Loans Secured With Crypto Threaten Australia’s Economic Stability: ABC Report

A report from the Australian Broadcasting Corporation (ABC) has highlighted the risks to Australia’s economic stability presented by the growth of crypto collateral loans, suggesting a sudden downturn in crypto markets could trigger the collapse of these lenders, potentially requiring a government bailout. 

According to economists cited in the report, the loans are inherently high risk because of crypto’s extreme volatility — the term “bonkers banking” is used to describe the concept. 

Of course, lending and borrowing has been a fundamental part of DeFi for years now, but the loans discussed in the report are a little bit different. They’re offered by companies that operate much more like traditional financial institutions.

Instead of putting your assets into DeFi protocols to generate a yield, they make money by borrowing from private lenders at a relatively low rate of interest and charging customers a somewhat higher rate of interest. It’s similar to how a bank makes money from home loans — but instead of property as security, the loan collateral is crypto.

The report by journalist David Taylor claims that a “handful of outfits” are offering these loans. He also claims that “at least five big Australian financial companies do it too” — though doesn’t specify which big financial companies these are.

Related: Treasurer Chalmers Champions Cryptocurrency to Modernise Australia’s Financial System

Bonkers Banking? Allowing Degens to Borrow Against Their ‘Magical Internet Money’

According to the ABC, the business model for many of these crypto-lenders works something like this:

• The lender borrows money from its own private lenders at a rate of, say, 11 percent.
• The lender then loans this money to its customer in return for the crypto collateral at an interest rate of around 15 percent, giving the lender a four percent profit margin.
• If the value of the crypto collateral increases (‘Bitcoin go up’), the customer could increase their loan amount.
• If the value of the crypto collateral declines, the customer would need to put in more crypto to cover the value of their loan.

The loan-to-value ratio (LVR) — the amount the customer can borrow compared to the value of the collateral — is generally set lower than what you’d see from typical bank loans, usually something like 50 percent. This relatively low LVR offers a risk buffer for lenders: the value of the collateral could halve before they’d be out of pocket.

While these loans are high risk for all parties, they do allow Aussie crypto holders — of which there are now over one million — to unlock some of the value of their investment without having to sell. This puts crypto on a similar financial footing as more established assets like real estate and motor vehicles, which is precisely what the economists are worried about.

As Johnny Pham, the co-founder of one of the crypto loan companies known as Vield, explained to the ABC:

Our target market, or our target clients, are those that hold Bitcoin…In those cases, when [borrowers] need the additional cash, they can use some sort of asset that they have go through to an Australian company to be able to borrow against it.

Johnny Pham, Co-founder of Vield

This push for cryptocurrencies to be used similarly to other more established assets has until recently been considered “ridiculous”, according to the ABC.

‘Contagion’ From Crypto Loans Gone Bad Could Threaten Australia’s Financial Stability, Says Economist

Speaking to the ABC, the independent economist, Saul Eslake, explained that if the popularity of these kinds of loans were to grow significantly, those sudden drops we often see in crypto prices could threaten the nation’s financial stability. 

“In the event that there’s a dramatic reversal in the value of those assets and the market for them dries up, then what history tells you what happens is that people sell what they can, rather than necessarily what they should, in order to get out of a sticky or illiquid position,” Eslake said.

And that’s how contagion happens, from what might be a small asset class of no great systemic significance on its own, to assets that do matter from the perspective of financial stability as a whole.

Saul Eslake, Independent economist

However, the report acknowledges that the scale of these operations is small and “there’s no clear and present danger to Australia’s financial system”. The fear, though, is that crypto is increasingly seeking to go mainstream and if it does, these kinds of lenders could proliferate and with that the risks could increase significantly.

Related: Australian Educator Battles Crypto Scammers: The Barefoot Investor Takes On Identity Thieves Head-On

Eslake says minimising these risks as the crypto industry looks to grow comes down to strong laws and good regulation to protect investors:

What the law needs to do, what regulators need to do, is to ensure that people who are not especially sophisticated, or who don’t have the capacity to understand and assess the risks that they might be exposed to aren’t sucked in by unscrupulous operators.

Saul Eslake, Independent economist