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An Introduction to Rehypothecation With Cryptocurrency

Published 19 March, 2019

    Capitalism and increasingly global markets have worked to lift the quality of life of humans around the world dramatically. Financial markets work by learning and adapting through product development by ecosystem participants and progressive regulation. At a time when we face global challenges, the world needs a more globalized financial system that is accessible to individuals on a level playing field.

    How can we help Bitcoin and blockchain technology win market share? We can develop scalable, trustworthy lending systems to support growth of the asset class. As part of that journey, we will need to use rehypothecation.

    BlockFi recently announced a new product, the BlockFi Interest Account. This announcement generated a lot of buzz and has been embraced by many in the crypto community. Even with the outpouring of support, some did not like the risks associated with the product. The ability to self custody large amounts of value with Bitcoin is one of the unique qualities of blockchain technology and something that will always be the preferred method of storage for many in the community.

    Our new product does carry risk, which we thoroughly disclose and thoughtfully manage. We think it’s important for people to know and understand the realities of rehypothecation and its  role as a financial tool to help grow the cryptocurrency industry.

    One concern that is voiced frequently is that rehypothecation creates more that 21M Bitcoin. In our view, without a major change to the current implementation of Bitcoin, you can’t create more than 21M Bitcoin. This is a technological reality of the Bitcoin blockchain. Even if you are worried about margin trading or rehypothecation enabling this, platformsthat enable margin and up to 100X leverage have already existed for some time, including during the 2017 bull run.

    Why do we want rehypothecation in the crypto market? Let’s look at 5 key points regarding rehypothecation in traditional markets and how this capability is unique with Bitcoin:

    1. Securities rehypothecation generally lowers the cost for consumer access to products. For example, this can be seen in financial service providers offering free custody, free trading, and ever-declining asset management / ETF fees. In BlockFi’s case, it’s what enables us to offer a yield on Bitcoin and Ether.
    2. Rehypothecation promotes market liquidity and price discovery by enabling market participants to express a multitude of views. So far, our experience has been that borrowing crypto is part of arbitrage, market making, and short selling activities. This helps balance supply and demand for Bitcoin globally, at all the different and fragmented marketplaces. This activity supports fair and orderly markets, which lead to prices being closer to Bitcoin’s true value, and are paramount to the growth and usefulness of Bitcoin.
    3. With Bitcoin, settlement isn’t instant but we do have a settlement layer that is much faster when compared to traditional markets. It’s kind of like having the DTCC already built-in, but with more transparency. Bitcoin operating firms might need to borrow Bitcoin for their inventory, but don’t want the price risk. Bitcoin settles fast but not instantaneously, and there isn’t a traditional settlement cycle. This means that you need to have the Bitcoin before you transfer it. Having good actors to facilitate this flow in a “one to many” or network model is important for scale.
    4. Rehypothecation was not responsible for the financial crisis. Poor underwriting, too much leverage and miscalculated risk (especially at large insurers) were the culprits. The benefits of rehypothecation far outweigh the costs – which are effectively zero if it’s done correctly. Other thought leaders have described “good vs bad” lending in the Bitcoin market and BlockFi falls squarely in to the good camp.
    5. Our goal as an industry is to effectively compete with the traditional financial system. In order to do that, we will need to use existing tools from the traditional financial system and leverage the blockchain to improve on their function.

    What we’re excited about at BlockFi is the ability to create a more equitable global financial system – for equity, debt and yield. We believe that we should welcome new crypto users with an educational and inspirational tone about what is happening in the crypto market and why it’s good for humanity globally. And the community agrees.

    This is the first part in what we expect to become a series of articles. Let us know what you would like us to discuss next. You can learn more on our website, BlockFi.com, and find us on Twitter at @TheRealBlockFi and @BlockFiZac.

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    Disclaimer: Rates for BlockFi products are subject to change. Digital currency is not legal tender, is not backed by the government, and BIA accounts are riot subject to FDIC or SIPC protections. Security is our top priority. Please see our Vulnerability Disclosure Form and Bug Bounty Program.
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    Disclaimer: Rates for BlockFi products are subject to change. Digital currency is not legal tender, is not backed by the government, and BIA accounts are not subject to FDIC or SIPC protections. Security is our top priority. Please see our Vulnerability Disclosure Form and Bug Bounty Program.
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