Despite all of the positive news regarding digital assets from the new administration, the integration of the crypto ecosystem with the U.S. banking system remains incomplete. The cessation of “Operation Chokepoint 2.0” restrictions has not fully enabled institutions and individuals to tap into money markets with the same efficiency as traditional banking on Main Street or Wall Street.
This current state of affairs has opened up a significant opportunity for many crypto-native entities, allowing them to leverage their strong collateral and borrow U.S. dollars (USD). This scenario introduces asset-backed loans that potentially yield returns exceeding initial expectations.
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With junk bond spreads currently below 300 basis points (bps) over U.S. Treasuries, loans backed by Bitcoin (BTC) may deliver more attractive yields than junk bonds, while posing lower risks compared to investment-grade bonds. According to BlockFills’ analysis utilizing standard credit default modeling techniques, the fair value for BTC-backed loans is projected to be around 150-200 bps over USTs; however, they are currently trading at 400-600 bps over USTs.
Overcollateralized BTC-backed loans present an enticing avenue for traditional financial institutions to engage in the crypto market at scale, drawing parallels to historical innovations such as mortgages and junk bonds. Structured in a Tri-Party arrangement, these transactions involve a third-party custodian overseeing funds held in escrow. This arrangement alleviates the burden of directly managing crypto custody, margin calls, and collateral liquidation during default scenarios.
Current participants and businesses in the crypto market face constraints in accessing the USD banking system. BTC-backed loans could bridge this gap effectively, as the collateral is robust, liquid, and tradable in both onshore and offshore markets. This situation presents a stark contrast to corporate loan default conditions, where bankruptcy proceedings may drag on for years or even decades.
It is essential to note that a portfolio comprising such loans may not offer true diversification, given the reliance on cryptocurrency as collateral. Nevertheless, hedging strategies could be implemented through the options market, which has gained liquidity in both listed and over-the-counter (OTC) markets for BTC.
The BTC-backed loan market symbolizes a compelling opportunity to bridge the realms of crypto and traditional finance. Though not designed for the high-risk returns associated with direct investments, these loans adhere to investment criteria that resonate with the more conservative investment community, characterized by terms like “excess risk-adjusted return” and “harvesting premiums”—terms often prevalent in discussions from the 80s and 90s.
Written by Ari Pine, Co-Head of Exotic Derivatives* Products at BlockFills, a trading and market technology firm.
Please note that the levels cited above are indicative and provided for general guidance, illustrating potential scenarios based on specific market conditions. They do not account for future market fluctuations, execution risks, or other dynamic factors. Always consider conducting your own analysis to ensure your decisions align with your financial objectives and risk tolerance.
*Derivative products are available to Qualified Counterparties Only. For U.S. Persons, clients are defined as Eligible Contract Participants (“ECP”) as outlined in Section 1a(18) of the Commodity Exchange Act and related guidelines. Non-U.S. Persons must qualify as Eligible Professional Clients. BlockFills exclusively provides services to clients residing in the UK, provided they meet an exemption under the UK financial promotion regime (including investment professionals, high-net-worth individuals and entities, etc.).
