The crypto industry’s biggest secret – the Shadow Banking System, where cryptocurrencies worth billions of dollars are borrowed & lent on an un-collateralized basis, between some of the industry’s biggest names, was exposed in recent months as the biggest driver of the spectacular bull market… as well the collapse & contagion that is still ongoing.
While the crypto shadow banks are going through their most difficult moments, it was the Securities and Exchange Commission’s (SEC’s) decision to declare a lending program an unregistered security offering might have unintentionally saved Coinbase from the same deadly blow that struck BlockFi, Celsius, Voyager, Gemini, and many others.
Crypto shadow banks are companies that engage in bank-like activities such as borrowing & lending but obviously are not licensed banks, hence fall outside the regulatory constraints of fully licensed banks, which are required to have capital reserves to cover losses from bad loans or available liquidity in case of a bank run.
With the promise of “Less risk than a bank with better returns for customers.”, crypto shadow banks such as Celsius, BlockFi, Voyager & Gemini managed to attract billions of AUM from professional and retail investors, which got lent out further to the world’s biggest crypto whales, the likes of 3AC and Alameda Research.
In the midst of the 2021 bull market, the crypto industry’s second biggest player had its own plans to launch a lending program, namely Coinbase Lend.
While the details of Coinbase’s Lend program are no longer publicly available, I found out that the program would work by “matching lenders of the USDC stablecoin with qualified borrowers” and that “Coinbase would guarantee the principal creditors lend out”.
It is unclear whether Coinbase would match borrowers to lenders directly or simply create a pool out of which they could undertake lending activities.
While the semantics of Coinbase’s wording is of less importance for this story, the playbook was meant to be similar to that of the largest crypto shadow banks; borrow cryptos worth billions of dollars from clients already onboarded with Coinbase and lend out in the Shadow Debt Market to worlds largest proprietary trading firms, hedge funds, and market makers.
The details of Coinbase’s Lend program caught the attention of the SEC, and the US regulator reacted fiercely & aggressively by threatening to sue Coinbase if the program was launched.
Coinbase Lend program was immediately scrapped, with Coinbase noting SEC’s “unfair treatment” since many other crypto shadow banks were engaging in those same lucrative borrowing & lending activities.
The rest is now history.
SEC’s decision unintentionally saved Coinbase from the same catastrophic fate that struck BlockFi, Celsius, Voyager, Gemini, and many more – the collapse of Terra/LUNA, the blow-up of 3AC, the fiasco of FTX & Alameda Research, and the ongoing contagion.
In retrospect, it’s easy for crypto critics & skeptics to point fingers at crypto companies or praise regulators around the globe, but very few people understand the plumbing & infrastructure of the crypto ecosystem, with crypto shadow banking as the biggest mystery of them all.
My goal is to provide insider insights into the secretive workings and shed light to strengthen our industry which will be the backbone of infrastructure for the world’s growth in the coming decades.
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