On September 7, 2022, we invited clients to join us on our subreddit
for an AMA (Ask Me Anything) featuring our Chief Risk Officer, Yuri Mushkin.
During the AMA, our community asked some important questions about our risk management and the future of BlockFi.
We’ve compiled the questions and answers here, edited lightly for grammar and context:
On our lending activities
Why are you still doing uncollateralized loans?
A fair and good question, which has been asked a number of times recently. TLDR: We think there is a role for both uncollateralized and collateralized products, if done prudently. Here are my thoughts broadly:
Many of the big losses reported in digital asset and traditional lending recently were around collateralized lending. For example, many of 3AC related losses were related to fully or partially collateralized loans. Also in TradFi just last year, the largest and most sophisticated sell-side banks (e.g., Credit Suisse, Nomura, Morgan Stanley etc. ) lost a combined $10 billion dollars to a single client, Archegos Capital, in what was effectively collateralized lending activity. To over-simplify collateralized lending as “safe” and uncollateralized lending as “unsafe” would be a misunderstanding in my opinion...
A prudent lending framework which is also commercial requires a team of seasoned credit and legal professionals and requires the following:
Legal/ contractual rights to act quickly (typically 24-48 hours)
Limits on the gross size of the loan
Limits on the type and quantity of acceptable collateral
Sophisticated model to determine the amount of collateral needed for each specific lending situation (itself determined by the size of the loan and type of collateral)
Risk systems, complemented by an experienced trading and risk management team monitoring the portfolio 24/7
Access to multiple exchanges and OTC desks to liquidate collateral quickly, with minimal slippage
Risk culture, starting from the top, that allows an organization to act quickly and in the best interest of our clients.
We have invested into building the Credit and Lending function at Blockfi to meet these standards. We’ve provided some info on our approach to Credit Risk Management in the links posted by Brandon above. And happy to share more about our credit approach also!
On our risk management
More of a philosophical one: Why can BlockFi offer higher rates than Ledn, and much higher rates then DeFi apps such as AAVE and Compound - you can borrow USDC there under 1% pa right now - is that not the 'risk free' yield on usdc? What additional risks that blockfi take in order to generate its yields + profit margins?
Defi Protocols such as AAVE and Compound are providing a lending product which does not always work for a subset of institutional clients. These DeFi venues typically don't perform KYC/AML checks and are offering fully over-collateralized borrowing, with variable interest rates, automatic liquidation and associated penalties and without extending credit or underwriting of the borrowers.
While the majority of our institutional loan book is currently also partially or fully collateralized, many of our institutional clients are willing to pay higher yields in exchange for the terms we provide; which include stable interest rates, term loans, margin cure periods and other institutional grade offerings. BlockFi also underwrites the majority of its institutional borrowers, including the collateralized borrowers, which allows us to gain recourse to assets of the borrower beyond any pledged collateral in the event of default. We described the requirements of an institutional grade collateralized lending platform here: https://www.reddit.com/r/blockfi/comments/x8bsgo/comment/inhk2d2/?utm_source=share&utm_medium=web2x&context=3
We also generate yield from uncollateralized lending, similar to TradFi banking institutions. In traditional banking, uncollateralized lending ranges from the very risky, such as consumer credit cards, to the significantly less risky, such as loans to large investment grade corporations (for example, a loan to Apple). Lending on an unsecured basis commands a comparatively higher interest rate vs. collateralized lending, which allows us to pass this additional yield through to our clients. Note for context that 3AC loans which BlockFi extended historically were not uncollateralized, because 3AC did not meet our necessary criteria for credit extension.
At BlockFi fully uncollateralized lending is limited to our largest and most established Tier 1 clients, which have a significant capital base, audited financial statements and a willingness to be transparent and engaged with us around ongoing credit monitoring. These Tier 1 clients, which operate in the crypto markets, often represent an attractive risk/reward profile because despite their strong Balance Sheets they are not able to receive credit from TradFi banking institutions, hence they are willing to pay attractive rates to borrow.
To extend credit we first negotiate a very detailed legally enforceable contract with all of our borrowers. These contracts establish BlockFi as a senior lender with full recourse to the borrower’s assets, and include financial and non-financial covenants and remedies. These covenants allow BlockFi to monitor the credit quality of the borrowers on an ongoing basis and legally take action in case of certain events or conditions (e.g., material adverse developments) of any number of conditions that constitute an event of default (e.g., a decline in Net Asset Value).
