Cryptocurrency lenders The distressed investors embracing a crypto winter

Who ‘ya gonna call’ when there’s a run on a bank that isn’t really a bank? A non-bank bank, writes Robin Blumenthal.

That is what has been happening of late, ever since a couple of high-profile centralised crypto lenders went belly up after a cryptocurrency crash known as crypto winter.

“We are seeing activity with crypto lenders approaching traditional distressed managers about securing rescue financing,” says David Conrod, co-founder and chief executive officer of FocusPoint Capital Group, a New York-based capital raising and advisory business. Conrod says his firm is working with one manager that has been approached by multiple firms.

In the past few months, two big crypto lenders, Celsius Network and Voyager Digital Holdings, filed for bankruptcy protection. This underlines the weak controls in certain corners of the crypto-lending business, where depositors were promised double-digit returns only to see their accounts frozen and their investments go up in smoke.

Opaque investments

Crypto lenders are not required to be transparent about their reserves, or to hold a certain amount of capital. Regulation varies by country, and by state in the US, and regulators have yet to determine definitively whether or under what conditions the investments qualify as deposits, securities or commodities.

There are several different types of unregulated crypto lending platforms. Decentralised finance, or DeFi, is non-custodial, where counterparties transact digitally and maintain ownership of their tokens, with yield coming from interest paid by borrowers. “Platforms can automate functions traditionally managed by banks or custodians using blockchain smart contracts,” according to digital assets news service Blockworks.

“DeFi lost no money in the past few months”, says Timothy Spangler, a partner at law firm Dechert. “Your counterparty has the ability to sell instantly; there is no smiling and dialling.”

By contrast, a centralised finance, or CeFi, platform manages all deposits and loans on a centralised platform and internal balance sheet, with depositors losing direct control of the assets in return for the platform investing it. Many of these depositors were using them as custodial accounts and not as investment vehicles, and there was a mismatch of collateral to the lent-out crypto currencies. Centralised lending “looks and feels like a bank for cryptocurrencies – without the same regulatory oversight and consumer protections”, Blockworks says.

CeFi lenders are largely unregulated and uninsured. But that may change. A group of state regulators is investigating crypto lenders and several institutional investors have been badly burned. Over the summer, one of Voyager’s borrowers, crypto hedge fund Three Arrows Capital, was ordered to liquidate, and Caisse de dépôt et Placement, one of Canada’s largest pensions, had to write off its $150 million stake in Celsius.

Amid this chaos, some see opportunity, despite the risks.

“We are looking very carefully into many of these situations, as we believe there could be value in these platforms,” says one distressed manager, who requested anonymity. Their firm has been approached by a dozen crypto-lenders. “With the right operating frameworks, providing transparency and confidence to the clients, these companies can be rescued and turned around to the benefit of all stakeholders,” they say.

The companies are exploring different capital solutions, such as debt financing using any of the business segments as collateral. Also under discussion: a recapitalisation of the main business, or a payment-in-kind solution where existing depositors receive an equity stake in the company to cover the portion of deposits that will not be returned.

But it will not necessarily be a slam dunk. In its bankruptcy filing, Celsius showed a balance gap of $1.2 billion, with user deposits comprising most of its $4.72 billion of liabilities.

For crypto, the situation could worsen. Energy costs are squeezing crypto “miners” and inflation is pressuring coin prices, which may lower valuations. A bad crypto winter may be ahead, with opportunities for distressed managers.