Risk Management is core to our DNA and central to our mission: to accelerate global prosperity through crypto-powered financial services. Since 2017, we’ve paid over $575 million of crypto interest to BlockFi clients worldwide while honoring 100% of client redemption and withdrawal requests, within our terms.
These results wouldn’t have been possible without our risk management strategy led by a team of seasoned professionals with experience from the world’s leading financial institutions.
Overview of Risk Management at BlockFi
The foundation of our Risk Management approach is the pursuit of risk-adjusted returns that achieve our strategic objectives while protecting our clients. We’ve established an independent Risk Management function, comprised of a team of professional risk managers, each with a deep understanding of crypto markets and over 15 years of experience at firms such as Goldman Sachs, Morgan Stanley, Bank of America, Citibank, and other leading financial institutions. Together, the team has experience of managing risk through extreme financial situations, such as the global financial crisis of 2008-09, the European debt crisis of 2011-12, and the COVID-triggered crash in 2020. Our Risk Management function is independent from the business and reports to the Board’s Audit and Risk Committee to manage financial and non-financial risks across our Institutional and Retail businesses. The Risk team uses a comprehensive risk management framework across four key risk areas:
- Credit Risk
- Liquidity Risk
- Market Risk
- Enterprise Risk
For the purposes of this blog post, we’ll focus on Credit, Liquidity, and Market Risk.
Credit Risk Management involves a thorough analysis of our counterparties to understand their financial standing and ongoing ability to repay loans. A critical aspect of credit risk is managing concentration to help ensure we don’t take on too much risk to any one single borrower.
As part of the credit analysis process, all institutional counterparties undergo a full due diligence and underwriting analysis which includes a review of their operation and financial statements, with focus on leverage and liquidity. Each client is assigned an internal credit rating (e.g., Tier 1, 2, or 3) along with a specific credit limit corresponding to the rating achieved. The credit evaluation is part of a detailed onboarding process, which also considers the business model, KYC/AML, organizational structure, industry dynamics, client reputation, track record, quality and frequency of financial disclosures, and their general transparency. For counterparties engaged in trading activities, we review the risk framework and associated controls. In conjunction with establishing credit appetite, we typically negotiate a master loan agreement which may include a number of borrower covenants, and includes our contractual lender rights.
At BlockFi, unsecured lending appetite is limited to our largest and most established Tier 1 clients based on the potential of attractive risk-adjusted returns. Only those clients that have a significant capital base, verifiable financial position, and a willingness to be transparent and engaged with us may be afforded an unsecured credit limit. Our risk appetite to our Tier 2 and Tier 3 clients is limited, and as a result, this client segment is asked to collateralize their loans.
Our Credit Risk Management team regularly reviews the credit framework, client transactions, and changing market conditions. During the recent period of prolonged market volatility, a detailed plan was executed to manage distressed counterparty situations, drawing on years of experience and best practice in traditional finance. As a result, we were able to enforce contractual rights under our loan agreements and took swift action to mitigate potential losses.
We manage liquidity risk with a dedicated framework and set of measurement and monitoring tools across three key dimensions:
- Asset matching
- Duration management
- Liquidity buffers
Asset matching reduces digital asset conversion risk by seeking to deploy digital assets into loans or investments that will generally “match” or generate returns in the same denomination of the corresponding liabilities. In simpler terms, bitcoin loans are made with bitcoin, not with other cryptoassets. This is analogous to currency matching, a cornerstone of traditional finance.
Duration management helps to ensure that we’ll be able to continue to meet our short-term obligations to clients on a timely basis, including BlockFi Interest Account (“BIA”) and BlockFi Private Client (“BPC”) account holders. Our lending book’s term structure is influenced by the term structure of our liabilities. Given that we have on demand obligations to most of our clients (e.g., BIA account holders), we aim for at least 50% of total amounts due to clients upon demand to either be held in inventory or deployed as loans that can be called within seven calendar days. Where we source liabilities with a longer duration (e.g. 3- or 6-month terms from BPCs or institutional borrowings), we are more able to deploy liabilities to longer-term assets (e.g., loans of similar 3- or 6-months duration).
