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Understanding the Collapse of Crypto Shadow Banking

Hidden behind the public view is one of the crypto industry’s biggest secrets, the crypto shadow banking, where cryptos worth billions of dollars are borrowed & lent on an un-collateralized basis, between some of the biggest names. Crypto shadow banking was the biggest driver of the spectacular bull market, and the ongoing collapse & contagion.

Crypto shadow banks engage in bank-like activities such as borrowing & lending but are not licensed banks, hence falling outside of the regulatory requirements, which require capital reserves to cover losses from bad loans or available liquidity in case of a bank run. Crypto shadow banks can be lending platforms (BlockFi, Celsius), and exchanges (FTX) when creating credit or lending out clients' deposits to enhance liquidity or credit networks (Genesis Trading, Hidden Road) facilitating institutional borrowing & lending.

The key player in the crypto shadow banking is Genesis Trading, namely its highly successful & lucrative lending desk. Genesis Trading is the world’s leading lending desk, facilitating two-way originations between lenders & borrowers, and is considered a trusted counterparty for institutional investors, market makers, hedge funds, & crypto companies with large treasuries.

Genesis was not immune to the stress in the crypto markets and as of November 16th, it has implemented a withdrawal freeze amid efforts to stave off potential bankruptcy. Genesis cited “unprecedented market turmoil” caused by the collapse of FTX & 3AC, which led to “abnormal” levels of withdrawals that exceeded its liquidity.

Perhaps the most fascinating data on crypto shadow banking comes from Genesis's active loan book, which was transparently provided to the public until the end of Q3 2022. While Genesis loan book does not fully cover all the shadow banking activities, it can be considered an excellent proxy, since the lending desk of Genesis was the largest player in the world’s crypto shadow ecosystem. From a peak of almost $15 billion of active loans in Q1 2022 to a collapse of $2.8 billion in Q3 2022, resulting in a drop of over 80% over a period of fewer than 6 months. Crypto shadow banking is going through its collapse and the unique & valuable data points from Genesis Trading's quarterly reports confirm this.

Crypto shadow banking activities were the biggest driver of the spectacular bull market, as well as the ongoing collapse & contagion. World’s regulators are tapping into the dark, trying to understand the causes of the collapse. In the current crisis, crypto industry leaders & experts have an opportunity to provide insights into how the industry really operates & transparently explain crypto shadow banking activities. My goal is that my writing creates a platform for open discussion on how to enhance our industry & put a healthy foundation in place, that will support the world's growth in the coming decades.

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