By Ray Birch
ST. PETERSBURG, Fla.—A handful of credit unions offering cryptocurrency services have said their next step will likely be finding ways to leverage members’ digital assets to drive lending.
However, some recent developments among fintechs already operating in the crypto lending space suggest CUs should proceed with caution, Lou Grilli says.
“Crypto-secured loans have been in the news a lot lately, and not for good reasons,” said the senior innovation strategist at PSCU. “Crypto lender Voyager Digital filed for bankruptcy when a single borrower, Three Arrows Capital, defaulted on its $650-million loan collateralized by its crypto holdings—the value of which decreased by half.”
BlockFI, another lender in the crypto space, had to lay off staff after it announced a large client failed to meet its obligations on an overcollateralized margin loan, Grilli noted.
“A third example, Celsius Network, an interest-earning yield platform, has frozen withdrawals after failure of its decentralized finance strategies,” Grilli stated.
While those examples represent loan commitments far larger than any single loan a credit union is likely to ever make, the events should nonetheless be on the radar of credit unions that have entered the cryptocurrency space—at present members are only being offered the ability to buy, sell and hold crypto through third parties—especially if they are now considering taking into account members’ digital holdings when they apply for a loan, said Grilli.
As CUToday.info reported, the $3.6-billion UNIFY Financial CU in Torrance, Calif., has been offering bitcoin services to its entire membership. And while the credit union sees a number of other potential future crypto-related services, it told CUToday.inifo that among those is the opportunity to increase loans.
As members begin to hold onto their cryptocurrency much like they do of liquidating in the near term, UNIFY CEO Gordon Howe several months ago said the long-term perspective will make crypto a good source of collateral. He added that UNIFY does not plan to loan against the full market value of crypto at the time of the loan, possibly lending at 60% of the currency’s value, he said.
Biggest Example of DeFi
Grilli said lending in the crypto space is currently the biggest example of decentralized financial services, or DeFi.
Lou Grilli
“DeFi are banking-like services, such as borrowing and lending, but outside of the regulated financial industry,” he explained. “And it serves a major purpose—many people, and more importantly, large institutional investors, have accumulated substantial positions in various crypto coins. When they want or need cash, they can borrow against their holdings.”
Grilli pointed out what is occurring with crypto lending now is not unlike what taken place among traditional FIs when it comes to consumers and the stock market, and is similar to “margin loans.”
“The borrower does not have to sell their holdings in order to raise cash, anticipating that the underlying crypto being put up as collateral will continue to increase in value over time,” Grilli explained. “What happens when the value of the collateralized assets declines below the loan amount? The lender calls the margin, requesting the borrower to put up more collateral. If they can’t, then the loan defaults, which is what happened in several recent examples of crypto platform failures.”
A Safer Alternative at Some Banks
Grilli noted a few OCC-charted financial institutions are offering a somewhat safer alternative to these DeFi platforms.
“Signature Bank and Silvergate Bank both offer crypto-collateralized loans,” he said. “Since they are both banks, they offer more stable funding sources—with their non-crypto assets secured by FDIC insurance—and tougher underwriting standards than the startups. This shows momentum for crypto in lending in the regulated U.S. banking space.”
As a number of leaders whose credit unions have begun offering cryptocurrency services to members have stated, some members who are holding on to their crypto want to have those digital assets considered as lending collateral.
“They would certainly prefer the trust, security and stability of their credit union instead of an overseas-based crypto lender, possibly more than a big bank,” said Grilli. “However, for the foreseeable future, credit unions are not allowed to take custody of a crypto asset as collateral. Meaning, for now, credit unions cannot directly participate in DeFi. But there is something more progressive credit unions can be doing in this space.”
What Can A Credit Union Do?
How can credit unions safely participate in this space?
“Underwriting loans involves the member’s ability to repay. The underwriting process looks at the member’s assets,” noted Grilli. “Most loan applications were written before cryptocurrencies became somewhat mainstream. The potential borrower would rather not sell their crypto holdings to turn it into cash in order for it to be considered as an asset.”
Grilli pointed out that even cash as an asset is volatile in the sense that the member can spend down cash holdings right after the loan is closed.
“Financial underwriting questionnaires should be revised to capture details about crypto assets held, with details including the type of asset, number of units of that asset, who is the custodian (i.e. where the asset is being held),” Grilli said. “This may help some homebuyers be able to qualify for a loan they might not have otherwise, thereby expanding the credit union’s loan portfolio and creating more happy members.”
Risk-Weighting the Collateral
Grilli emphasized that while a borrower’s crypto is being considered, largely just to paint a more accurate picture of the person’s balance sheet and to qualify the individual, the digital currency should be given a risk weight—of sorts.
“Just like when a credit union looks at a borrower’s stock holdings…Tech stocks are more volatile than say a phone company or a bank stock,” Grilli said. “So, when you're looking at crypto, it depends on what kind of crypto, how long the borrower has held it, who holds it, and then maybe if it’s considered more volatile count it at 20% of its value instead of 50%. The credit union should also consider if the crypto is flying high at the time, and be more wary of it’s true value.”