All borrowers then undergo a full due diligence of their operating history, and their financial and liquidity profile based on a detailed review of financial statements and discussions with the borrower. The credit evaluation also considers the business model, the use of borrowed funds, various industry dynamics, their reputation, track record, quality and frequency of financial disclosures, and their general transparency. For counterparties engaged in trading activities, we also assess their risk management framework.
We believe this type of lending activity benefits the crypto ecosystem, including retail users. The profile of clients who are able to obtain uncollateralized credit from BlockFi are often able to deploy that capital productively and efficiently into the ecosystem. For example, market makers use lending proceeds to provide liquidity on multiple global crypto exchanges simultaneously, thereby lowering trading spreads and improving price discovery and execution for end-users.
Overall, we consider the capability to extend credit as a value add to the ecosystem and differentiator for BlockFi, as it requires significant resources which we've invested into to perform onboarding, compliance checks, analyze borrower financials, and negotiate loan terms by a team of seasoned underwriters who understand credit risk in different market conditions and have the ability to work out problematic loans if needs arise. In fact, to date we've not had a loan default which was underwritten on a fully unsecured basis.
Despite being unprofitable as a lender, BlockFi recently raised rates on deposits, not lowered. Who is subsidizing this yield? Do you think it is healthy for the industry to subsidize yield with venture capital money? Do you think subsidized yield forces lenders to take outsized risk to stay competitive, such as lending uncollateralized to degenerate hedge funds like 3AC?
In context of our overall lending operations, since BlockFi’s inception in 2017 we have originated cumulatively over $60 billion of loans, and to date our total losses in connection with these loans, including the 3AC losses which we reported, have amounted to approximately 0.3% of this $60 billion amount. Comparatively we typically earn considerably more than 0.3% net yield on our originated loans, for example the 3AC related losses of approximately 80m were less than the aggregate “lifetime” revenues earned on the 3AC relationship.
Regarding our rates, we manage these based on supply and demand factors and look to match the term and yield of our liabilities with assets and relevant yields we’re able to attain, basically to allow our clients to benefit from the term structure of the asset yields in the institutional crypto markets.
The profile of clients who are able to obtain credit from BlockFi and other CeFi lenders are often able to deploy that capital productively and efficiently into eco-system for the benefit of retail and institutional users. For example, market-makers use credit facilities to provide liquidity on multiple global crypto exchanges simultaneously, thereby lowering trading spreads and improving price discovery and execution for end-users. This is analogous to the availability of credit in the traditional markets, which stimulates innovation and economic growth, so long as it’s conducted with proper oversight, due-diligence, and prudent regulation where applicable.
Can you go into how risk management has evolved over the last two years and if dealing with the gbtc carry trade helped strengthen BlockFi's risk position heading into the 3AC/Celsius/Voyager events of this year?
I love this question - you’re giving me an invitation to brag about my team. I joined BlockFi in June 2021 and have brought on quite a few folks who have decades of risk experience. This group has leveraged best-practices from TradFi, that I believe are universally applicable to all asset classes, including digital assets. We’ve put a ton of rigor around processes and committees that served us well for the events of the Summer. Particularly navigating credit risks and liquidity risks which proved challenging for some other lending platforms.
For example, we were able to detect issues early and start conversations with 3AC proactively. We made the decision to accelerate the 3AC loan on June 11th due to the client’s inability to meet our margin call requirements. We were in a good position to execute hedges to immediately sell or reduce risk of the collateral, consistent w/available market liquidity. This was on a weekend, however crypto spot and futures markets have the benefit of trading 24/7!
We’ve also done a few other things to protect clients going forward, including i) raising additional loss absorbing capital ii) tightening our requirements for the types of collateral we accept and the “haircuts” we assign to collateral; we no longer have GBTC anywhere on the balance sheet iii) working on additional secured lending structures (stay tuned!).
And back to my team – they are also great problem solvers and we understand that there are lots of crypto specific risks ( e.g., increased levels of volatility and jump risks, smart contract risks, security risks, and liquidity risks). So we’re continuously learning and working on new and novel ways to mitigate these; for example we have stayed away from many unproven venues or DeFi yield opportunities such as Terra/Luna, or liquidity issues with stETH.
On the strength of our balance sheet
Are you solvent?
