The fact that a crypto crash is happening has become old news. But the details that signal it are still pouring in by the day. The most recent sign of the apocalypse is the temporary freeze on lending by Vauld, a popular cryptocurrency lending service, which took place on Monday.
This was following a recent string of events: To begin with, popular platforms like Coinbase have seen some stock drops, while at the same time Terra Luna saw a historic price crash that sent shockwaves through the industry. Both of these were based on the credit system of the industry as a whole.
As a result, lenders have had to massively reevaluate all that they are doing. But what does that include?
How Crypto Lending Works
Most people are under the impression that crypto lending works just like lending with fiat currency. That is true, but not for the reasons that people think. You see, there are two layers to crypto lending.
The First Layer of Crypto Lending
The first layer is related to trade. Imagine that you are trading cryptocurrency on a trading platform. You trade your Bitcoin for some Ethereum. Then, you see that you can make a profit if you trade that Ethereum for some Dogecoin. Well technically speaking you cannot make that trade just yet.
The trading platform will want to wait for your trades to be validated. This can take as little as twenty minutes, or as long as two days if the trading platform wants to be really safe. But here is the cool thing: Most trading platforms will still allow you to trade during this period of “settlement”.
You traded Bitcoin for Ethereum. That trade did not settle, but the trading platform is pretty confident that it will settle successfully. So, when you go to trade for Dogecoin, instead of using your Ethereum, the trading platform lends you their Ethereum, which they know exists and is not tied up in settlement.
For the risk they take, you pay a tiny fee. But that fee is so small that it is quickly outweighed by the efficiency that this form of lending allows. By trading faster like this, you can make more money.
The Second Layer of Crypto Lending
But that is not all there is to cryptocurrency lending. In addition to that, you also have lending in the more traditional sense. You can get a loan for a lot of reasons. To buy a house, to buy a car, or even to buy stocks. And in this case, you can get a loan of cryptocurrency to buy another cryptocurrency.
This kind of lending is, by necessity, far less common than the first kind. But it is arguably more significant to Vauld’s decision to stop lending out cryptocurrency.
After all, their business model is built on the idea that they lend out money to a customer and the profit comes from the customer paying that money back. That customer is likely making a speculative investment. They present a claim to Vauld saying how Vauld’s investment in them will yield a return for Vauld. If the customer does not make the money they expected, they still pay Vauld back.
But Vauld cannot just go around handing out piles of cryptocurrency hoping that people pay them back. So, if the industry looks like it is not fit for anyone to make profitable investments, the smartest thing for Vauld to do is stop lending entirely.
Is This Permanent?
No, Vauld’s freeze on lending is not permanent. It can’t be, as they would simply go out of business if it was. But not only is this freeze not permanent, but a freeze on lending does not mean a freeze on trading. Just because trade is slower, that does not mean it is over.
Trades can still be done while taking the long settlement periods into account. In fact, there are protocols for exactly this scenario. We mentioned that some trades take twenty minutes to resolve while others can take as many as a few days. That has to do with the way cryptocurrency works.
One of the advantages that trading using cryptocurrency has over trading with fiat currency is the fact that the blockchain has the ability to validate trades for trading platforms. These are not always the fastest systems, but the sheer amount of data you have corroborating any given trade means that you can accurately use the blockchain to confirm that everyone in a trade has the money they say they do.
In short, most settlement periods for cryptocurrency trades are actually longer than they need to be in order to be safe. Since lending has been restricted by Vauld (and many other lenders), trading platforms have turned their focus from security through lend-trading to security through the blockchain.
Not everyone has access to this, granted. You have to be verified in a number of ways and have enough cryptocurrency to be considered worth the risk of faster trade settlement. But it means trade can still happen, even in economically turbulent times.
How This Reflects Crypto at Large
It probably does not surprise many people to hear about crypto lenders halting loans at this point. Part of the calculations of interest on loans is determined by the credit of the group doing the lending measured against the credit of the person to whom that group is lending the money to.
In the current climate, many lenders are lacking the certainty that they once were. Terra, the company that manages the legendary disaster of Terra Luna, is a good example of this. Their currency was pegged to other crypto holdings, meaning that when people started mass withdrawals and sales of that cryptocurrency, their credit began to tank. It wasn’t long till the value of their currency tanked too.
Vauld is pausing lending, but that is hardly a surprise. And not only is it unsurprising, but it is also wise. If a company were to loan money to anyone who asked for it, they would be out of business quickly. If anything, this is a sign that the crypto industry is adapting to the collapse and not just collapsing.