Crypto-Backed Lending Explained | Himanshu Sahay

Alex: Hello everybody, and welcome to the Curiosity Code podcast. Today I'm joined by Himanshu Sahay. He's co-founder and chief revenue officer of Arch Lending. He helped build crypto lending infrastructure after cutting his teeth scaling Snapchat, Bird and Tinder. And he's here to talk about what actually broke in 2022.

Alex: And what nobody wants to admit is still broken today. Himanshu, you've had already a few public appearances and episodes on podcasts talking about 2022. I'm not gonna talk a lot about it here, but what I'm curious about is what's the one detail from inside that era that you never get asked about?

Himanshu: That's a good question. I think people focus a lot on the one or two headlines that happened back then. So the main theme of what happened, for those of you who aren't aware, is there was a crop of lenders that I define as the first era of crypto-backed lending and these had massive books, Celsius, BlockFi, Voyager, Genesis and FTX as well in a span of about 6 months. All of these fail for a number of different reasons, whether that was rehypothecation or just bad book management and a duration mismatches between how much capital, the length of capital you have available versus the length you've lent out for. So let's say you are using retail deposits to fund your crypto-backed loans.

Himanshu: Now retail deposits can be taken back at any point when the user wants to take their cash out. But if that cash has been lent out for a six month or 12 month term, that cash isn't available to be given back. Now there's many ways to double count things which these people did and made those things work in certain scenarios. But when it became a bank run situation when everybody wanted their money out together, the capital wasn't available to be given back. So there were a few different issues like this.

Himanshu: I think the main thing people focus on is oh, this proves that crypto-backed lending isn't quite sustainable. That's not true. I think we've proven in the last four and a half years since then that crypto-backed lending is sustainable and is today much bigger than it was back in 2022 and even 2021 at its peak. And we've actually shown much more significant advancements in crypto-backed lending today. So I think people focus on the negative that this one event happened and as a result this industry isn't quite sustainable.

Himanshu: But in fact this was a necessary event to show us all the pitfalls of what can happen if you don't manage a book properly, if you don't manage a lending business properly. My co-founder and I, we have especially my co-founder, he has deep expertise in lending. He did the first securitization at Brex and raised over a billion dollars there. We've since then raised the first structured credit facility in the crypto-backed business in 2024 with Galaxy and to be tokenized and transferred. Other lenders have done similar things as well and today our lending offerings are much more advanced than what offerings were available in 2022.

Himanshu: In 2022 you could either borrow over collateralized vanilla crypto-backed loans or if you were an institution hedge fund. You could borrow under collateralized or uncollateralized from a number of places. That caused a lot of issues. Today, if you are a high net worth individual or institution, you can actually go borrow with a number of structured products. We've recently announced some advancements on collar loans like a managed collar or a managed knock-in collar, which are two.

Himanshu: Sorry, which are two somewhat misunderstood structures. But there's a lot of good press that came out of this and I'm happy to explain it as well on how these things work. But they basically allow you to borrow at pretty high LTVs in a safe hedged manner at very, very low single digit interest rates. And we've seen this have a lot of success with high-net-worth individuals, with institutions, particularly DATs that have a large bitcoin balance that maybe isn't quite monetized today. They may have operating businesses that have cash flow, but they want to use leverage against their bitcoin which is sitting there today, to actually make it more productive and improve their bitcoin per share, which is a very important metric for them.

Alex: I want to slowly roll it out, like how the industry evolved since 2022. And I think as you mentioned in the backstory, 2022, like the biggest challenge there was or the reason for that was rehypothecation. So right now lenders don't rehypothecate what actually changed structurally to make that true. And how much of it would survive a bull market.

Himanshu: Yeah, I think back then it was a race to zero. Everybody was racing to bring their rates down. And the easiest way to do that was to rehypothecate. What that means is the collateral that you have, you can go get yield on it. And then that was typically done by lending out unsecured to market makers or other people who wanted bitcoin.

Himanshu: Typically you borrow bitcoin to go short against bitcoin. Right. So that was being done and it wasn't done in a safe manner. Clearly there are some lenders today at the very, very high institutional level that do it somewhat more safely. We strictly don't do it.

