How Crypto-Collateralized Loans Restore Honest Lending (And Avoid Financial Crisis)

The fact that cryptocurrencies solve liquidity problems for multiple financial processes is now well known, but as the industry evolves and expands, could it save the world from another financial crisis?

‘We are in danger of sleepwalking into a future crisis’

In 2008, the catastrophic failure of a global banking system manipulating overly encouraging governmental regulation sparked a nightmare for billions of consumers around the world.

While economies continue to feel the knock-on effects, the banking system has seen little in the way of a fundamental overhaul. The tinder which ignited the fire in the US – collateralized debt obligations (CDOs) tied to poor-quality debt such as mortgages – has not seen a suitably safe replacement.  

“We are in danger of sleepwalking into a future crisis,” Brown told The Guardian in a recent interview. “There is going to have to be a severe awakening to the escalation of risks, but we are in a leaderless world.”

The ratings system of CDOs gave away the signs that collateral was not ‘honest’; subprime mortgages abounded in the US model, resulting in behavior criticized by economists where credit agencies manipulated the worst of the debt to look more secure.

The US Federal Reserve began bailing out failing lenders with collateralized loans, a phenomenon all the more ironic given the reluctance to shore up consumers using its own money.

Restoring Non-Fractional Banking & Honest Lending

In 2018, with failings long pointed out, there is hardly a sense of urgency to change the banking system to prevent a repeat crisis.

One alternative – undoing fractional reserve banking where an institution needs only to hold a tiny amount of its deposit liabilities – has yet to hold sway over the establishment. In the cryptocurrency world, however, a taste for non-fractional is developing. For example, stablecoin Tether’s rumored primary reserve bank NBI is a non-fractional institution.

While still a niche phenomenon, talk of Bitcoin going Wall Street is becoming increasingly vocal. And for collateralized lending, both personal and corporate, the industry is already demonstrating its application.

Taking the example of Bitcoin 00, the world’s most established cryptocurrency, collateralized lending seems a perfect application. Easy liquidity, 24/7 markets, global price consensus, borderless, politically-neutral with immutable transactions, allow easy trading in and out of the asset.

At the consumer level, collateralized lending is making a slow comeback courtesy of cryptocurrency markets.

InLock, a fledgling startup dedicated to offering collateralized fiat loans for cryptocurrency is eyeing the concept’s potentially giant expandability in the coming years, alongside a slew of competitors. 

“The concept of having a collateral class with money-like liquidity is relatively new. The growth will be enormous once major financial institutions realize the opportunity this new form of lending has to offer,” CEO Csaba Csabai explains.

The term ‘loan’ might not even be the best description, since it’s a lot more like an exchange of fiat to crypto with a promise to exchange it back at the same rate.

While Bitcoin remains volatile and capable of protracted downturns, collateralized loans offer security against bear markets. Even if a client’s crypto collateral is liquidated by falling prices, the fiat cash is still leverageable.

“The borrower sees it this way: I need some money to spend, but I believe my crypto will go up in price, so I really don’t want to sell now,” CMO Péter Gergő adds. 

I’ll lock it as collateral, take out a loan in fiat, pay interest, and make a profit when exchanging back my crypto for fiat at the end of the contract period. 

Can crypto-collateralized loans help the financial system return to more honest lending practices? Share your thoughts below!

Images courtesy of Shutterstock, inlock.io