Cutting Through the FUD Part V: The Risk of a Crypto Credit Bubble
Lately there has been talk of a crypto credit bubble brewing. In my view, this concern is overblown. Credit bubbles are very rare events and are the result of many years of excesses and loose credit standards. Crypto lending is still in its infancy and does not yet pose a systemic risk to the ecosystem.
Some analysts have pointed to the strong growth of digital asset lending on Genesis Global Capital (from $200M in 2Q18 to $870M in 3Q19) as evidence of this growing bubble. This is supposedly validated by intelligence of new Chinese miners who have recently entered the space that have borrowed heavily to fund equipment purchases and working capital. Some of these miners are apparently in financial difficulties and are capitulating.
While factually accurate, these reports are alarmist at best. On Genesis Global, originations have risen to $870M in 3Q19, but active outstanding loans stood at $450M. While we don’t know the total system debt with centralized lenders, Genesis is arguably the biggest.
A major Chinese crypto lending platform Babel Finance had an active loan balance of $88M as of 30 Jun-19. We estimate this figure is around $85–100M as of 30 Sep-19. MatrixPort (started by Jihan Wu of Bitmain), a new entrant in this space won’t disclose the size of their book, but they are likely smaller than Babel Finance.
While lending standards have eased somewhat compared to 2018, they are by no means loose. Most loans are still over-collateralized and borrowing rates are quite high.
Many smaller Chinese miners got into the mining game in 2Q19 when the price of BTC was on an upward trajectory. Many were able to capitalize on the high BTC prices during June to October this year. These small miners are highly opportunistic and move very quickly to capitalize on any profits. Instead of selling the BTC mined, some of these miners collateralized them for cash loans as shown by Genesis’ rising cash loans from Asia in 2Q19. At the end of September, total outstanding international cash loans was $140M of which ~$100M was from Asia. This figure should be less than $80M now.
Based on our analysis, these high cost miners have a cash breakeven cost in the low-mid $7Ks based on current BTC hashrates. Some of them are shutting operations. The bigger miners have an incentive to force these smaller players out of the industry even if it is at the expense of some near term profits. Assuming BTC’s network hashrate stays somewhat constant, after the block reward halving in May 2020, these miners would require a BTC price of $14–15K to be in business.
The major OTC desks reported heavy BTC sell flow from Chinese miners in November and early December, likely to pay down outstanding cash loans. This flow has tapered off recently.
Bottomline: we believe there is a bit of credit indigestion in the short term, but nothing resembling a major credit bubble of any sort. We would need a much bigger inflation in asset prices over a longer period for such risks to materialize.
