Explained: What is over-collateralization?


On today’s show, we talk about Bitcoin borrowing and lending with BlockFi’s CEO, Zac Prince. Additionally, Preston was accompanied by Blockfi investor, Mark Yusko from Morgan Creek Capital Management. They talk about the basics of how Bitcoin lending works.

Preston Pysh
I love the background, and I think that it adds to the overall story of … Especially when you start talking about how the legacy system really wasn’t going to change unless it had to change. What we’re about to describe, people’s eyeballs are going to be pop open as they hear this. So, let’s describe the one BTC that was deposited on BlockFi. What happens after it gets there?

Zac Prince
After that Bitcoin gets deposited at BlockFi, it is commingled with other assets at BlockFi with one of our custodians. Today, BlockFi works with three custodians. Gemini is our primary custody platform, but we also custody with Fidelity and BitGo. The reason for that is that we decided early on that we wanted to build a debt and credit business, a financial services business, not a new custodian that was going to safely hold private keys, so we just decided to work with the best folks in the market. We picked them based on their operating history, whether they’ve been through audits or not, how much insurance they have. So, that’s the starting point.

Zac Prince
From that point, these assets are available to be utilized in different types of lending activities. These different types of lending activities are what generate the yield that we’re offering to our clients at BlockFi. Fundamentally, there are two different types of loans that BlockFi makes. There are loans where collateral is posted back to BlockFi, and there are loans well over-collateralized, and there are loans which are smaller as a percentage than the over-collateralized loans, but there are loans where they are under-collateralized.

Zac Prince
Also, we have two different types of borrowers who are borrowing from BlockFi. We have our retail clients who are borrowing directly in our mobile app or our web app. They’re always borrowing dollars, secured by the value of their cryptocurrency holdings on our platform. And then we have institutional borrowers, who depending on who they are may be borrowing in a similar construct as our retail borrowers where they’re always minimum 2X over-collateralized, or they may be borrowing where they are one to one collateralized or under-collateralized. And importantly on the institutional side, the loans could be denominated in dollars or cryptocurrencies, they’re denominated in Bitcoin.

Zac Prince
Now let’s talk about the risk management. The over-collateralized part is pretty easy, and that’s where we started. What do you need to effectively manage risk when you have over-collateralized loans? You need a system that is monitoring prices, that is connected to liquidity, and that is available to take actions in the event of price volatility where you would need to, based on the loan to value ratios of the different loans.

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