Yes, BlockFi is solvent. Due to uncertainty and volatility in the digital asset markets, in June we determined that additional financing was necessary to strengthen our balance sheet, and we secured a $400m unsecured line of credit from FTX to help ensure we have sufficient loss absorbing capital to withstand any further market disruptions. Repayment of any loans under this line of credit is subordinate to our obligations to repay clients.
What do this quarter's financials look like, are you still profitable? Cash flow positive?
Appreciate the question, but we don't disclose this information publicly. Please check out our latest Transparency report which we publish quarterly, which covers (i) fair value of assets transferred to us by clients, (ii) how we deploy these assets and (iii) an overview of certain of our key policies for managing credit and liquidity risk. More info: https://blockfi.com/blockfi-transparency-report-Q2-2022
Will blockfi ever publicly disclose their loans and risk assessment? I'd assume yes if you pursue an IPO?
We don't disclose individual borrower names or loan terms because of Non Disclosure Agreements. Our standard loan agreements prohibit sharing those details. However we published a lot of information about our risk assessment practices, including our framework for credit and underwriting recently: https://blockfi.com/in-depth-look-at-blockfis-risk-management
Have you checked out the Transparency report
that we publish quarterly? It has a lot more information about our loan book in aggregate, and covers things like (i) fair value of assets transferred to us by clients, (ii) how we deploy these assets, including the fair value of our loans to retail and institutional clients, and (iii) overview of some of our risk policies for managing credit and liquidity risk.
How does BlockFi's current equity look (as defined by E = ClaimsOfBorrowedAssets-CustomerDeposits+OtherAssets-Debt). What is it in absolute amounts and what is the ratio to customer deposits?
We believe our balance sheet is strong and capable of weathering ongoing or additional volatility. You can see the fair value of assets transferred to our platform by clients and how we’ve deployed them in our transparency report
We have designed a risk capital model, based on the Basel approach for measuring credit risk, customized to our digital asset portfolios. We use this model to estimate how much loss-absorbing capital we need to hold to protect client funds. You can review the approach here: https://blockfi.com/in-depth-look-at-blockfis-risk-management
I have a lot on BlockFi and supported you during these times and market conditions, but I am now really worried if BTC goes down to lets say $8k....
In that scenario: Will BlockFi still stand? Will BlockFi become insolvent or threatened by bankruptcy? Should customers be worried if the BTC price goes to $10k, $5k? Is there a level where BlockFi would need to pull the plug because I need to know because it can destroy all I have built (what I have is in loans, so I can not just withdraw it out unfortunately).
A significant drop in BTC and other digital assets, beyond what we’ve already seen, could negatively affect our revenues (as we earn a spread on the notional amount of BTC, other digital assets on our platform).
A significant drop in BTC, ETH etc could potentially stress our borrowers and the value of collateral they posted in connection with loans we’ve made to them. All of our retail lending is overcollateralized; we typically allow retail clients to borrow funds with a value of up to 50% of their collateral. We’ve never had losses in our retail lending portfolio. Majority of our institutional loans are also partially or fully collateralized and similar to retail loans, the collateralized institutional loans are subject to margin calls in the event that collateral value decreases beyond a specified threshold relative to the loan value.
BlockFi’s balance sheet, though, is not directly exposed to the price of crypto assets in so far as we generally do not take market risk with our balance sheet, outside of the facilitation of client orders to buy or sell crypto. We also run adverse stress scenarios to help ensure we have sufficient liquidity and risk capital on hand to manage client withdrawal requests during periods of market volatility.
What is the current capital structure with regards to customer deposits and other liabilities? Which liabilities (including their size) have a higher liquidation preference than customer deposits (are these loans, or do they include certain tranches of equity and who holds them)?
Assets transferred to interest bearing accounts by our clients are our general, unsecured and unsubordinated obligations and are entitled to share ratably with our other general, unsecured and unsubordinated obligations in any proceeds distributed in the event of any insolvency, liquidation, reorganization or similar event related to us.
I have almost all BTC as collateral in BlockFi. It would be nice to know that I should not worry about BlockFi doing a "Celsius" or other bankruptcy or liquidation event. Can you promise this will not happen because BlockFi has a good backend (FTX and so on)? I am afraid that all our savings will get "lost/stolen" from us…
We believe our balance sheet is strong and capable of weathering ongoing or additional volatility. You can see the fair value of assets transferred to our platform by clients and how we’ve deployed them in our transparency report, that Brandon shared earlier.
