A new form of lending is emerging in Australia, and everyone, including the lenders, agrees it’s risky.

So, what are we talking about here?

A handful of outfits are offering loans in exchange for cryptocurrencies.

That is, within any given lending arrangement, Bitcoin and Ethereum, for example, are accepted as collateral — an asset offered up as security for a loan.

This type of lending kicked off in 2017, and ramped up during the pandemic.

There are a few points to make here.

Firstly, some economists say, this is bonkers banking given cryptocurrencies are risky, volatile and have no intrinsic value.

Secondly, this lending practice is legal, and the lenders are licensed.

Thirdly, the borrowers in these lending contracts, the ABC has been told, are relatively wealthy.

Finally, it’s worth asking the question: are these lenders playing a bigger game here? And what game could that be?

The fact is cryptocurrencies are pushing into areas of finance that, once upon of time, would have been considered ridiculous.

Now, millions of Australians are reported to own at least one cryptocurrency, a few Australian firms are engaging in lending to retail or everyday mums and dads using crypto as collateral, and at least five big Australian financial companies do it too.

Let’s first though look at the specifics of the lending contract.

How do crypto loans work?

A typical crypto loan is valued at roughly $140,000.

The lender makes money by borrowing cash at an 11 per cent interest rate, and lending that on to customers at a higher 15 per cent.

The margin here is 4 percentage points.

If the price of Bitcoin goes up during the term, or period, of the loan, the customer can borrow more money for a car or even a home deposit, for example.

If it falls sharply, the borrower is asked to stump up more cash.

The loan to value ratio (LVR) differs between lenders but one lender the ABC spoke to had an LVR of 50 per cent.

Generally, the lower the LVR, the higher risk to the customer and the lower the risk to the financial institution.

Put simply, the price of the cryptocurrency being used as collateral would need to seriously plummet before it presented a financial risk to the lender.

What’s bizarre, however, is that this volatility is recognised as a risk.

Banks and their 10 foot pole

This may explain why the commercial banks are reluctant to provide these crypto lenders with finance.

“Currently, if you walk into a typical bank, if you have equity in your Bitcoin, a bank is not going to lend it to you,” Vield co-founder Johnny Phan told the ABC.

“They only lend against property or against your credit profile.

“We also do that in same manner, but we’re using Bitcoin instead of property, for the security.”

Vield says it’s so confident in the on-going interest in Bitcoin as asset class, it sees its lending as a service to borrowers who share that confidence.

In short, if Bitcoin is a legitimate asset, why shouldn’t it replace a dwelling or house as a type of mortgage, or security for a loan?

And things do go wrong.

In July 2022, Crypto enthusiast Bayani stumped up 1.6 Bitcoin as collateral for a $20,000 loan from US-based crypto exchange and lender, Celsius.

But the price of Bitcoin plummeted and Celsius ran into financial trouble.

He received emails from the company informing him his LVR was dropping, and he was asked to provide more collateral.

He was hesitant to do this because, he says, there was speculation on social media the company was in financial trouble.

He ended up losing all his Bitcoin, worth over $50,000.

In the end he received $33,000 from the liquidators, but he used a large chunk of that to pay back his $20,000 loan, leaving him with $13,000.

If you include the price of Bitcoin, Bayani was left thousands of dollars out of pocket.

Financial stability risk

Independent economist Saul Eslake says the collapse of both small and large financial institutions, using cryptocurrencies as security, can present big risks to Australia’s financial stability, especially if lending against cryptocurrencies became widespread.

“The risk in circumstances like this is that people who find themselves with significant exposures,” he says.

“In the event that there’s a dramatic reversal in the value of those assets and the market for them dries up, then what history tells you what happens is that people sell what they can, rather than necessarily what they should, in order to get out of a sticky or illiquid position.

“And that’s how contagion happens, from what might be a small asset class of no great systemic significance on its own, to assets that do matter from the perspective of financial stability as a whole.”

The logic is simple: house prices don’t often crash.

Indeed collateral, in general, used to cover loans, is known for its financial stability.

Economists fear that crypto lenders with large loan books might find it difficult to cover their finance obligations in the event of a collapse in the price of a cryptocurrency.

But those financing cryptocurrency lenders, the lenders themselves, and customers are all exposed to vulnerable financial positions.

It just takes one group of people to “panic” sell shares, or other assets, in an attempt to obtain cash to cover a loan for contagion to spread across the globe.

This, economists say, presents a problem for everyone.

“I think [the financial stability concern is] around the negative potential negative impact to households, mainly, and to businesses,” AMP’s deputy chief economist Diana Mousina says.

“So if lending in that particular space is seen as risky, which I think it is seen as risky because of the fundamental collateral that is undertaken in Bitcoin, that’s sort of the problem for the government because they could potentially have to bail out households or businesses, and that then forces the government to come in.”

Adding up the risks

There’s only a handful of lenders in Australia that are accepting cryptocurrencies as collateral for loans.

While there’s no clear and present danger to Australia’s financial system, the federal government and regulators are watching them.

“Crypto assets can be highly volatile,” ASIC told the ABC.

“Lenders securing loans with crypto may risk the collateral becoming insufficient to cover the loan if the value of the crypto drops quickly.

“For consumers, this means a higher risk of having your loan called back early, and needing to sell your crypto assets to cover a default.”

But here’s the problem.

The industry’s keen to grow, but economists have told the ABC the further the industry grows, the more it will present a major risk to Australia’s financial stability.

“What the law needs to do, what regulators need to do, is to ensure that people who are not especially sophisticated, or who don’t have the capacity to understand and assess the risks that they might be exposed to aren’t sucked in by unscrupulous operators,” Saul Eslake says.

Understanding the risks for cryptocurrency could prove especially challenging.

But there’s another leg to this story.

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Crypto in search of legitimacy

While economists are keen for this industry to stay as a niche offering, and ASIC requires, at a minimum, for them to abide the law, the lenders themselves want legitimacy.

What do I mean by that?

If Bitcoin or Ethereum become acceptable as collateral, it adds to the industry’s sense of belonging in mainstream finance.

Or as Vield’s Johnny Phan says, “I think we are servicing a niche market.”

“Our target market, or our target clients, are those that hold Bitcoin.

“So if you don’t hold Bitcoin and you don’t need a loan, you wouldn’t come to us.

“But in those cases, when [borrowers] need the additional cash, they can use some sort of asset that they have go through to an Australian company to be able to borrow against it and feel comfortable that they’re still getting the appreciation of Bitcoin over time … as they may become a long-time believer of Bitcoin.”

What’s that? A “believer” in Bitcoin.

Donald Trump seems to be a believer, and the flow-on effects of his pro-crypto agenda are fuelling a surge in Bitcoin demand, pushing it to an all-time high in January.

Is the momentum strong enough for cryptocurrencies to push their way into mainstream finance as a broadly accepted form of security?

That would be truly revolutionary.

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