Why services like BlockFi may be toxic to the LTC community

I believe that services like BlockFi, that allow people to deposit LTC and earn a yield on that LTC (currently 6.5%), may turn out to be toxic to the LTC community.

I think this due to how the activities of these services may promote negative affects on sentiment and exchange rates, and due to how such activities may lead to community members eventually losing their deposited LTC too.

For example, BlockFi makes money by earning a return on the deposited LTC that it can lend out. That is, they loan out the deposited LTC to borrowers and they keep the spread between what they can lend it for and what they pay to depositors. Normally, borrowers return the borrowed LTC when they no longer need it.

The people borrowing LTC are doing a number of things with it.

Some activities, like market making, are more benign relative to others.

However, some activities revolving around pairs trading and arbitrage are potentially much more negative and dangerous to the invested LTC community.

First, borrowers may be shorting LTC and longing BTC in a simple pairs trade. This directly pressures LTC/BTC, and, as a result other LTC pairs.

Worse, another thing that borrowers may have done is to go another dangerous step further than the pairs trade. That is, they may have borrowed LTC, traded it for BTC, then deposited the BTC into the GBTC trust for 6-month restricted GBTC shares. This was a popular arbitrage trade for a while. They planned on capturing the GBTC premium over BTC spot. That was a large premium for a long time and was more than enough to cover the interest expenses of borrowing LTC. The thinking was that BTC locked in the GBTC trust would have a delta very near 1 to spot BTC and thus they would be hedged, and not net short BTC (especially in a BTC bull market). GBTC is essentially a derivative of BTC, and in this context delta measures the change in value of GBTC relative to the change in value of the underlying BTC. But, that arb trade has gone sour. The delta turned out to be less than 1 (not a great hedge – i.e.- partial short exposure to BTC). GBTC has been trading at a consistent discount to NAV (usually in the 0 to -20% range) for a little over a month now. People in this trade may have steep losses already and are still net short BTC – and they lose more money when the GBTC discount to NAV widens. When these people lose money, it becomes less likely that they will be able to deliver the LTC collateral that they originally borrowed from BlockFi to start this whole trade/mess. When you see BTC/USD go up quickly and GBTC stay flat, or go down, the people in this trade lose even more. Times like those are very risky for BlockFi depositors as the probability of default by the borrowers increases (if they lose enough, they go out of business, don’t return the borrowed coins, and BlockFi depositors incur a loss). When you see LTC/BTC stay flat, BTC/USD go up, and GBTC stay flat, or go down, there is a very real possibility that you are seeing evidence of people being stuck in this trade, who are waiting to unwind at less of a loss (while it moves against them). It is interesting to see that demand to borrow LTC from BlockFi has not gone down even though the demand for BTC has (as evidenced by recent interest rate reductions). Perhaps this is another sign that people are trapped in this trade and hoping to wait it out.

If you keep LTC in lending platforms, like BlockFi, then you might want to pay attention to how their activities could be toxic to your portfolio. You may want to consider withdrawing some of your value from these platforms while you can.

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Interesting theory, I think it could be developed a bit further to see how this would play out at a bigger scale. People won’t stop collecting 6.5% on the short term only to hope for a better long term return , unfortunately