A blockchain company domiciled in Gibraltar is set to introduce lending to digital-asset markets.
Lendingblock will go live in November with a beta version involving partners such as OTC broker OSL in Hong Kong, and exchanges Quoine in Japan and Genesis in the U.S.
The company will open offices in Asia and the U.S. in 2019 as well.
There is no lending capability in blockchain-based markets today. Lendingblock intends to deliver this initially to allow investors to lend their tokens to OTC brokers or other players in search of a particular exposure, in return for a fee paid by the borrower. Smart contracts will manage the process, including in case of a default.
Steve Swain, London-based co-founder and CEO at Lendingblock, says the initial use case is akin to securities lending in traditional finance, in which an investor such as a pension fund on-lends securities it holds so that someone else can make temporary use of them, with the securities returning along with a fee for the privilege.
Securities lending 2.0
Securities lending developed in the U.S. with third parties aggregating and managing the activity, namely custodian banks acting as agents to their buy-side clients, and prime brokers, which did the same for hedge funds and prop desks. Pension funds, indexers and fund managers enjoy extra return on assets they own and don’t need for liquidity purposes; brokers need specific stocks to fill orders, make markets, and collateralize derivative positions.
Such centralized players added efficiency, but the business is not transparent, fees are high (securities lending is a high-margin activity for custodians), and the market has been subjected to abuse: in the mid-2000s, custodians such as State Street were sued by their pension-fund clients.
The strategic bet is about securitization and issuance
Linda Wang, co-founder and chief commercial officer, says Lendingblock’s vision is also to extend lending into the world of collateralization. “The strategic bet isn’t about trading bitcoin,” she said. “It’s about the securitization of assets and the issuance of securities being done on blockchain.”
For now, trading is the only viable use case, but collateral is the bigger opportunity. (Factoring is another possible use case.)
Swain says liquidity conditions will vary around different types of tokens, which will create varying demand for collateral. Today smart contracts can’t operate across digital assets. Holders of ethereum can stake it against another token, but if they need their ethereum back, they’re going to get it in some other form.
“We’re opening a centralized order book,” Swain said. “While the loans remain bilateral, we will custody the collateral and manage the process.”
The idea is to create the infrastructure for securities lending without the role of custodian agents or prime brokers – to enable cross-asset lending and collateralization within the world of digital money.
Swain said, “This is not a cut-and-paste job. We’re not bringing in securities lending as it works in the traditional world. We’re reimagining how it can be applied to the decentralized world in a way that is transparent, where everyone is an equal player, and without the middleman.”
This is not a cut-and-paste job
Lendingblock has built its own wallet infrastructure. For every loan transacted on its network, it creates a unique hot wallet, where lenders place their principle. Lendingblock releases the asset to the borrower and places the wallet in cold storage, until such time a loan comes due. The company outsources custody to a third party, which it declined to name.
Wang says the important thing is that each position is segregated. There is no commingling of user assets. “You can see where your money is at all times,” she said. (The technical term for such commingling is rehypothecation, a word many people discovered for the first time ten years ago when Lehman Brothers collapsed – its prime-brokerage business had commingled client money with its own balance sheet. Oops.)
Because these loans operate under specific time periods, and by definition are meant to involve assets not required for immediate liquidity purposes, the use of cold storage is not a problem; there should not be an immediate need for a trader to get their hands on these assets. “There’s no instant right of recall,” Swain said. “If there’s a default, we can get a price quote from a broker and settle it post-trade.”
So what kind of investment returns are likely for lenders?
Swait says bitcoin borrow rates among OTC brokers ranges from 8 percent to 14 percent (annualized); rates are higher for other digital assets. Such markets are volatile and opaque, so rates in theory should be lower if Lendingblock can establish a centralized marketplace that is liquid.
As for the company, it will charge both an annual percentage fee and a flat transaction rate applied to both lenders and borrowers; the execs declined to specify their rates.