Cryptocurrencies (and Securities Lending)

April 11,  2018

Cryptocurrencies offer an advantage to traditional payment methods in that they mostly operate on decentralized peer-to-peer networks that all but eliminate the overhead associated with credit and banking functions. As of the end of March 2018, the value of all cryptocurrencies issued (or “mined”) totaled about $300 billion, according to CoinMarketCap.com, down from a peak of $760 billion in early January. That total is spread across more than 1,500 unique cryptocurrencies.

The alleged key benefit of using cryptocurrencies in lieu of government-backed currencies is considered to be quicker payments due to the removal of third-party intermediaries. In addition, cryptocurrencies are said to be immune to counterfeiting, and payments via cryptocurrencies cannot be reversed by senders, two issues that can pose a challenge for credit card companies. Finally, many cryptocurrencies allow users to make payments in relative anonymity, which is attractive to some users.

Cryptocurrencies are far from perfect vehicles and have a long way to go before they overtake traditional currencies, banking and credit card activities. Critics highlight a number of downsides. Security, in-flux regulatory requirements, limited acceptance by vendors and the staggering amount of power used to “mine” cryptocurrencies all remain concerns.

Bitcoin (BTC), the most well-known of these new assets, constitutes more than a third of the entire cryptocurrency market cap as of early 2018. However, it has been losing market share to some of its competitors as new cryptocurrencies are mined. Ether (ETH), for example, now makes up a little over 17% of the total alt-coin market cap, while up-and-coming Ripple (XRP) is just above 9%. According to World Coin Index, Bitcoin saw a remarkable 1,200% increase in value relative to the USD from 2016 to the end of 2017. Ether also rose by an incredible 10,000% year over year, while Ripple was up an astonishing 45,000% during the same timeframe. Other alt-coins such as Eos, Dash, Litecoin, Monero and Tron also experienced staggering increases in value relative to the USD last year as momentum money poured into the space.

The Bitcoin Investment Trust ETF (GBTC), launched in 2016, offers a little insight into how the securities lending industry is reacting to Bitcoin. Much like the underlying currency itself, GBTC has been very volatile in both the cash markets and securities lending market. GBTC began 2017 trading in the cash markets at $129 per share. By the end of the year it had increased to $2,016, representing a rise of 1,400%.

GBTC was in fairly high demand in the lending market for most of last year. Utilization in this ETF began at a little over 66% but dropped to a low of 29% by summer 2017. However, by fall, utilization had risen again to 90%. Lender-to-broker fees traded in a wide range from warm to hot, while broker-to-broker fees traded even higher. 

However, when comparing the utilization and fees to borrow this particular derivative versus Bitcoin itself, it is apparent that perhaps short sellers were a little wary of being too aggressive in this very volatile asset last year.

These are early and exciting days in the marriage between cryptocurrencies and financial instruments. Bitcoin futures are now trading on the CBOE and cleared at OCC (see “A Day in the Life of Craig Donohue,” page 34). Other ETFs exposed to the cryptocurrency space, such as LEGR and BLOK, are now publicly traded, and more cryptocurrency-tracking ETFs are expected to launch this year. 

While the potential for returns is high, so are the risks. As the cryptocurrency space continues to expand (or contract) and new issues are brought to market, follow DataLend for a unique look into how these trends are reflected in the securities finance industry.