How Big Can Collateralized Crypto Lending Get?

BTC is in fixed supply.  This is one of, if not the, top reasons people who love it love it.  However this fixed supply has interesting implications for the collateralized crypto lending markets.

As discussed previously on this blog if we start with 1 unit of stablecoin to lend out against BTC collateral and require an overcollateralization haircut of X% we can end up with 1/X in gross loans (longer discussion here).

We know stablecoins are printed and lent to various platforms from the public press.  Here we will discuss how the fixed supply of BTC constrains the growth of this lending.

The key observation here is: the aggregate liquidation order has to be for fewer coins than the total outstanding.  Simply put the price must be high enough that: \begin{equation} \frac{Stablecoins}{Haircut} = Supply \times Price \end{equation}

Assuming 18M BTC outstanding we get the following minimum prices to support lending at the given haircut:

At an average haircut of 10% with 50B raw stablecoin outstanding to lend the market requires a BTC price at least 27.8k.  At 4% and 75B the required floor is now over 100k.  With higher haircuts the prices are obviously lower.  This is not a difficult spreadsheet to build.

Take a look at the bottom few rows.  This is a real limit on non-fiat-backed stablecoin issuance!  In some sense a lower haircut is like a looser monetary policy -- lending is easier.  But with a fixed money supply the price must rise, possibly dramatically, to provide adequate collateral for non-fiat-backed loans.

A stablecoin issuer that wants to issue more coins against collateral must make a choice: how do they balance the haircut against the number of coins they want (need) to issue?  Note that when the haircut is below 50% most of the lending is not from the original issuer -- it is instead follow-on rehypothecation loans out there in defi land.

A lender that wants to ramp up business has to monitor what fraction of the total coins they might already need to sell.  The supply of coins is currently growing slowly.  But in the short term -- in the sort of timeframe one might need to execute a liquidation order -- the supply is effectively fixed.

There Is No Free Lunch

Printing coins to push up prices, or to grease the wheels of lending platforms, or for any other purpose may at first feel like an unconstrained activity, something that can go on forever.  But this is ultimately a markets activity.  We are talking about borrowing and lending, buying and selling.

Lending against collateral is a transformation of some sort.  It is an event creating a flavor of credit.  Otherwise what purpose does it serve?  Creating credit in a system with a fixed-in-stone money supply feels like an activity that cannot continue without limit.

This is that limit: there is a price at which more than the entire monetary base needs to be liquidated to satisfy someone's liabilities.  And these liquidations may occur on platforms nobody can easily shut down.