Navigating crypto markets requires a comprehensive understanding of risks and returns, some specific to crypto, some universal to all assets. In this post, we provide more information about how we generate returns and how we manage our risks in all market conditions.

How we generate returns

In a nutshell, we deliver superior risk-adjusted returns by building a diversified portfolio of primarily short-term, secured/overcollateralized loans, largely within, but not limited to, the crypto industry. We believe that the crypto economy is an extension of the traditional economy, and should not exist in a vacuum.

We generate returns in two main ways, neither of which depend on cryptocurrency prices.

  1. Extending Credit - We lend assets to a panel of credit-committee approved, fully vetted counterparties and charge interest that we then share with you. Those counterparties may require working capital in crypto or in fiat, and can be found in both crypto and traditional industries. All loans are currently over-collateralized.

  2. Providing Liquidity - We enable people to trade in cryptocurrencies through our platform. In doing so, we act as a marketplace, charging a spread on trades and hedging net market exposures. To be clear, we are not taking any directional positions. We are not exposed to either the upward or downward price movements of those assets.

How we approach risk

Stablehouse faces many of the same risks associated with a traditional financial institution. We are built by experienced market practitioners from both traditional finance and crypto, who have been through many market cycles and have an unwavering focus on risk.

Some of the headline risks we face and how we mitigate them are detailed below:

Market Risk (Trading Risk)

This refers to losses experienced due to price changes in the financial markets. In the crypto markets, this may be compounded by the liberal use of leverage.

Stablehouse does not engage in any directional trading, leveraged or otherwise. We are net neutral to market movements.

Concentration Risk

This refers to the loss in value of an investment or to a financial institution when exposures move together in an unfavorable direction.

While we cannot fully eliminate systemic risks such as this, we are market neutral and do not undertake any form of directional bets. In addition, we diversify our lending exposures by continuously working to grow the number of counterparties, diversified across both industries and physical geographies.

Credit & Counterparty Risk

A significant concern, especially relevant in light of recent market events, is that counterparties might not be able to fulfill their obligations. In the case of lenders like Stablehouse, this relates to the risk that borrowers would not repay their loans.

The opaque nature of many lending agreements in crypto is also of systemic concern. At Stablehouse, all our counterparties are rigorously pre-approved using a credit-scoring model developed from the CAMELs rating system. This is the same system used by institutions such as the Federal Deposit Insurance Corporation (FDIC).

This risk-based model determines how much exposure we take. All our loans are currently over-collateralized, and we accept only highly liquid collateral.

Additionally, our regulator reviews all our policies on credit and our counterparty risk assessments.

Liquidity Risk (including Asset/Liability Risk)

This refers to the inability to meet liabilities as they fall due. It could include instances where an entity has assets that are not easily converted to cash nor readily fungible.

Liquidity issues are a major concern in the current market crisis. Some market participants had ample illiquid assets in crypto, but faced mounting short-term liabilities such as withdrawals denominated in cash. This subsequently led to insolvency as these institutions were unable to meet their immediate obligations.

The crypto industry is especially susceptible to asset/liability mismatches as debts are often denominated in liquid assets like cash, while assets on balance sheets are often held in more illiquid cryptocurrencies. Duration mismatches may also occur when assets have been lent out for a period of time to obtain yield, at the same time that the debt comes due. This creates an asset/liability gap that adds layers of risk and complexity to investments.

Our asset-liability management is tailored such that funds are accessible at all times with minimal duration mismatching. This means our investments have the same daily liquidity as your deposits, because a majority of our portfolio is allocated to overnight lending that is repayable on demand. Positions that have longer terms will be staggered based on our liquidity position.

Our Markets and Investments team is responsible for ensuring we have ample liquidity through the rigorous risk management of all our exposures. The team is comprised of seasoned and accomplished executives who have worked in some of the world’s leading financial institutions. To ensure that we are always well-capitalized, regular stress tests will be conducted. These tests will contain a set of extreme market scenarios, including stressed conditions and prolonged market downturns.

Regulatory Risk

This refers to the risk that changes in the law will adversely affect a company. In crypto, this is particularly relevant as the industry is relatively new and the rules are constantly evolving. The current market volatility has highlighted the need for safeguards, similar to those that govern traditional finance, in order to protect both investors and companies.

We view regulation as necessary for the protection of our customers.

Well conceived legislation generates consistent guidelines and sets the bar for risk management practices. We chose Bermuda as our regulatory partner based upon their advanced regulatory framework regarding digital assets, where the Digital Assets Business Act (DABA) is the statutory basis.

To provide the highest levels of investor protection, we require a regulatory framework that regulates all our offerings. This distinction matters: unlike in many other jurisdictions, the Bermuda Monetary Authority has oversight and supervision on every product we bring to market.

The transparency you need

We hope you now have a better understanding of our investment and risk management principles and how we work to protect your crypto assets at all times.

We are building a future where crypto IS everyday finance. This means offering you the transparency you need when choosing Stablehouse as your trusted financial partner.