Rehypothecation in crypto lending: Is it a risk?

Rehypothecation is a financial practice where lenders reuse the collateral borrowers provide, often to increase liquidity or generate additional yield. In traditional finance, banks have long engaged in rehypothecation under stringent regulations, leveraging depositor funds to facilitate lending while maintaining consumer protections. However, in crypto, where oversight is still developing, the practice is met with skepticism.

Why do some platforms rehypothecate collateral?

Many lending platforms opt to rehypothecate assets for several reasons:

• Maximizing liquidity: By using borrower collateral, lenders can generate additional returns.
• Lowering interest rates: Some lenders pass the yield they earn back to borrowers, reducing loan costs.
• Following traditional finance models: Banks have practiced rehypothecation for decades, but with government-backed protections.

While these benefits can enhance lending efficiency, the lack of robust consumer safeguards in crypto raises concerns.

The risk: crypto’s regulatory gap

Unlike banks, which have FDIC insurance, capital reserve requirements, and strict oversight, crypto platforms largely operate without these protections. Failures of rehypothecating lenders like Celsius and BlockFi underscore the risks—when liquidity dried up, users lost access to their assets.

Is rehypothecation inherently bad?

Not necessarily. With the right protections in place, rehypothecation could become a non-issue for borrowers. Traditional finance has shown that rehypothecation, when properly regulated, can contribute to a healthy financial ecosystem. The key is ensuring that consumers are protected through transparency, proper risk management, and capital reserves.

Why now may not be the right time for rehypothecating lenders

Given the volatility of the crypto market and the ongoing regulatory uncertainty, many investors currently prefer lenders that do not rehypothecate their collateral. Secure custody of assets remains a top priority. As the industry evolves, however, the focus will shift from whether a lender rehypothecates to whether they provide transparency, asset security, and strong protections against major market fluctuations.

Milo’s approach: security first

To date, Milo has never had a margin call, a testament to the company’s risk management and customer-focused approach. As the industry progresses, rehypothecation may become a less critical factor in choosing a lender. Instead, investors will prioritize lenders that provide clarity on how their assets are managed and safeguarded, ensuring peace of mind in all market conditions.

The future of rehypothecation in crypto lending

Rehypothecation itself isn’t the problem—it’s how and under what conditions it’s done that matters. As regulations and risk management frameworks improve, rehypothecation could become a standard, well-understood practice in crypto finance, much like it is in traditional banking. Until then, transparency and asset security will remain the top concerns for borrowers and investors alike.

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.