The Opportunity in High Yield Crypto-Backed Loans

Despite all of the positive news about digital assets coming from the new administration, the crypto ecosystem still isn’t fully integrated with the U.S. banking system. Even with the removal of “Operation Chokepoint 2.0” restrictions, institutions and individuals aren’t able to access the money markets with the level of efficiency that traditional Main Street, let alone Wall Street, is able to.This has created an opportunity for many crypto native-entities to take advantage of what they do have — good collateral — and to use that collateral to borrow U.S. dollars (USD). The result is an asset-backed loan that has the potential to yield more than it “should.”See all newslettersCrypto Long & ShortSign up hereWith junk bond spreads less than 300 basis points (bps) above U.S. Treasuries, BTC-backed loans may offer more yield than junk bonds with less risk than investment-grade bonds. Using current market conditions and a standard credit default modeling technique, BlockFills estimates a fair value of 150-200 bps over USTs for BTC backed loans, yet they currently trade at 400-600 bps over USTs.Overcollateralized BTC-backed loans may present a great opportunity for traditional finance institutions participating in crypto at scale, in a fashion that is reminiscent of prior innovations like mortgages and junk bonds. These transactions can be structured in a Tri-Party arrangement, which is when two parties engage a third party as a trusted custodian for funds held in escrow. This removes the need to custody crypto, handle margin calls and deal with selling the collateral under default conditions.Crypto market participants and businesses simply do not have full access to the USD banking system. These BTC-backed loans are a possible solution to fill the gap. The collateral is good, tradable and liquid in both on- and offshore markets. This compares favorably with default conditions in corporate loans where bankruptcy proceedings can last for years (or decades).A portfolio of such loans does not represent diversification since all these loans would be backed by cryptocurrency. However, that does mean that a portfolio may be hedged using the options* market, which has also become liquid in both listed and OTC markets for BTC.The BTC-backed loan market is an opportunity that bridges crypto and traditional finance. It’s not meant to provide the sort of “degen” returns that may be available in outright positions but instead speaks to the sorts of investment parameters that come with vocabulary recognizable to the Patagonia vest-wearing crowd. Terms like “excess risk-adjusted return” and “harvesting premiums” are reminiscent of the 80s and 90s.