Original Title: The Boom and Bust of $7 Billion in Crypto Assets Lending | Interview with Yang Zhou, Founder of PayPal Finance (Part 1) | Bill It Up Memo
Original Author: Bill Qian
Source:
Reprint: Daisy, Mars Finance
Bill: Hello everyone, welcome to Bill It Up. This week's guest is Flex Yang Zhou. His vision is to make finance a service accessible to everyone globally. He has successfully founded cash loan company Standard Financial Inclusion, the Web3 lending giant Beibaofinance from the previous cycle, and now the stablecoin company Stables Labs. Yang Zhou, hello, welcome to our show!
Yang Zhou: Thank you Bill, thank you for the invitation.
Bill: We've actually known each other for a long time. I remember the first time we met, I was still at JD, and you were working at PayPal. During the last cycle, PayPal was at the 1.0 stage and was actually very successful. Can you tell us about the highlights of PayPal at its peak?
Yang Zhou: The peak of PayPal was in March and April 2021. That was right at the peak of the last bull market for Bitcoin, and Coinbase's listing pushed the overall market sentiment to a climax. Bitcoin once surged to around $64,000 in April, and the Funding Fee and the popularity of arbitrage trading also reached their highs. During that period, the total assets under management at PayPal, including lending, were approximately $7 billion.
Bill: 7 billion dollars, which is larger than today's Pantera's AUM.
Yang Zhou: Yes. In fact, the scale of centralized lending institutions has always surpassed that of decentralized ones. For example, at that time, excluding Tether, which has data transparency issues, the largest publicly disclosed one was Genesis, which had a scale of about 13.8 billion dollars, far exceeding the scale of current DeFi lending protocols like Aave. The core reason lies in the different customer groups served by centralized institutions. In Asia, we primarily serve large miners. When Bitcoin rose from over 3,000 dollars to over 60,000 dollars, we noticed that the assets of miners increased 23 times. As a result, some miners who initially had a scale of only 100 million or so quickly grew to four to five billion dollars appeared, and this group was quite representative in Asia at that time. For the United States, I believe the main driving reason behind Genesis's significant growth was the arbitrage trading from GBTC at that time. From 2018 to early 2021, GBTC was generally at a premium, so there was a very strong driver pushing many people to borrow BTC from Genesis to subscribe to GBTC, followed by a 6-month lock-up period, and then simultaneously selling BTC in the spot market.
Bill: You just mentioned the 6-month lock-up period and arbitrage of GBTC, which was a relatively large lending scenario for Genesis at that time.
Yang Zhou: Yes, the main driver.
Additionally, because Genesis needs the supply of BTC, as it has a large amount of deposits in USD from clients, it lends the USD to us Asian institutions, and then the Asian institutions supply BTC to it, forming a very large closed loop where both sides get what they need. As the price of Bitcoin rises rapidly, the scale continues to grow.
Bill: So at that time, it was equivalent to you and Genesis, representing the East and the West, doing a Swipe, and everyone satisfied their own needs.
Yang Zhou: That's right. The core driver at that time was: Asians needed US dollars, and Genesis happened to have a supply of US dollars; Genesis's clients needed BTC, and we had a supply of BTC, so it came together quickly, leading to rapid scaling. However, this growth was more driven by the industry's Beta, with the core being the increase in Bitcoin's price itself, rather than natural growth. Because the new supply of Bitcoin is limited, once the price rises significantly, the scale of the entire lending market will also be amplified.
Bill: Understood. Based on this, I understand that PayPal later also engaged in a lot of proprietary trading, which was actually the starting point for the risks that appeared later, right? Can you share a bit about this?
Yang Zhou: Yes, the entire development of PayPal has roughly gone through three stages.
The first stage is the purest lending business: miners pledge BTC, and then PayPal lends stablecoins to them. This stage is relatively pure. However, after November 2020, as the market rapidly rose, customers put forward new demands—they didn't just want to borrow money and leave; they hoped for BTC or ETH-based wealth management products. The problem is that relying solely on lending is difficult to meet such demands. For example, the annualized borrowing rate for BTC might only be a few thousandths, and the borrowing rate for ETH is roughly equal to its staking yield, about 3%-4%. This has limited appeal for customers. So at that time, we thought of using options to solve the yield problem, to establish some positions for customers, and to create structures for selling calls or selling puts, thereby generating BTC or ETH-based returns. In other words, at that time, PayPal actually bundled asset management and proprietary trading together with lending. Of course, it was also constrained by the market situation at that time. The entire market was actually under a non-regulatory state, so lending companies did not have the awareness to say “I need to strictly separate lending, trading, and proprietary trading”; everyone was just doing everything together.
Bill: But the thing about “mixing”, I understand that Wall Street is actually also “mixing” now. I understand what you might be trying to express is that during the process of “mixing”, there may have also been a relaxation in risk management, right?
Yang Zhou: Yes, but the “mix” in Wall Street actually follows a cyclical pattern. At first, everything is purely mixed together, and when risks arise, regulatory bodies force them to separate. After a while, when capital efficiency is found to be low, financial institutions lobby with regulators, gradually loosening restrictions and merging again. Then risks arise again, and they are separated… This cycle repeats.
