欧盟法律应如何监管加密货币借贷？-How Should Crypto Lending Be Regulated Under EU Law

HowShouldCryptoLendingBeRegulatedUnderEULaw?

EmiliosAvgouleas*·AlexandrosSeretakis**

Abstract

ThecollapseofGenesisisthelatestinacascadeoffailuresofcryptolenders.Thelastyearhasseennumerousmajorcryptolenders,suchasCelsius,VoyagerandBlockFi,goingoutofbusinessindomino-likefashion.Thefailureshaverevealedthevulnerabilitiesofcrypto-marketlenders’businessmodel,mostnotablytheliquidityandmaturitymismatchesintheirloanportfolios,andtheirmarkedlyweakcorporategovernance.ThepresentarticleexploresavenuestoregulatecryptolendingwithintheframeworkofEUfinancialservicesregulation.ItarguesthatcryptolendersshouldbetakenasfallingwithinthedefinitionofcreditinstitutionsunderEUlaw,andthus,asaresult,shouldbesubjecttothestringentlicensingandprudentialrequirementsintroducedbytheCapitalRequirementsDirectiveandRegulation.

Prudentialregulationisoneofthewaysthathavebeensuggestedfortheregulationofcrypto-marketoperators,alongsidetheinvestorprotectionframework.Takingintoaccountthatcryptolenderseasilyoperateonacross-borderbasisandthatprudentialregulationisfullyharmonizedintheEU,wetakeanEU-wideperspectiveandfocusouranalysisonEUlaw,ratherthanmemberstatelaws.Inaddition,prudentialregulationcandealwithanysystemicriskissueswithwhichinvestorprotectionregulationcannotdeal.However,inordertoavoidmoralhazardandnotgiveinvestorsthefalseimpressionthatcryptolendersaresafetoo-big-tofailinstitutions,wesuggestthatcryptolendersshouldnotenjoythefullprotectionofprudentialregulations.Inparticular,theyshouldnotbeofferedlenderoflastresortsupportandtheyshouldnotbeallowedtosubscribeintoadepositinsurancescheme.Eventhoughitisoftensaidthatcryptomarketsposenorisktotheregulatedsectorduetolimitedinterconnectedness,itshouldbenotedthatduetothehighleverageofcryptoinvestors,therealrisktotheregulatedsectorcomesfromthepossibilityofcryptoinvestorsmassivelyliquidatingtheirpositionsinotherassetmarkets.1

KeywordsCryptolending·Prudentialregulation·Financialstability·EUlaw·DeFi·Fintech·Cryptoassets

✉EmiliosAvgouleas

eavgoule@exseed.ed.ac.uk

✉AlexandrosSeretakis

alexandros.seretakis@tcd.ie

*ChairofInternationalBankingLawandFinance,UniversityofEdinburgh,Edinburgh,UK

**AssistantProfessorofLawinCapitalMarketsandFinancialServices&Fellow,TrinityCollegeDublin,Dublin,Ireland

1AccordingtotheFSB,thisisalsothemainriskthatnon-bankfinancialintermediationposestotheregulatedsector.EventhoughtheinterconnectednessbetweenNBFIoperatorsandinstitutionsintheregulatedsectorisverylimited,liquidationofpositionsinassetmarkets(firesales)thatregulatedfinancialinstitutionscarryontheirbalancesheetspresentsstabilityandsolvencyissuesforregulatedinstitutionsaswell.Thiseffectisthemainsystemicriskconcernemanatingfromthecryptosector.SeeFSB(2022a).

