateralized options
Expectations from Borrowers:
In response to the heightened funding rates and market movements previously mentioned, we continue to observe a marked increase in inbound inquiries for unsecured financing from (crypto-native) trading funds. However, as disclosure standards across the board haven’t materially changed from the previous cycle as well as other reasons mentioned above we still only engage on an unsecured basis with just a handful of counterparties that can comply with our underwriting and monitoring requirements.
Quotes from these top-tier, (tradfi) trading firms for unsecured loans are consistently rising above 15% for stablecoins, and for BTC, rates are soaring above 5%, occasionally venturing into double-digit territory for one-off opportunities.
Meet the team: Tomislav Simunovic
We are very pleased to announce Tomislav Simunovic has joined the M11 Credit team last month as an intern. Tomi will be supporting the M11 Credit team in various aspects.
Tomi is a crypto native, who has been actively involved in the space for a little over four years and decided to pursue a career in web3 after initially working in the field of Medical Technology. Besides researching Blockchain technology and testing new protocols he is into sports, health and nutrition.
He graduated with a degree in Health Science & Technology from ETH Zurich last year.
