“Tulip mania meets the real economy at WhatsApp speed”

With celebrities from the cryptocurrency world joining the Davos globetrotting elite – and bettors who suffered sleepless nights in the market crash – it’s time for regulators to reflect on the real-world implications of the next boom-and-bust cryptocurrency cycle.

Fintech and crypto applications have rapidly expanded into digital cash, loans and complex products that look as simple as a credit card in email form. This creates financial avenues that go far beyond one-way bets on Bitcoin or boring apes: Decentralized Finance (DeFi) platforms offer investors 8%-10% crypto yields; Funding startups around the world. Tulipmania meets the real economy at the speed of WhatsApp.

In these times of market stress, rewards that show themselves unsustainable have given way to a string of chaotic losses – underscoring the enormous challenge facing policymakers, some of whom admit they have given up on cryptocurrencies.

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Cryptocurrency funds are currently being withdrawn from lending platforms, even those backed by real-world assets. A project with an 8% yield on tokenized debt issued by French payday lender Bling has been “substantially” redeemed, exceeding its available cash and credit lines from venture capital backers. For one investor I spoke with, that meant it could be months before he got his money back. The primary motivation for his initial investment was free token rewards, but that has since disappeared.

At the same time, at the other end of the chain, lending to end consumers has also encountered bottlenecks. Bling suspended its cash advance service in April as regulators cracked down on the industry. One consumer advocacy group estimates that one month of Bling’s Instant Upfront costs equivalent to an annualized rate of 128% if fees are included.

Small mortgage-backed projects like this eager to sell assets are clearly a far cry from the scale of the $60 billion Terra crash that left desperate South Koreans finding their way to founder Do Kwon’s door. But it does illustrate why regulators are nervous about future risks to the financial system.

These free rewards and high returns attract those who might be least able to afford them. Data from the European Central Bank shows that cryptocurrency ownership is a U-shaped event, with high- and low-income households more likely to own cryptocurrencies than middle-income households.

Links to the financial system are growing as venture funds and banks seek to capitalize on the disruptive potential of cryptocurrencies — Societe Generale has been tinkering with DeFi lending, while others are launching stablecoins. “There is a very broad perception in the investor community that you have to try it,” said economist Eswar Prasad, author of “The Future of Money.”

The cryptocurrency market today is moderately sized — the total value currently locked in DeFi is around $100 billion, or about one-sixth of last year’s total venture capital investment — but if the industry sees a future explosion of more than a dozen crypto loans Growing situation keeps growing? The race to sell assets to meet cryptocurrency redemptions could have huge spillover effects, especially if algorithmically managed through smart contracts. Similarities to the subprime mortgage market that sparked the global financial crisis in 2008 are emerging with increasing frequency.

The ECB said last week that “while the risks are currently low, they could rise significantly if platforms start serving the real economy, rather than remain confined to the crypto space,” citing the growth of crypto credit on DeFi platforms as a factor 14 in 2021.

Serving real-world businesses is still good news for cryptocurrencies, according to founders and financiers of DeFi platforms like Centrifuge or Goldfinch. They argue that algorithmically managing projects and reducing paper shuffling means unlocking efficiency gains and access to capital, and building useful infrastructure in the same way that past market bubbles built railroads and the internet.

Maybe. But these are also bank-like activities that allow for more bank-like oversight. They often involve complex financial structures that string together several Delaware-based LLCs with little legal recourse and high counterparty risk. They are part of a broader explosion of fintech lending that has yet to be properly tested in a downturn. Fintech investor Peter Lugli said it looked more like “shadow banking squared” than a high-speed train.

Expect some of these activities to be dragged more into the public eye due to institutional and regulatory concerns: perhaps the next step is that the likes of Bling will act more like regular banks, while DeFi lending platforms will feature a more centralized big-name fund due diligence investigation. But given the return of animal spirits, regulators will know that from here, managing risk will only get harder.

(Apart from the title, this story was unedited by NDTV staff and was posted from a syndicated feed.)