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1Introduction

Oneofthebiggestchallengesfacingpolicymakerswithrespecttocryptomarketsisthetreatmentofcryptolending.ECBPresidentLagarderecentlystatedthatcryptolendingshouldberegulated.2AccordingtotheECBPresident,thegrowingincidencesoffraud,criminaldealingsanddubiousvaluationpracticesinthecrypto-lendingspaceposesevereriskstoconsumers.Onequestionflowingfromherstatementis:howshouldcryptolendingberegulated?ThepresentarticlewillexploreavenuestoregulatecryptolendingwithintheframeworkofEUfinancialservicesregulation.ItwillarguethatcryptolendersfallwithinthedefinitionofcreditinstitutionsunderEUlaw.Asaresult,theyshouldbesubjecttothestringentlicensingandprudentialrequirementsprovidedbytheCapitalRequirementsDirectiveandRegulation.ItshouldbenotedthatcryptolendersarepredominantlyoperatingintheUS,withtheirpresenceinEuropestilllimited.However,theconsiderablegrowthofcryptolendinginEuropemayleadcrypto-lendingfirmstoexpandtheiroperationsinEurope,thusnecessitatingaregulatoryresponsefromEuropeanpolicymakers.Asimilarpatterncouldbeobservedwithregardtotheregulationofcreditratingagencies.TheBigThreecreditratingagencieswereallbasedintheUS.Nevertheless,theirexpansioninEuropeandtheirroleinaggravatingand/orcausingthefinancialandsovereigndebtcrisisforcedEuropeanpolicymakerstoadoptacomprehensiveregulatoryandsupervisoryframework.3

Thelastfewyearshaveseentheexponentialgrowthofcryptolending,withlenderssuchasCelsius,BlockFiandDeFiprotocols,suchasMakerDAOandCompound,dominatingthespace.4Nonetheless,thefailureofCelsiusNetworkandVoyagerhasalarmedpolicymakerstotheimportanceofcryptolendersforcryptomarketsandthefragilityoftheirbusinessmodel.Moreover,thespectacularcollapseofFTXcreatedcontagionacrosstheindustryandhadaspillovereffectoncryptolenders,withmajorfirmssuchasGenesisandBlockFisuspendingwithdrawalsofcustomerfundsandfilingforbankruptcy.5Asthepresentarticlewillargue,theactivitiesofcryptolenders,whichinvolvethetakingofdepositsincryptoassetsandthegrantingofcryptoloans,resemblebankingactivities.However,lackofregulationcreatesacompetitiveadvantageforcryptolendersvis-à-vislicensedbanks.Unregulatedcryptolendersareabletoproducereturnsbytakingonexcessiverisk.Furthermore,astherecentCelsiusdebacledemonstrates,theprocyclicalnatureofcrypto-lendingactivities,firesalesofinvestorholdingsinotherassetclasses,highleverageemployed,andtheriskofdepositorrunsmaygiverisetosystemicrisk.6Prudentialregulationwillmakecrypto-lendinginstitutionssaferandmorestable.Forexample,prudentialregulationwouldhavepreventedcryptolenders’exposuretoasingleassetclassandwouldhavecuredtheirvulnerabilitytoliquidityrisks(e.g.,userruns).Itwouldalsohavelimitedtheabilityofcryptolenderstobehighlyleveraged.Inthiswaycryptolenderswouldhavebecomemorestableandresilient,andthestringofrecentfailureswouldhavebeenaverted.Itisplausibletoarguethatifcryptolendersweresubjectto

2Beganski(2022);Hetzner(2022).

3Theoverdependenceofinvestorsoncreditratingsandtheflawedbusinessmodelofcreditratingagenciesfuelledthesubprimemortgagebubbleandareconsideredtobeamongthecausesofthefinancialcrisis.SeegenerallyPartnoy(2017).Fortheshortcomingsofthecreditratingagencyindustry,whichcontributedtotheEurozonedebtcrisis,seeGaillard2013.IntheaftermathofthefinancialcrisistheEUadoptedtheso-calledCRARegulation,whichprovidedforthemandatoryregistrationandsupervisionofcreditratingagencies.TheRegulationwasamendedin2011and2013.ForanoverviewofregulatoryreformbothinEuropeandtheUS,seegenerallyCoffeeJr.(2010).

4Shimron(2020).

5FletcherandOliver(2022);Findlay(2023).Morethan$900millionincustomerfundsremainfrozeninGenesis’sbankruptcy.SeeSweet(2023).

6PonnezhathandWilson(2022).SeealsoIMF(2021).