Himanshu: And among the more retail or individual lenders out there, which I think everybody knows the names today, by and large people don't rehypothecate. But which is why I always encourage every client to go look at the terms of how their assets are custodied and what's going on with the assets. There's two ways you can kind of rehypothecate. One is just lending it out. But also if you have a capital partner and you give full custody of the collateral to the capital partner, you're introducing additional counterparty risk to that capital partner for the client.

Himanshu: Most lenders today say they don't rehypothecate, but they actually give the collateral fully to the capital partner. So that does introduce another third party risk. We don't give collateral to our capital partners. They sit in our custody at Anchorage Digital, which is a qualified custody bank in the US. They've had an OCC charter for many years.

Himanshu: And I think it's very important for customers to be educated on that nuance where they need to understand exactly where the collateral is sitting with the custodian that they are trusting. Or is it sitting with their capital partner who they don't know who that capital partner is?

Alex: Who is actually borrowing against crypto today? And I don't know, do you have visibility on what they're spending it on? I'm just curious. I suspect the answer is not what people actually assume it is.

Himanshu: Yeah, I think a lot of people assume, oh, people who borrow against crypto are going are going and buying more crypto. While that is a use case, that's not the primary use case by any means. But most people who borrow from us, over 80% of clients borrow in dollars, not in USDC and they use that for long term use cases. Our average client is borrowing for two or more years at a time. They keep rolling their loans over every year and they use it for real world use cases.

Himanshu: Broadly, I split our clients across individuals and businesses. On the individual side, they're using it to fund short term cash flow, needs to buy houses to fund, in some cases medical payments, refinance higher interest debt because crypto-backed loans are much lower interest and they don't amortize, they're interest-only. And with us you don't have to even pay interest until maturity, which can be years from now. On the business side, it's different use cases. It's a lot of owner-operator businesses across the country.

Himanshu: We funded so many coffee shops, we funded a sailing business, we funded Hollywood movies, we funded a private racetrack, all kinds of use cases. And then on the larger side there's commercial real estate use cases. There's a lot of bitcoin miners. We funded everything from a small data center or a small bitcoin mining operation to a 15, 20 megawatt operation as well. There's so many use cases out there.

Himanshu: And typically it's people that understand the collateralization of bitcoin, understand that this is their reserve asset, this is something that they're doing for a long time and this is their stable capital base. So you never sell your stable high performing assets, you borrow against them. In the world of private banking, this has been done for generations. Where once you build up a strong capital base, you hold that forever, you never sell it and you always borrow against it because cash is a depreciating asset. So you don't hold cash, you use cash as a tool and you borrow against an asset that's appreciating.

Alex: Do you see that behavior changing over the past couple of years or you see any trends, you know, where it's going in terms of, you know, what people are borrowing for?

Himanshu: Yeah, for sure. I think people, especially in a bear market, we had the benefit of building in a bear market, 2022, 2023, even to an extent, half of 2024. And people in that time frame were still not quite educated on how they can use this asset. And understandably so it depreciated so much they weren't quite sure. And if you didn't fully understand Bitcoin, if you didn't fully understand the long term value, to you, it was just an asset.

Himanshu: That couldn't go up and down. As they understand that, more and more I think their eyes open up to the real long term value of what they can do against us. For example, if you borrow against your house or you borrow to buy a car or something else, you're paying interest and principal every single month so that by the time your loan is over, you've actually paid off everything. With this, it's actually a way to borrow for the long term because you're only paying interest every month, you're not paying any principal, it's not compounding, it's simple interest. And you have the option of deferring your interest to maturity.

Himanshu: So if you're trying to be capital efficient and actually use that capital for an investment use case, this is the best way to do it because you have most of that capital available to you, not being used in interest and principal payments, it's available to you to actually make productive. So if you have a hurdle rate from your investments of say 8, 9, 10%, you can actually easily meet that while still being productive on your capital. Because your cost of capital with us is less than that.

Alex: That's an interesting distinction in terms of what you guys offering compared to conventional loan. What did it take for you to be able to offer?

Himanshu: Yeah, the first two years it was very, very hard to get capital. You know, our first year and a half we lent off our own book just off equity dollars. And we had to really prove that our system, which is fully automated all the way from origination, AML, KYC to margin calls, liquidations, et cetera, all that is fully automated. And in order to prove that to capital partners, it took a long time. We finally were able to get our first structured credit facility which was an initial size of 70 million.