The cycles of traditional financial institutions tend to be longer than those of blockchain or Crypto Assets. So you will see that in the history of modern traditional finance over the past 100 years, there have been about seven or eight of these risk events. In contrast, the cycles of Crypto Assets are much shorter: possibly once every four years, or even every three or two years, which could be about 1/4 of the cycle of traditional finance. Traditional finance takes 100 years, while we complete it in 20 years with Crypto Assets.
So at that time, the situation of “merging” was very common. This was also true for Genesis and Three Arrows. However, after the risk events of the previous cycle, everyone gradually began to “split” again. It is also a cyclical process.
Bill: What type of position risk caused PayPal to eventually start experiencing liquidations?
Yang Zhou: In fact, we cannot look at it purely from PayPal's perspective. If we want to trace the entire process back to its roots, the starting point of all risks in 2022 actually comes from the high fee rates at the beginning of 2021.
Bill: Sorry, which high fee are you referring to?
Yang Zhou: This refers to the Funding Fee arbitrage in the Crypto Assets market, where the “risk-free arbitrage” yield in the Crypto Assets industry was around 40%-50% annualized at that time. At the end of 2020, the supply of USDT was about 20 billion USD, and by April-May 2021, it had increased to over 60 billion, rapidly adding twice the amount of funds to the market for arbitrage trading. And this money wasn't short-term; those acting as intermediaries in this trading, whether fund managers, intermediaries, or brokers, promised clients a product cycle of one to two years. After another boosting in July-August 2021, this money became even more committed to staying, so when the market turned bearish in the fourth quarter of 2021, this money did not exit immediately.
At that time, the Federal Reserve's monetary policy began to truly enter a tightening cycle, and then things became quite interesting. The money couldn't flow out because they didn't want to off Ramp. I promised others a two-year management period, so I had to collect the management fees. But where did this money go during this period? They started looking for new outlets, one of the main destinations being Terra's Anchor protocol (UST/Luna). At that time, Terra's scale was rapidly growing, and we also noticed that Luna's market value actually started to grow rapidly in the fourth quarter of 2021. Originally, the Terra/Luna mechanism could be maintained when the scale was small, but as more and more funds came in, you would find that too many risks had already accumulated.
When some institutions noticed this risk, it was already around February-March 2022. At that time, Terra was still boldly announcing its large-scale purchase of Bitcoin, briefly pushing a wave of “small spring” that led everyone to have some expectations for the market. However, the flaws of Terra/Luna were ultimately discovered by some institutions, which began to launch attacks. The result is well known: in May 2022, Terra collapsed in just three days, UST evaporated 20 billion USD, and Luna was also obliterated, causing a total of 40-50 billion USD of M0, or base money supply, to disappear from the entire Crypto Assets industry. Considering that the currency multiplier in the crypto industry at that time was about 30 times, it was equivalent to the entire market value being wiped out by 600 billion USD. At this time, the one stepping up to “take the fall” was Alameda of FTX. It is a market maker that is used to not hedging and makes money through long-term pump-and-dump strategies. But this time it faced a direct zeroing out, taking on the liquidity fleeing from Terra across the entire market, becoming the largest buyer.
Bill: So the buyer takes over and goes to zero, it was the biggest loss bearer at that time.
Yang Zhou: Yes, Alameda may have lost 10-20 billion USD at that time. However, because it is a centralized institution, there are ways to “cover up” the losses, so it was not immediately exposed. However, the shock from Terra's collapse quickly transmitted to a series of centralized lending institutions such as 3AC, PayPal, and BlockFi.
Bill: How should we understand this conduction?
Yang Zhou: Because there are not many centralized institutions in the industry that can provide lending outlets. Those who dare to borrow money at high interest rates of 7%-8% mostly have their funds linked to Terra, which directly or indirectly flows into the Anchor protocol.
Bill: So your debtor actually went to Terra for wealth management?
Yang Zhou: Yes, both direct and indirect connections will be established. The result is that after the collapse of Terra, almost all centralized lending institutions faced huge risks at the same time.
Bill: Wait a moment, so in the last bull market, your debtors were no longer miners who borrowed money to produce again, but many people borrowed money from you and eventually went directly or indirectly to invest in Luna?
Yang Zhou: Yes. In fact, miners began to gradually deleverage after December 2020. When BTC rose from 20,000, 30,000, to 40,000, they were continuously deleveraging.
Bill: Miners are actually more risk-aware.
Yang Zhou: Yes, miners have a strong risk awareness and have experienced too many cycles. Including this cycle, we say that Bitcoin has been unable to break through 100,000, and one interesting reason is that miners have been selling coins at 100,000. Many miners I know have their deleverage point at 100,000, and as soon as it hits 100,000, they start selling. Therefore, the last cycle was stuck at 40,000, which is actually quite similar to this cycle being stuck at 100,000.
So in the last cycle, the demand from miners has decreased, and the main demand for lending comes from arbitrage and speculation, such as doing Funding Rate arbitrage. More than half of the lending portfolio on PayPal has flowed into this kind of “margin trading.” Clients borrow money from us at a fixed interest rate, and then they use trading methods to seek higher returns to cover this portion of interest. Therefore, it can be said that the lending exposure has shifted from the actual production demand of miners to arbitrage and speculation demand, which is also a process of gradually accumulating risk.