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prudentialregulation,recentcrypto-lenderfailuresandattendantinvestorlosses7wouldhavebeenprevented,e.g.,intheUSonlybanksandsimilarregulateddepositaryinstitutionsareallowedtotakedeposits.8

Unregulatedcryptolendershavenotbeensubjecttoanyconductofbusinessorotherrulesfortheprotectionofinvestorsorusers,makingiteasyforcryptolenderstomisrepresenttheirstatusandconcealtherisksoftheirproductsfrommarketusers.Thepresentarticlewilltreatcryptolendingasanactivitydistinctfromothercrypto-assetmarketactivities,suchascrypto-currencytradingortakingcustodyofcryptoassets,whichareactivitiesdealtwithbythedraftEURegulationonMarketsinCrypto-Assets,alsoknownas‘MiCA’.9

2DeFiandCryptoLending

2.1DeFi

ThecombinationofblockchaintechnologyandsmartcontractshasgivenrisetoanewformoffinancialecosystemknownasdecentralizedfinanceorDeFi.10ThetotalvaluelockedinDeFireachedanall-timehighof$253billioninDecember2021.11DeFiisatermusedtodescribeanecosystemcomprisingfinancialapplicationsbuiltontopofblockchainnetworkswhichdonotrelyontraditionalfinancialintermediariessuchasbrokerages,exchanges,orbanks.12DeFiaimsatreplicatingexistingfinancialserviceswithouttheinvolvementofcentralizedintermediaries.13InaDeFienvironmenttheuserscanmaintainfullcontrolovertheirassetsandinteractwiththisecosystemthroughpeer-to-peer(P2P),decentralizedapplications(dapps).DeFiapplicationsdonotneedanyintermediariesorarbitrators.Pre-setCodespecifiestheresolutionofdisputesthatcanbepredictedinadvance.Essentially,theCodeislawamongusersandthus,inthecontextofblockchainplatforms,ithasbeengiventhename‘LexCryptographia’.14

AmongtheallegedadvantagesofDeFiisthebypassingofrent-seekingintermediariesinfinancialservicesandthecultivationofanenvironmentwheretechnologicalinnovationcanthriveandoffermoreconsumerchoicewhenitcomestopaymentsandlowertransactioncosts.

7Inductively,thetotalofinvestorlossesintheCelsiussagawasinthevicinityof$4.7billion.Thissumshowshowimportantitistoprotectinvestorsandmarketsfromtheegregiouspracticesofcryptolenders.Sigalos(2022).8Alexanderetal.(2014).See26U.S.Csec.581.Theterm‘bank’meansabankortrustcompanyincorporatedanddoingbusinessunderthelawsoftheUnitedStatesorofanyState,asubstantialpartofthebusinessofwhichconsistsofreceivingdepositsandmakingloansanddiscounts,orofexercisingfiduciarypowerssimilartothosepermittedtonationalbanksunderauthorityoftheComptrolleroftheCurrency,andwhichissubjectbylawtosupervisionandexaminationbyStateorFederalauthorityhavingsupervisionoverbankinginstitutions.

9MiCAintroducesaregulatoryframeworkfortheissuanceandtradingofcryptoassets.ItcoverscryptoassetsthatarenotclassifiedasfinancialinstrumentsunderMiFIDII,suchasutilitytokensandstablecoins.Furthermore,MiCAintroducesrulesforcrypto-assetserviceproviders,whicharerequiredtobeauthorizedinordertooperatewithintheEU.CounciloftheEU(2022).

10TheEthereumplatformisthemostpopularchoiceforDeFifinancialservicesandproducts.TheEthereumblockchainallowsthedesignandemploymentofhighlyprogrammablesmartcontractswithautomatedexecution.Buterindefinedsmartcontractsassystemswhichautomaticallymovedigitalassetsaccordingtoarbitrarypre-specifiedrules.SeeButerin(2014),p1.Moreover,Ethereum’scomposablesoftwarestackensuresthatDeFiapplications(dapps)arebuilttointegrateandcomplementoneanother.SeeAvgouleasandSeretakis(2022),p17.