We believe we have ample liquidity and loss absorbing capital to support the business and navigate additional market volatility and disruptions if they come.
On 3AC and “crypto contagion”
It is my understanding that the 3ac loss blockfi took was associated with slippage when disposing of posted collateral. Are you taking any steps to secure future OTC liquidity in order to be able to liquidate such positions without nuking the market?
Yes, 3AC losses were associated with slippage hedging and selling BTC and GBTC collateral. We have a number of large exchanges where we can trade, and we also work with OTC market makers and liquidity providers.
After making the decision to accelerate the loan due to the client’s inability to meet our margin call requirements, we started to execute hedges to immediately sell or reduce risk of the collateral, through a combination of exchange and OTC venues, consistent w/available market liquidity.
Liquidation of GBTC and similar non-crypto collateral takes longer, as these products trade only on Monday-Friday during equity market hours. In addition, unlike digital assets, GBTC and similar products require services of traditional custodians and broker dealers, and following an event of default it can potentially take days or weeks to take possession of non-crypto collateral pledged under the loan agreements.
Going forward, we’ve also reduced the range of collateral types that we accept, and have placed limits on less-liquid forms of collateral, (we don’t have GBTC anywhere on the balance sheet currently) Note that the 3AC relationship spanned several years, during which time BlockFi earned revenues that exceeded the loan losses we’ve realized.
On our agreement with FTX
Does the FTX deal contain provisions (as seen in the leaked voyager docs) that recall or otherwise curtail the loan if the 3ac claim hits a certain write-off level?
No, the FTX agreements don't contain any provisions specifically relating to our 3AC exposure.
At risk of being blunt: You had to take emergency financing from FTX that mostly wiped out shareholder equity. Doesn't that by itself refute claims of having appropriately managed risk?
I always appreciate a blunt question!
Regarding our FTX deal:
As a company, BlockFi always puts clients first. Raising additional risk capital has been an ongoing priority ever since my joining last year. The past year was challenging for many companies in the industry, including many fintech companies in public markets. For BlockFI, we were also navigating regulatory uncertainty around our yield product. Against that backdrop and the challenging market conditions in late 2021 that continued through 2022, when the Terra/Celsius/3AC disruptions hit the market in May and June, we decided that fortifying the balance sheet was critical to execute asap to strengthen our ability to honor obligations to clients. The FTX deal helped to provide certainty to our ability to continue operating safely with the knowledge BlockFi can weather additional storms with a $400 million line of credit.
Regarding our risk management framework:
Since I joined BlockFi in June 2021, we have invested into building foundational risk capabilities across each “risk stripe”. We put in place experienced risk managers who are independent from the business and set up a Board level Risk Committee that helps oversee (1) credit risk underwriting (2) market risk and collateral assessment (3) treasury and liquidity management; and (4) non-financial risks etc. This helped us to remain open and honor 100% of client withdrawals during all the market disruption recently.
On BlockFi Yield
Hi Yuri! What's happening with US non-accredited? When are you expecting these users to be able to get back into your BIA accounts?
We are limited in what we can say during the registration process, but registering BlockFi Yield is our team’s #1 priority right now. As soon as we have an update, we’ll share more with you!
On the future of crypto
Hey Yuri 👋 What are the biggest crypto risks you see over the next 12-18 months?
One of the big risks is related to the macro economy. The Fed has reversed its decade-long interest rates easing policy, and we’ve yet to see the full effect of this new phase. In previous periods of market volatility, crypto assets broke their correlation to the macro economy after several months, however, we’re seeing a much longer period of correlation during the entire 2022 so far.
Working with regulatory bodies on a constructive framework is also key. Making the platform resilient not only around financial risks, but also collaboration with regulatory bodies, and uncompromising focus on compliance, operational and cyber related risks. At BlockFi we have a Chief Compliance Officer and a Chief Information Security Officer, given how important those areas are.
With that said, there is clearly a lot of exciting adoption and development in the digital asset space, ranging from payments use-cases, borrowing and lending markets, even the music industry. As the adoption of digital assets grows, the user-base grows - and both retail and institutional users benefit from financial services around the new asset classes. Traditionally BlockFi has been a big part of that ecosystem growth, and I think platforms which make sacrifices but survive this period of volatility will be very successful in the medium to long term.
How do you sleep at night?
We have a great team at BlockFi and Kingsdown makes a great mattress - highly recommend.
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