Stablecoins as Collateral

Bitcoin, Cardano, Litecoin, stablecoins… if you're anything like me, talking about cryptocurrency can feel like speaking a foreign language. But as digital currencies become increasingly more popular, it may be a language worth learning.

Here, we are going to focus on stablecoin, which is a type of cryptocurrency designed with the intention of maintaining a more stable value. This is typically achieved by the cryptocurrency being pegged to a traditional asset like the US dollar or gold. One unit of the stablecoin is intended to always equal one unit of the reference asset. This differs from other cryptocurrencies like Bitcoin, whose prices can fluctuate often and significantly. The main goal of stablecoins is to reduce the price volatility associated with these other cryptocurrencies that are often less stable.

An emerging approach to lending you may have heard about is using stablecoins as collateral for mortgages and other loans. New crypto-fintech companies like Figure, Ledn, and Milo are piloting or offering crypto mortgage products. Users may pledge stablecoins or other crypto assets as collateral to obtain a mortgage or real estate-backed loan. As with most things, there are benefits and risks that come with this new concept.

One of the major benefits for both lenders and borrowers of using stablecoin as collateral is that these loans may be processed faster through blockchain technology, often without traditional credit checks. Here are some examples of how underwriting speed could be improved when using stablecoins as collateral for a loan:

• Blockchain provides a transparent and real-time record of stablecoin holdings; therefore, lenders may be able to instantly verify the amount and ownership of collateral without waiting for traditional bank statements or asset appraisals.
• Since the loan is fully collateralized by stablecoins, lenders don't always require extensive credit or income checks, which speeds up approval.
• Blockchain systems operate round-the-clock, allowing loan processing any time without traditional office hours or delays.
• Fewer intermediaries mean less back-and-forth communication, cutting down on delays typical in traditional loan underwriting.

Another potential benefit for borrowers is that they can retain exposure to their crypto holdings (i.e., don't have to sell assets) while unlocking liquidity through loans and avoid triggering capital gains tax. When you retain exposure to your stablecoins, it means you keep holding onto them instead of selling them. By using your stablecoins as collateral for a loan instead of selling them, you get access to cash without selling your assets-so you avoid triggering a taxable event and don't have to pay capital gains taxes right away.

Where there are benefits, there are also potential risks. The federal legal and regulatory framework for digital assets is currently evolving, resulting in significant regulatory uncertainty in this space. To learn more this blog lays out some of the state regulations that currently exist and what's on the horizon in the federal world with the GENIUS Act, STABLE Act, and the CLARITY Act.

Another potential risk is depegging. If a stablecoin loses its peg to the underlying currency (e.g., due to poor reserves or market shocks), the collateral value could drop unexpectedly. This drop in value would cause the collateral backing the loan to become less valuable than expected and could have some negative consequences, such as the lender asking for more collateral.

One last potential risk with using stablecoin as collateral for a loan is with the use of the platform. If the lending platform's code has bugs or vulnerabilities, such as hacks, it could be exploited, putting the collateral at risk.

It's important to know that state-charted credit unions can serve as custodians for digital assets, as long as their state allows it. However, the Federal Credit Union Act prohibits federally chartered credit unions from direct custody; therefore, those institutions would have to employ the use of a third party or Credit Union Service Organizations for custody of digital assets. In May 2024, the NCUA issued the following statement in regards to credit unions serving as custodians for digital assets:

"Whether federally insured, state-chartered credit unions chartered in a particular state have the authority to serve as a custodian for cryptocurrencies and other digital assets depends on state law and regulation. There is no prohibition in the Federal Credit Union Act or the NCUA's regulations preventing federally insured, state-chartered credit unions from conducting this activity, provided the credit union can do so safely and soundly and in compliance with all applicable laws and regulations."

You can find the above statement in the "Digital Assets and Cryptocurrencies (May 2024)" section of the NCUA's Frequently Asked Questions About Share Insurance page. It's also important to note that passage of the GENIUS Act would permit federally chartered credit unions to serve as custodians for stablecoins.  This would also require the NCUA to issue a regulation to that effect.  The relevant language in the bill states the following:

"SEC. 13. Authority of banking institutions.

(a) Rule of construction.—Nothing in this Act may be construed to limit the authority of a depository institution, Federal credit union, State credit union, or trust company to engage in activities permissible pursuant to applicable State and Federal law, including—

(1) accepting or receiving deposits and issuing digital assets that represent deposits;

(2) utilizing a distributed ledger for the books and records of the entity and to affect intrabank transfers; and

(3) providing custodial services for payment stablecoins, private keys of payment stablecoins, or reserves backing payment stablecoins."

As stablecoins gain traction, they present the opportunity to modernize loan origination-offering faster underwriting, real-time asset verification, and broader access to borrowers through blockchain technology. While risks like regulatory uncertainty, depegging, and platform vulnerabilities remain, the potential for streamlined operations and expanded member use makes stablecoin-backed lending a space worth watching closely.