11Minter(2021).ThecollapseofthecryptomarketseverelyimpactedtheDeFisector,withthesectorpartlyrecoveringduringthesummerof2022.

12AvgouleasandSeretakis(2022),p13.

13Ibid.,atpp16-17.

14SeegenerallyDeFilippiandWright(2018)andDimitropoulos(2020).

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AccordingtoDeFiproponents,theremovalofcentralizedintermediarieswillleadtoamoreopen,transparentandresilientfinancialecosystem.15DeFiinfrastructuresprovideflexibilityandtransparencyincontractdesignaswellasahighlevelofrecordsecurity.DeFiplatformsenablethecreationofnewfinancialinstrumentsanddigitalassetsbyallowingdeveloperstobuildontopofexistingprotocols,customizeinterfaces,andintegratethird-partyapplications.Asaresult,theyareoftencomparedwithlegopiecesandreferredtoasmoneylegos.

DeFioperationsincludedecentralizedexchanges,decentralizedderivatives,insurance,assetmanagementandcryptolending.Decentralizedexchangesallowthetradingofdigitalassetswithouttakingcustodyofuserassets,whichallowsuserstore-deploytheirassetsinotherinvestmentactivities.16Decentralizedderivativesaretokensthatderivetheirvaluefromanunderlyingassetortheoutcomeofanevent.17DeFiinsuranceservicesaremostlyusedforinsuringagainsttherisksposedbysmartcontractfailuresandhacksofDeFiprotocols.18Claimsarepaidoutwithdigitalassetsafterthevoteofclaimassessors.Asfarasassetmanagementisconcerned,DeFiinvestmentfundsinvestincryptoassets,whicharelockedupinasmartcontract.19Thelendingmarketisanotherfast-growingsectoroftheDeFiecosystem.DeFiseekstobypassthetraditionalintermediariesinborrowingandlending,mostnotablybanks.DeFilendingandborrowingaregovernedbysmartcontracts,andloansareoftenovercollateralized,withborrowersdepositingcollateralincryptocoins.

ItshouldbenotedthatDeFicreatesmajorchallenges,especiallyrelatingtofraudandmarketinstabilityandvolatility.Indeed,cryptolendinghasbeenidentifiedasapotentialsourceofrisktothefinancialsystem.Also,cryptomarketshaverecentlybeenimplicatedinallegedmoney-launderingschemesandeffortstobypassrecentWesternsanctionsonRussia.20

2.2TheNatureofDeFiMarkets

AccordingtotheIMF,thetremendousgrowthandexpansionofcryptomarketspresentsrisksforfinancialstability.21Therecentturbulenceincryptomarkets,includingDeFimarkets,hasexposedstructuralvulnerabilitiesintheecosystem.Inparticular,themayhemincryptomarketshasexposedcryptoassets’volatility,withthecryptomarketwitnessingwildpriceswings.22Cryptoassetsexhibitextremefluctuationswhicharegreaterthanthoseofotherfinancialassets.23Moreover,despiteclaimstothecontrary,thecorrelationbetweenthechangesinthepriceofcryptoassetsandriskierassets,suchasequities,hasbeenincreasingoverthepastfewyears.24Anothermajorsourceofvulnerabilityistheabilityofinvestorstoestablishhighlyleveragedpositions,whichexacerbateprocyclicalityandvolatilityandcreate,likeotherformsofshadowbanking,25invisiblelinksofinterconnectedness.Dapps,suchastradingandlendingplatforms,facilitatethebuild-upofleveragedpositions.Forinstance,themaximumpermittedmarginindecentralizedexchangesishigherthaninregulatedexchanges.Moreover,

15Schar(2021).

16ThelargestdecentralizedexchangeisUniswap,whosetotaltradingvolumeexceeds$1trillion.Quarmby(2022).

17WhartonBlockchainandDigitalAssetProject(2021),p14.

18Ibid.,p15.

19Ibid.,p16.

20FlitterandYaffe-Bellany(2022).

21IMF(2021),p39.

22Brainard(2022),p2.

23HernandezdeCos(2022),pp4-5.

24Ibid.

