An unbalanced sheet—Explainer on the asset-liability mismatch in crypto lending firms
In recent months, several crypto lending firms such as Celsius and Vauld have frozen deposits in the wake of plummeting values of cryptocurrencies. Experts, however, have flagged concerns over the business model of yield-generating crypto firms as reports of asset-liability mismatches have come to the fore.
Crypto lending platforms allow customers to buy, lend or borrow and trade crypto assets or tokens. On the face of it, the business seems like the traditional banking business, with customers opening accounts, and the platform offering collateral-backed loans.
While an asset-liability mismatch is not a new phenomenon in the crypto sector, a look at the balance sheets of firms like Celsius offers insights into the reason crypto lending firms are particularly susceptible to an unbalanced balance sheet.
What does an asset-liability mismatch tell us about the business?
When a businessman buys/produces goods or services, he finances the cost by either taking a loan or infusing the business with his own money/equity, which are treated as liabilities. When the business earns a profit, it is held as cash in the assets column and an equal amount is transferred to the equity column. Therefore, in principle, the assets side of the balance sheet should be equal to the other side comprising liabilities and equity.
Even though the equation holds in theory, past instances of asset-liability mismatches have been seen in cases such as in the collapse of Punjab and Maharashtra Co-operative (PMC) Bank. For banks such as PMC, deposits by consumers are held as liabilities while the loans given out form a part of the company’s assets. It was later discovered that the bank had advanced money through fictitious accounts, creating a situation of a
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