Himanshu: Once we proved that out, then we got to get to higher sizes. And today we have access to orders of magnitude more than that and we've lent out much more. But it really just was iterative steps where it was a combination of the cost of capital being pretty high and lenders not quite comfortable with the asset class. But then they understood that Bitcoin truly and crypto broadly truly is the best collateral. It trades 24/7/365.

Himanshu: You can't turn it off. As a lender, this, if you do it properly, there should be no way for you to ever have a loss because the market is not going to go under you overnight. You're always running liquidations and margin calls. Even if the team is sleeping, it doesn't matter. So it's just a series of iterative steps.

Himanshu: And I think today the industry is much, much more advanced where a number of different lenders have capital facilities, costs have come down significantly and I think it's much more accretive time to be a borrower because the industry is really working for you here.

Alex: Yeah, interesting. One other question that I had about, you know, your loans is that you offer retail borrower a loan with no liquidation. That sounds like, you know, it removes the borrower's worst outcome. So who is absorbing it instead?

Himanshu: Sure, yeah. So we're coming up with this soon. So there's a few ways to do this the way we do it. And I'm not sure how other lenders are planning to do this. I know a couple of other lenders have mentioned plans to do this, but it's very simple.

Himanshu: You basically have to hedge the position. So we will typically buy a put at the price where the loan will be 100% LTV and we protect the downside from that. So if it does go below 100% LTV or I guess if you're looking at an LTV scale, if it goes above 100%, the borrower can just walk away. It's non-recourse. And along that, along that time, because the put is making money as bitcoin falls, the borrower doesn't have to worry about margin calls or liquidations.

Alex: Is there any additional cost for the borrower?

Himanshu: Yeah, they have to pay for the put. It's not a significant cost. I know it's maybe a couple hundred basis points on top of the loan, but if you care about the non-liquidation mechanism, I think it's super accretive to you. And there's other hedge solutions we have for institutional clients which maybe I won't go into right now, they're a bit more complicated. But there's so many ways to really make this work for you.

Himanshu: Because we don't look at a loan as a one size fits all solution. We have six different loan offerings for different kinds of clients, different kinds of use cases depending on how you want to manage your position and really try to fit and make things work for different kinds of clients based on what their needs are at that time.

Alex: What's the hardest problem at Arch right now that has nothing to do with 2022 and everything to do with what's happening today.

Himanshu: That's a good question. It's, It's still education. It's always been education, but now the education is a little different. I think the education in the first couple of years was, hey, you know, we're not Celsius and we're not BlockFi. Here's how we do things, here's how we keep your assets safe.

Himanshu: And we really built a reputation for safety and security where that's what we're known for today. Over time, as we started getting into a few different options of what our loans can do and what we can do to really make your use cases work for you. With our different products, it got to a question of, okay, how do we educate you on which option is best for you? It's very simple to go just Google crypto-backed loans and compare six lenders on the headline rates. But the headline rate isn't really something that tells the full story.

Himanshu: You really have to look at the nuance of what happens in different stress scenarios and how either the lender is keeping you safe or, or how they're in some cases unfortunately fucking you in those situations. So we really try to be very front and center in what our terms are, what our numbers are, what our fees may or may not be, and exactly how you would be expected to respond in different situations. And then on top of that, if you have different structured products, we try to be very clear on exactly what you're getting and why this one option could be a better one for you than this other option, which isn't quite clear from a headline rate position.

Alex: Moving on to, you know, the lending mechanics, where does Arch cost of capital come from and how does that number change? what rate you can actually offer someone borrowing, let's say, $5,000 against Bitcoin.

Himanshu: Sure. So just like every other lender, our cost of capital is typically a spread on top of the federal funds rate, which today is around 3.62%, and then on top of that there's a spread charged by our capital partners, which is a mix of banks and other venues, and we will charge a spread on top of that. We don't rehypothecate any capital, so we don't have any other way of making money. It's pretty much just spread or interest income. And we typically borrow in wholesale facilities for longer durations and then we lend that out to our clients in whatever duration they choose.

Alex: Has that cost moved a lot in the last 12 months?