25Arguably,thebestwaytoapproachcryptolendingisasaformofshadowbanking.Itshouldbenotedthatarunoncollateralintheshadowbankingsectorwasheldtobeoneofthemaincausesoftheglobalfinancialcrisis.SeetheclassicpaperbyGortonandMetrick(2012).Otherscholarsalsounderstanddecentralizedfinance(DeFi)asaformofshadowbanking,see,e.g.,Allen(2022).

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collateralizedlendingallowstherecyclingofcollateral,enablinginvestorstobuildlargeexposuresusingthesamecryptoassets.Naturallyleveragedpositionsarethefirsttobeunwoundwhenthereisdownwardpricepressureincryptomarkets.Finally,thepseudonymousnatureoftheDeFiecosystemandcryptomarketsmoreingeneralmayfacilitatemoneylaundering,terroristfinancingandmarketmanipulation.Furthermore,regulatorsareunabletohaveacompleteviewofthemarketandmonitorfinancialstabilityrisks.26Whatismore,astheBankofInternationalSettlementsnotes,anonymityanddependenceoncollateralundermineDeFi’sgoaltopromotefinancialinclusion.27EspeciallyinthecontextofDeFilending,relianceoncollateralbenefitstheownersofassets.

Mostoftoday’sDeFiactivityisoutsidetheregulatoryperimeter,butthisisasituationthatisnolongertenable.Thus,theEuropeanCommissionhasrecentlyproposedadigitalfinancepackageaimedatfosteringEurope’scompetitivenessandinnovationinthefinancialsector.ThepackageincludesaDigitalFinanceStrategy,aRetailPaymentsStrategy,andlegislativeproposalsoncryptoassetsanddigitaloperationalresilienceandaplotregimeformarketinfrastructurespoweredbydistributedledgertechnology.ButtheDigitalPackagethatisstillunderconsiderationisonlythebeginning.EUfinancialservicesregulationwillsoonrequireawholesaleoverhaulinordertokeeppacewiththedigitaltransformationofthefinancialvaluechainbothwithintheEUandglobally.

2.3TheParticularCaseofCryptoLending

ThesuddencollapseofCelsiusandVoyagerhasturnedtheattentionofpolicymakerstothefragilityofthebusinessmodelofcryptolendersandtheircontributiontosystemicrisk.Cryptolenders,suchasCelsiusandVoyager,soughttoprovideasolutiontotwodistinctproblemsfacingcryptoholders:lackofliquidityandlackofmarketpurchasingpower.28Cryptoholdersfacealiquidityproblemsincecryptocurrenciesarenotwidelyacceptedasamediumofexchange.Asaresult,holdersofcryptowhowanttomonetizetheirholdingscanconvertthemintofiatcurrency.29Moreover,itoffersthemtheopportunitytoearnhandsomereturnsontheircryptoholdings,throughstaking,whichisonlyavailabletoholdersofbigportfolios.30Specificcryptolendersengageinsecuredlending,whichallowsholderstodeposittheirassetsandborrowfiatcurrencyorotherdigitalassetsusingtheircryptoholdingsascollateral.

Furthermore,userscanalsoearnrewardsontheseassetsatratesthataremorefavourablethanthoseofferedbytraditionalintermediariesorothercryptoplatforms.Cryptolendersareinessenceperformingcreditintermediationoutsidetheregularbankingsystem.Asaresult,theyshouldbeunderstoodasaformofshadowbanking.Forexample,AdrianandAshcraftdefineshadowbankingas‘awebofspecializedfinancialinstitutionsthatchannelfundingfromsaverstoinvestorsthrougharangeofsecuritizationandsecuredfundingtechniques’,31whiletheFinancialStabilityBoarddefinesitas‘creditintermediationinvolvingentitiesandactivitiesoutsidetheregularbankingsystem’.32

ItshouldbenotedthatCelsiuswasoneofthebiggestcryptoplatformsintheworld.HeadquarteredinNewJersey,USA,Celsiushad,inMay2022,around$12billionofassetsundermanagementandhadissuedloansinexcessof$8billion.Accordingtoitschiefexecutive

26Drakopoulos(2021).