Liquidity buffers (a.k.a funds-on-hand) help to ensure we have sufficient liquidity to support client withdrawal requests, even under periods of elevated withdrawal demand. Our Liquidity model projects regular and stressed conditions for in/outflows over different time horizons and for different digital assets. In addition, we monitor early-warning indicators (e.g. liquidity coverage ratios, asset in/outflows) to take necessary actions or adjust our go-forward assumptions if needed. Our short-term liquidity guidelines include holding at least 10% of total amounts due to clients upon demand in inventory.
A multi-disciplinary team of Retail, Institutional, Treasury and Risk members meets regularly to make liquidity-informed decisions and ensure we have sufficient liquidity at all times to meet/exceed client expectations, meet our Terms of Service, and make risk-reward decisions in line with our risk appetite statement. The framework has helped us ensure all client redemption and withdrawal requests to date have been processed within our normal terms of service, even during periods of extreme stress in crypto and broader financial markets.
Market Risk and Quantitative Analysis
We don’t currently take on any material principal trading positions other than in facilitation of client trading activities, hence our balance sheet is subject to minimal trading risks. Nonetheless, our Market Risk and Quantitative Analysis team plays a central role in identifying exposure to market events and counterparty and liquidity related risks. For example, when determining required counterparty margin levels we analyze our loan exposure to changes in market conditions, such as extreme price fluctuations of the loan, collateral assets, and/or reduced liquidity available for trading. The team also develops quantitative risk models, including our margin model and the economic capital model, that ensures BlockFi has sufficient risk capital to withstand severely stressed conditions.
As discussed above, we require our Tier 2 and Tier 3 institutional client borrowers, and many of our Tier 1 institutional client borrowers, to post collateral against their loans. To establish the appropriate level of collateral required for a specific lending situation, we use a proprietary Margin Model, which incorporates BlockFi’s credit appetite, the credit limit assigned for each specific borrower, and the type and quantity of coins or assets which are provided as collateral, among other inputs. In an industry as dynamic as crypto, margin management is an essential part of operating a collateralized lending business.
With respect to our collateralized loans, we subject even the most liquid collateral, such as BTC, ETH and stablecoins, to a market risk “haircut.” This “haircut” is used to reduce the value which we ascribe to collateral in order to provide a margin of safety for us to liquidate the collateral in the event of potential counterparty default. The margin of safety for potential collateral liquidation is important to minimize any resulting losses in our USD or crypto denominated lending book. For example, a loan of $100 USD may be collateralized by an equivalent of $120 in BTC.
In cases of extreme market volatility, it’s possible that we could incur losses on collateralized loans in the event of a counterparty default and resulting liquidation of collateral. To protect our clients and ensure we remain solvent in such an event, we seek to maintain sufficient loss-absorbing risk capital as described in the next section.
Risk Capital Modeling
To help ensure we have sufficient risk capital to withstand stressed market conditions and potential counterparty defaults in the loan portfolio, we’ve designed a custom risk capital model for our digital asset portfolio. The BlockFi model is based on the Basel III Economic Capital Framework, which applies to most major banking institutions worldwide.
Our risk capital model seeks to capture potential joint defaults of BlockFi borrowers according to default probabilities, exposures, and estimates of losses given default of those borrowers. The default probabilities are based on our counterparty rating Tiers. The risk capital model considers correlations among possible defaults and the levels of exposure which may exist under those conditions. The model also includes concentration penalties which seeks to ensure there is sufficient risk capital to withstand a default of one of our largest counterparties.
Taking the best of traditional financial risk management practices and creating adaptations for crypto markets is what we do best. Risk management is one of BlockFi’s key strategic advantages and differentiators, powering our track record of delivering market leading interest payments, access to client funds, and preservation of client capital through all market environments.
Last updated on November 27th, 2022