Himanshu: Two years ago we were lending at 15%. Last year we were lending at 12 and a half, 13%. Today our loans start at 7 and a quarter percent. So it's, it's changed quite significantly.

Alex: Wow, interesting.

Himanshu: And, and I think it's not just a function of the federal funds rate coming down, because it hasn't come down that much. It's just the comfort and the size of the industry. It's grown so much that as there's more liquidity in the market, the rates come down. And I think that's great for the borrowers because now you have so many options on where you can borrow. You can really compare lenders.

Himanshu: There's so many independent reviewers who really compare the details of every lender and based on your use case, there's different options out there for you.

Alex: That's pretty cool. You also recently added gold as collateral alongside crypto. How do you decide how much you lent against gold versus bitcoin? And what does the difference say about how you actually rank the risks?

Himanshu: Yeah, for sure. So the tokenized commodities market is fast growing and the two oldest ones there that we've seen a lot of utility for is Paxos Gold and Tether Gold, PAXG and XAUT and a lot of family offices, traders, et cetera. Like commodities traders, they use the tokenized representation of gold because it's much easier to collateralize, much easier to move internationally and they want to borrow against it. So it's a much more stable asset or slightly more stable than Bitcoin. It still moves just as any commodity does.

Himanshu: So our LTV is slightly higher than what we offer for retail Bitcoin. However, I'll caveat that by saying that the minimum size for gold-backed loans today with us is about $250K. So it's not really meant for retail today. We will launch that for retail very shortly. On Bitcoin, for institutions, we do go much higher.

Himanshu: On the LTVs, we can go up to 75%. So it's similar to where we are for Bitcoin. On the institutional side, it still has the same automatic liquidations and margin call mechanisms that we have for Bitcoin and for all other assets. And it still has the same customer service and same client representation that we normally give any other client.

Alex: Did adding gold change who your typical borrower actually is?

Himanshu: So we've done a few loans privately, we just launched it today, so I'll have to check the book on where we are on the gold side. But we have done a few loans in our beta phase and definitely is a slightly different client base than what the bitcoin client base is. But it's not a sea change. It's still someone who understands the benefits of a tokenized asset and someone who benefits, who understands how you can collateralize something on chain and how you can use it to access liquidity against your asset. If you're holding gold, normally it's not very easy to liquidate or to move over.

Himanshu: This is much easier.

Alex: Was there an asset that you looked at and then refused to take.

Himanshu: So we get requests on a number of assets. Typically the way we look at it is if it's an asset that even if it's a high market cap asset, if it doesn't have a lot of liquidity, we typically will not lend against it because we don't want to have a significant portion of what the asset trades at as our collateral base. Because in the worst case scenario, in a stress test, if you were to try to liquidate, even if you're holding 10% of the float of an asset, that's not going to be able to be liquidated on open market. Now we do have OTC venues that we trade against and we typically will use those in those scenarios, but we just wouldn't lend against something that is illiquid unless we do a hedge position. And even then it's a very, very rare use case.

Himanshu: We have to do a lot more due diligence in the counterparty and it typically would have to be a very highly creditworthy institutional counterparty with some other recourse against other assets.

Alex: Talking about stress tests, If Bitcoin drops 50%, let's say overnight tomorrow, walk me through exactly what happens inside arch in the first 24 hours.

Himanshu: Let me ask you a question first. How many times in the last 10 years has Bitcoin dropped 50% in the last 24 hours? Zero. Zero. Now it does, it does drop.

Himanshu: Good point. It does drop 50% over days and weeks. And we've seen that in the last year. Great. So it's just a function of liquidity.

Himanshu: How much liquidity is in the bitcoin market? Significantly more than we hold on our book and most lenders do. So if you were to liquidate, hypothetically, if you were to liquidate the entire book and we only do partial liquidations, we never do a full liquidation, so we only liquidate to bring you back to healthy LTV. If you were to do that across the entire book in a 50% drawdown hypothetical scenario, we would be just fine because there's enough liquidity in the market and we also liquidate at a LTV that's much lower than where we'd be negative on the loan. So there's no way for us to have a loss there.

Alex: I'd like to look back to where we started and ask you about piece of best practice in your opinion from post 2022 lending that you think is actually theater. It sounds safe, but it doesn't meaningfully reduce risk.