27SirioAramonteetal.(2022),p2.

28Inre:CELSIUSNETWORKLLC,etal.,DeclarationofAlexMashinsky,ChiefExecutiveOfficerofCelsiusNetworkLLC,inSupportofChapter11PetitionsandFirstDayMotions,p2.

29Ibid.

30Ibid.

31TobiasandAshcraft(2012).

32FSB(2011).

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AlexMashinsky,theCelsiusbusinessmodelwascenteredondeployingdigitalassetstogenerateincomeforCelsius’operationsandgrowth.33Celsiusofferedtheso-called‘Earn’programthatenableduserstodeposittheirdigitalassetswithCelsius,whichwasthenallowedtousetheseassetsinordertogenerateyield.UsersearnedrewardsontheirassetsintheformofpaymentinkindinterestorCelsiustokens,withtheannualpercentageyieldreaching17percentoncertainassets.34Thecompanygeneratedtheyieldthroughvariousactivities,includinglendingservices,andalsoprovidedborrowingservicestoretailandinstitutionalclients.Furthermore,thecompanyhadextendedloanstoitsclientssecuredbydigitalassets,whichitwasallowedtorehypothecate.35Moreover,itengagedinstakinganddeployeddigitalassetsintoautomatedmarketmakerorlendingprotocols,forafee.36Lossessufferedoncertainilliquidinvestmentsandthecollapseofthecryptomarketledtomassivewithdrawalsbydepositors,destabilizingthecompany,whichwasforcedtoimposeabanonwithdrawalstostemthedepositorrun.

Voyagerwasthenextmajorcryptolendertofileforbankruptcyfollowingtheturbulenceinthecryptomarketandthedefaultofoneofitsborrowers.37Voyageroperatedacrypto-currencyplatformthatenableditsuserstotradeandstorecryptocurrency.Customerswereabletodeposittheircryptoholdingsandearninterestonthem.38Voyagerwasabletopayinterestondepositsbylendingcryptocurrencydepositedonitsplatformtothirdpartiesatapre-negotiatedinterestrate.Thewidespreadpanicincrypto-currencymarkets,theannouncementbyCelsiusNetworkthatitwassuspendingallaccountwithdrawalsandtransfersandthecollapseofThreeArrows,acryptofund,39whichhadborrowedmorethan$670million,ledtoarunbyVoyager’scustomers.40Thecompanywasforcedtosuspendwithdrawalsandtradingactivityonitsplatformandfileforbankruptcy.

Finally,cryptolenderswereseverelyhitbythesuddencollapseofcryptoexchangeFTX.TheFTXempire,foundedbyfallencryptomogulSamBankman-Fried,includedtheFTXcryptoexchangeandAlamedaResearch,aquantitativecryptohedgefundspeculatingindigitalassets.41FollowingtheannouncementofBinance,arivalexchange,thatitwouldliquidateitsholdingsinFTT,FTX’snativetoken,FTXsufferedaneffectiverunonthebank,withcustomers’withdrawalrequestsamountingtoanestimated$6billionoverthreeyears.42FTX,whichwasusingcustomerfundsinordertofinancetheriskyandilliquidbetsbyitsaffiliatedtradingfirmAlamedaResearch,wasunabletofulfiltherequests.43TheresultingliquiditycrunchforcedFTXtofileforbankruptcy.Thebankruptcyproceedingshaverevealedaggressiverisk-taking,anutterlackofcorporatecontrolsandriskmanagement,absenceoftransparencyandtrustworthyfinancialinformation,andself-dealing.44Inparticular,thecase

33Inre:CELSIUSNETWORKLLC,etal.,DeclarationofAlexMashinsky,ChiefExecutiveOfficerofCelsiusNetworkLLC,inSupportofChapter11PetitionsandFirstDayMotions,p5.

34Ibid.

35Ibid.

36Ibid.,pp22-23.

37Oliver(2022).

