An introduction to rehypothecation with cryptocurrency

Quick Take

  • Global economic challenges underscore the need for a globalized financial system accessible to all
  • Rehypothecation lowers the barrier to entry to financial products, promotes market liquidity and facilitates price discovery

Capitalism and increasingly global markets have worked to dramatically lift the quality of life for people around the world. Financial markets work by learning and adapting through product development from ecosystem participants and progressive regulation. At a time when we face global challenges, the world needs a more globalized financial system that is accessible to individuals on a level playing field.

How can we help Bitcoin and blockchain technology win market share? We can develop scalable, trustworthy lending systems to support growth of the asset class. As part of that journey, we will need to use rehypothecation.

BlockFi recently announced it is launching a crypto savings account with 6 percent annual interest, payable monthly in bitcoin or ether. This announcement made a splash in the crypto community, but some did not like the risks associated with the product. The ability to self custody large amounts of value with Bitcoin is one of the unique qualities of blockchain technology and something that will always be the preferred method of storage for many in the community.

The new product does carry risk, which we thoroughly disclose and thoughtfully manage. We think it’s important for people to know and understand the realities of rehypothecation and its role as a financial tool to help grow the cryptocurrency industry.

One concern frequently voiced is that rehypothecation creates more than 21 million bitcoin. In our view, that wouldn't be possible without a major change to the current implementation of Bitcoin. This is a technological reality of the Bitcoin blockchain. Even if you are worried about margin trading or rehypothecation enabling this, platforms that enable margin and up to 100x leverage have already existed for some time, including during the 2017 bull run.

Why do we want rehypothecation in the crypto market? Let’s look at 5 key points regarding rehypothecation in traditional markets and how this capability is unique with Bitcoin:

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  1. Securities rehypothecation generally lowers the cost for consumer access to products. This can be seen in financial service providers offering free custody, free trading, and ever-declining asset management / ETF fees. In BlockFi’s case, it’s what enables it to offer a yield on bitcoin and ether.
  2. Rehypothecation promotes market liquidity and price discovery by enabling market participants to express a multitude of views. So far, our experience has been that borrowing crypto is part of arbitrage, market making, and short selling activities. This helps balance supply and demand for bitcoin globally, at all the different and fragmented marketplaces. This activity supports fair and orderly markets, which lead to prices being closer to bitcoin’s true value, and are paramount to the growth and usefulness of Bitcoin.
  3. With Bitcoin, settlement isn’t instant but we do have a settlement layer that is much faster than traditional markets. It’s kind of like having the DTCC already built in, but with more transparency. Bitcoin operating firms might need to borrow bitcoin for their inventory, but don’t want the price risk. Bitcoin settles fast but not instantaneously, and there isn’t a traditional settlement cycle. This means that you need to have the Bitcoin before you transfer it. Having good actors to facilitate this flow in a “one to many” or network model is important for scale.
  4. Rehypothecation was not responsible for the financial crisis. Poor underwriting, too much leverage and miscalculated risk (especially at large insurers) were the culprits. The benefits of rehypothecation far outweigh the costs - which are effectively zero if it’s done correctly.
  5. Our goal as an industry is to effectively compete with the traditional financial system. In order to do that, we will need to use existing tools and leverage the blockchain to improve on their function.

 


Zac Prince is the Founder and CEO at BlockFi, a wealth management platform for crypto investors.


© 2023 The Block. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.

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