Himanshu: I've said this earlier today and I'll say it again. I think people need to really understand the difference between people saying they don't rehypothecate but actually understanding where the assets are held. So we go one step further than any other lender where if you ask us, we'll actually give you the address of where your bitcoin is held throughout the duration of the loan. And, and you can verify that in real time. Now we do not give collateral to any of our capital partners to hold.

Himanshu: It sits in tri-party account in our, in our own name in Anchorage. So it's our account. We're not posting it forward to anyone. Most lenders today, they're not very clear about where they hold assets. And I know for a fact some give it to their capital partners to hold.

Himanshu: That introduces an additional third party counterparty risk for it. You have to be very clear about understanding where your assets are held and ask a lot of questions. I think a lot of people will just look at a very attractive headline rate and will just not ask another question because they think that's fine and in a bull market they're probably just fine. But when things go to shit, that's when the stress starts happening. That's when you really have to understand what happens to your assets.

Himanshu: Interesting. I'm wondering what's I think we already spoke about it, but I'd like to tap a bit more on this so do borrowers actually pay more to work with a lender that doesn't rehypothecate? Or does safety lose every time to a cheaper rate? No, it doesn't. I think it used to and I think there was a distinction between the rehype and non rehype rates.

Himanshu: Today it's not that different. Most lenders, at least in the retail individual side, don't rehypothecate today. If there are some out there, then obviously I stand corrected. But the rates have come down quite significantly. If you're borrowing today, you're borrowing typically in the high single digits, even if you're retail.

Himanshu: And then if you're institutional, you can borrow in the mid single digits. Those are non rehypothecated rates. Typically you don't have to make the compromise anymore. And there's also ways to bring your rate down with hedging, which doesn't involve any rehypothecation. So I would be very careful about choosing a rehypothecated rate unless you really know the counterparty and really trust the counterparty.

Alex: I'd like to wrap it up with tapping into your past experience. So you built growth infrastructure at companies like Snapchat, Bird, Tinder. What's one instinct from consumer tech that turned out to be dangerous when you apply it to lending?

Himanshu: Well, I'll tell you one that turned out to be very useful. So in the world of crypto customer service and really clean consumer UX has not been the norm at all. People in defi often don't know what they're doing. It's very confusing. There's no way to reach the company or the project that you're working with.

Himanshu: So one of the things we've done front and center is customer service is at the top of everything we do. You can reach out to us in real time from any screen on our dashboard. You can book calls with us every single day. If you're a private client, you have a dedicated rep who will work with you at any time of the day. So having that customer service, because if people are giving us their hard-earned assets, they have to really trust us and know that they can reach us at any time.

Himanshu: In the world of private banking, this is very, very common. This is how things work. And that's what we wanted to bring here. So that's something that we really wanted to bring front and center and combine that with a great ux. Our UX has been known to be one of the best, if not the best in the industry.

Himanshu: And if you look at our reviews on trustpilot, people say this every single day. There's tons and tons of reviews out there. We really pride ourselves on that. So that's been really, really helpful. At the same time, the apps I was working on, the products I was working on, everything I built was touching 10, 20, 50 million users a day.

Himanshu: The scale here is different and the kind of clients we're dealing with is different. It's not the average retail client for the most part. It's typically high net worth individuals and above. For those clients. You really have to make things very, very simple and explained and you have to really give them all the terms and everything front and center.

Himanshu: You can't hide things behind terms and services and hide things that are going to be discovered at some point in the future and they'll just be like, okay, it's whatever. You really have to be very clear about what you're offering them and what they're getting into. Financial services is very different from consumer tech. On the social side, which I was working on in the past, you don't get to make a single mistake when you're dealing with people's money. Like there's no 95%, 98% accuracy or uptime.

Himanshu: It has to be 100%. So that's a very different paradigm and we have to be very, very mindful of client assets.

Alex: Excellent. Thank you very much for sharing everything you know about lending. I really enjoyed the conversation.

Himanshu: Alex, thank you for having me and hope you have a great rest of your day. Hope people learn something from this.

Alex: Yeah, yeah. Thanks again. And for the listeners, don't forget to subscribe to the channel, hit the like button on YouTube and leave your feedback at the podcast platform you're listening this to and see you in the next episode. Bye bye.

Himanshu: Thanks.