The crypto industry’s biggest secret, Shadow Banking where cryptos worth billions of dollars are borrowed & lent on an un-collateralized basis, was exposed as the biggest driver of the spectacular bull market, as well as the ongoing collapse & contagion. While the crypto shadow banks are going through their most difficult moments, it was the SEC’s decision to declare Coinbase’s lending program an unregistered security offering, that unintentionally saved Coinbase from the same deadly blow that struck BlockFi, Celsius, Voyager, Gemini, and many others.
Crypto shadow banks engage in borrowing & lending but are not licensed banks, hence fall outside the requirements of fully licensed banks, which have capital reserves to cover losses from bad loans or available liquidity in case of a bank run. With the promise of “less risk than a bank with better returns”, crypto shadow banks such as BlockFi, Celsius, Voyager & Gemini, attracted billions from investors, which got lent out to the world’s biggest crypto traders, the likes of 3AC & Alameda Research.
In the midst of the 2021 bull market, Coinbase had its own plans to launch a lending program - Coinbase Lend. While the details of Coinbase’s Lend program are no longer publicly available, it would work by “matching lenders of the USDC with qualified borrowers” and “Coinbase would guarantee the principal creditors lend out”. It is unclear if Coinbase would match borrowers to lenders directly, or simply create a lending pool. The semantics of Coinbase’s wording is of less importance, the playbook was meant to be the same as that of crypto shadow banks; borrow cryptos worth billions of dollars from clients and lend in the Shadow Debt Market to the world's largest proprietary traders, hedge funds, and market makers.
The details of Coinbase’s Lend program caught the attention of the SEC and the US regulator threatened to sue Coinbase if the program was launched. Coinbase Lend program was immediately scrapped, with Coinbase noting of SEC’s “unfair treatment” as many other crypto shadow banks were engaging in the same lucrative borrowing & lending. The rest is now history, SEC’s decision unintentionally saved Coinbase from the catastrophic fate that struck BlockFi, Celsius, Voyager, Gemini, and many more - the collapse of Terra/LUNA, the blow-up of 3AC, the fiasco of FTX & Alameda Research and the ongoing contagion.
In retrospect, it’s easy for critics to point fingers at our industry, but the truth is that very few people understand the plumbing of the crypto ecosystem, with crypto shadow banking the biggest mystery of them all. My goal is to provide insider insights into the secretive workings and shed light forward to strengthen our industry which will be the backbone of infrastructure for the world's growth in the coming decades.