A crypto savings account delivers huge interest — but at what cost?
Operators like BlockFi and Nexo offer rates that are north of 9%
The business model
Nonetheless, the rates are very high. So how do these banks do it?
A crypto bank’s basic model is to borrow capital at the interest rate it pays depositors, and then to lend it at a higher rate. Crypto banks seek to safeguard their position in two key ways. First, by lending out less than they have in deposits. Second, they make borrowers put up collateral for their loan. This involves aloan-to-value(LTV) calculation for working out how much collateral is required to secure a loan. For example, BlockFi reserves the right to liquidate collateral as soon as it reaches 80% LTV.
To borrow US$5,000 from BlockFi, you currently need to put up BTC0.25, which is currently valued at US$9,448. If that bitcoin value fell to US$6,250, the bank would sell some of your collateral to return the LTV to a healthy level.
In good times, this is a business model that can bring significant revenue. No doubt high-street banks could offer higher savings rates too, but they use some of that saving to be more competitive on their lending rates instead.
But as far as the crypto banks are concerned, it is unclear what would happen if either there was a sudden and prolonged crash in the crypto market such that these banks’ deposits were worth significantly less than what they had lent out, or if borrowing dried up.
If one of the above scenarios were to play out, then unlike with your savings account at a high street bank, your crypto savings are not insured. BlockFi for instance is based in the US, and is not insured by the Federal Deposit Insurance Corporation (FDIC) nor the Securities Investor Protection Corporation (SIPC), meaning recovering funds is much more difficult if the bank becomes insolvent.
BlockFi also notes in itsterms of servicethat where it or third-party partners experience cyber-attacks, extreme market conditions, or other operational or technical difficulties, they may immediately halt transfers or withdrawals of cryptocurrency either temporarily or permanently.
They will also not be liable for any loss or damage incurred as a result. This is particularly troublesome as it gives wide discretion for a crypto bank to not return your funds on demand, holding on to them where market conditions dictate (it should be said that BlockFi depositor funds are held in cold storage by major exchange Gemini and should at least be relatively safe from hacks). Other operators such as Celsius and Nexo don’t have such terms, but this just leaves their stance on such positions unclear.
There has also been some controversy around some stablecoins. For example, there have beenquestions aboutto what extent Tether’s operators have US dollar reserves to ensure the one-for-one rate holds. This makes it concerning that customers are being induced into holding such coins to access the highest interest rates. Aside from doomsday scenarios, there are alsolimits around withdrawalsin terms of volume and regularity, with fees paid for transacting beyond these confines.
As with the wider crypto market, it seems willingness to engage in this area is dependent on an individual’s risk appetite. If you’re willing to hand over your crypto to a bank for a profit, then you open yourself up to losing it for good. If you are prepared to accept that risk and are willing to hold your funds and not treat this as a current account, then a crypto-bank savings account might be for you.
This article byMatthew Shillito, Lecturer in Law,University of Liverpoolis republished fromThe Conversationunder a Creative Commons license. Read theoriginal article.
Story byThe Conversation
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