The Upcoming Credit Crunch and Bitcoin’s Contribution

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Economists warn of a banking crisis as a result of the corona recession. If there is no economic miracle, it is almost inevitable that loans will run out or banks will even go bankrupt. Why is the banking crisis looming – and what can cryptocurrencies and blockchains do to defuse them?<

The Institute for Economic Research Halle (IWH) published a paper on July 6, warning that the Corna crisis will trigger a crisis in German banking. Even in an optimistic scenario, it is inevitable that 6 percent of the banks will experience problems. Savings banks and cooperatives are under threat as they provide small and medium-sized enterprises with capital.

The mechanism is actually simple: a bank lends money to a company and receives interest in return. It deserves to share the entrepreneur’s risk. When a crisis hits, many companies lose revenue, making them unable to repay the loans. Ultimately, this leads to bankruptcy and credit default. This reduces the banks’ equity ratio. You can lend less and in the worst case go broke.

As a result of the corona pandemic, numerous companies suffered severe sales losses for a few months. Many businesses – for example in catering, tourism or events – continue to suffer significantly from the changed conditions during a pandemic. That makes credit default likely.

Of course, economists admit that any forecast is uncertain. You poke in the fog. Nobody knows what will happen with the pandemic and the economic crisis it triggered. The economists from Halle therefore make do with three possible scenarios: The V-cycle anticipates a boom in the second half of the year, which will quickly make up for the slump. The U-cycle assumes that the economy will slowly grow again after it has bottomed out. Finally, the L cycle assumes that the economy will remain in the valley for some time into which it fell. V is the optimistic outlook, L is the pessimistic one, and U is in between.

It is a little clearer what consequences a recession will have on loans. So far, increased amounts of bankruptcies have been reported, but the increase is still manageable. However, observations from previous crises show that loan defaults follow the slump in the real economy and gross domestic product much later. As the southern European economies showed after the 2008/09 crisis, they only peak four years later.

Even in the optimistic V-case, the IWH predicts, there will be loan losses of over € 127 billion. This will depress the equity ratio of six percent of banks below six percent, which will trigger an “acute disruption to the banking industry”. Even if things go well, there is a risk of a credit crunch. On the other hand, if things go really badly, as in the L cycle, economists expect loan defaults of over € 626 billion. As a result, five percent of the banks would even use up all of their equity and would probably go bankrupt. Since smaller banks in particular are affected, the study concludes with the warning that this time it cannot be called “Too Big Too Fail”, too big to be allowed to fail – but “Too Many Too Fail”: too many to be allowed to fail .

So it seems almost certain that in the next few years a credit crunch will hit us in the best case and a wave of bank failures in the worst case. Can cryptocurrencies help to avert or mitigate such a crisis?

As a Bitcoin blog, we naturally have a few ideas about this.

Lifeboats, lenders and tokens

First, cryptocurrencies separate the safekeeping of digital assets from banks. Anyone who wants to receive, save and send digital money no longer needs a bank. Crypto users withdraw their money from the credit system: they do not bear the risk that banks take on lending, and their money does not risk being wasted if the bank goes bankrupt due to loan defaults. Cryptocurrencies are the lifeboat that you better have on board when the hurricane winds up.

The money in a wallet is withdrawn from the credit system. If more and more people use cryptocurrencies, this should exacerbate the credit crunch rather than alleviate it. The banking system will be less able to support stumbling businesses, and banks that have to write off too many loans may go bankrupt themselves. In the tradition of liberal economies, that’s not bad in itself. The market should decide how resources are distributed. Unnecessary business models may die out and ailing companies go bankrupt. Instead of pumping consumption for endless growth, the economy can shrink healthily. That would be painful in the short term, but probably sustainable in the long term.

On the other hand, cryptocurrencies can also make a contribution to lending. Exchanges or wallets, but also DeFi websites or lightning hubs could position themselves as lenders to serve areas in which the banking system fails. Such platforms are far more international and transparent than traditional banks or online platforms for crowd lending. This could make lending fairer and reduce the toll on the middleman, so borrowers pay less interest while the actual lenders get more.

The tokenization of all values ​​could play a key role in bridging credit crunch. If you depict everything of value with a token on a blockchain – from the iPhone to the washing machine to life insurance and condominium – you can raise a hidden reserve of collateral for loans. At the same time, tokens on a blockchain make the mobilization of collateral in the course of lending so effective that friction almost completely disappears. Loans will flow more quickly and will be issued automatically. If they burst, secondary markets effectively use the tokenized collateral instead of being disposed of.

The scenarios could look something like this, with cryptocurrencies and blockchains helping to bridge a credit crunch.

A (too) long way

But there is still a long way to go. So far, crypto companies have been extremely rare as lenders; the big wallets and exchanges are probably not allowed to do this under regulatory law. DeFi and other service providers that lend cryptocurrencies usually require the deposit of other tokens as security, and in a value that exceeds the borrowed amount. This only makes such types of loans interesting for some niches, such as money markets, where traders borrow liquidity in the short term without breaking an existing position.

Tokenization is still in its infancy. It is still far from asserting itself in the stock market, and for most types of values ​​there is neither the technical infrastructure nor the legal environment to make tokenization legal. For example, a manufacturer would have to tokenize a refrigerator in a notarized manner during production, whereupon the token ends up in the supply chain at the consumer, who could then deposit it as security on a credit market. We are still far from that.

Such scenarios are therefore irrelevant to the banking crisis, which could peak in the next four years. It may be that some DeFis help with lending in niche areas, and it may happen that crypto companies increasingly grant loans and cryptocurrencies are deposited as security. But most often, cryptocurrencies will likely be used to keep the money safe from crunching banking. They are not the solution yet – but a lifeboat.

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