38Inre:VOYAGERDIGITALHOLDINGSINC.,DeclarationofStephenEhrlichChiefExecutiveOfficeoftheDebtors,inSupportofChapter11PetitionsandFirstDayMotion,pp11-12.

39Singapore-basedThreeArrowswasoneofthebestknowncryptohedgefunds,makinglargeleveragedbetsonrisingcryptoprices.ThecollapseofcryptotokenLunainflictedheavylossesonThreeArrows,whichhadmadesignificantinvestmentsinthetoken.ChipolinaandSamson(2022).

40Inre:VOYAGERDIGITALHOLDINGSINC.,DeclarationofStephenEhrlichChiefExecutiveOfficeofthe

Debtors,inSupportofChapter11PetitionsandFirstDayMotion,pp12-24.

41Oliver(2022).

42Huang(2022).

43Michaels(2022).

44JohnRay,thenewchiefexecutiveandchiefrestructuringofficerofFTX,stated:‘NeverinmycareerhaveIseensuchacompletefailureofcorporatecontrolsandsuchacompleteabsenceoftrustworthyfinancial

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exposedthepoorcorporategovernancestandardsandlackofaccountabilitypermeatingthecryptoindustry.HeadquarteredinNassau,theBahamas,FTXhadathree-personboard,includingitsfounderSamBankman-FriedandalawyerinAntigua.45Indeed,somecompaniesoftheFTXGroupneverevenheldaboardmeeting.FTX’scollapsehadawiderimpact,leadingtowidespreadcontagionincryptomarketsandamarket-widerunoncryptolenders,whichwereforcedtohaltredemptionsandloanoriginations.46Cryptolenders’difficultiesrevealedtheinherentvulnerabilityoftheirbusinessmodelcausedbytheliquidityanddurationmismatchoftheirloanportfolio.

3Cryptolending:RisksandRegulatoryResponse

3.1WhatAretheRisks?

Thekeyfinancialstabilitythreatofcryptolendingcomesfromtheexcessivevolatilityofcrypto-currencymarketsandthefactthatlotsofcryptoassets,suchasnon-fungibletokens(NFTs),47areverycomplexandverydifficulttovalue,makingitverydifficulttoobtainadequatecollateraltosecuretheloan.48So,asaresult,userleveragewithinthesystemremainsuncontrolled.Thispracticeexposescryptolenderstosuspicionsandrumorsabouttheirfinancialhealth,thuscausingmarketpanic,manifestedasdepositorruns,whichexposethewell-concealedliquidityimbalanceswithincryptolenders,leadingcryptolendersandcrypto-exchangeplatformstofacetheriskofilliquidity.AnindicativeexampleistheFTXdebaclewheremarketconfidenceinFTXevaporatedshortlyafterthereleaseofareportbycrypto-currencynewsplatformCoinDesk,whichonthisoccasionrevealedtheclosetiesbetweenAlamedaandFTX.49Inthisway,instabilitycanspreadtootherinstitutionsormarketsegments(contagion),resultinginageneralizedconfidencecrisis.50Eventhoughtheinterconnectednessbetweencryptolendersandmainstreamfinancialinstitutionsislimited,amarketpanic,includingaflighttosafeassets,isabehavioralphenomenonandisveryhardtocontainexante.Avalidconcernhereiswhetherinvestorrunsfromthecryptomarketscanevolveintoageneralizedconfidencecrisis,despitethefactthatthelinksbetweencryptolendersandregulatedfinancialinstitutionsappeartobelimited.

Moreover,thenumberofretailinvestorswithexposurestocrypto-currencymarketsiseverincreasing.TheproportionofBitcoinsupplyheldbyretailinvestorshasreachedanall-timehighat17%.51Thevolatilityofcryptocurrenciesandcryptomarkets,andtheirboomandbustcycles,canleaveinvestorsexposedtosignificantlossesandamplifymarketinstabilitythroughtheaforementionedcollateralchannel.Forexample,arecentpaperbytheBankforInternationalSettlementsfoundthattheoverwhelmingmajorityofretailinvestorsinBitcoin,

informationasoccurredhere.’SeeInre:FTXTRADINGLTDetal.,Debtors,