Nexo: A Risk Analysis And A Customer's Review
- Nexo's Concept: Hodlers of crypto assets can continue holding their crypto and take a loan with their crypto as collateral, thus enjoying further price appreciation.
- Nexo's differentiation factor is their own Nexo Token, which creates a real utility to buy and hold it.
- There are various risks related to crypto-credit-lines as we've seen in March 2020.
A few months back, a friend of mine told me about Nexo (NEXO-USD), and I became very curious. Receiving 6-12% interest, depending on what kind of currency you're storing within Nexo, sounds really good. There are similar offerings on the market like BlockFi. What's the big difference?
Nexo has its own token. It's an important differentiation factor towards other credit-lending services. Nexo very cleverly creates a utility for its Token on its platform to create value for the customer.
First, let's dive deeper into what Nexo is. If you already know what Nexo's products and services are, feel free to jump to the section "The Big Deal - The Nexo Token."
Around 60% of Bitcoin (BTC-USD) wallets are long-time hodlers that keep their coins for 1+ years. Another 25% hodl their bitcoins anywhere between one and 12 months. Nexo and BlockFi target these groups and offer them a way to use their asset without forgoing the price appreciation.
Bitcoin and other crypto hodlers, miners, hedge funds, crypto companies, and cryptocurrency exchanges are just part of the customer segment that Nexo is targeting. Another are the owners of Tokenized Assets who need liquidity and can provide their asset as collateral with Nexo.
This whole concept is not new. Pawnshops have been offering this kind of service for years. The difference is that Nexo's assets as collateral are much more liquid and prone to price fluctuations.
Nexo's product line
Savings Account with Interest
The main incentive to keep your crypto-holdings with Nexo is to enjoy the appreciation of your crypto-assets and receive interest on your holdings anywhere between 6-12%.
By having crypto in the account as collateral, they offer loans up to 50% of the user's assets' current market value (Loan-to-Value - LTV of 50%.) They manage default risk with smart contracts. If the market price of the holding decreases, Nexo's Oracle will inform the user of the changing LTV ratio within his/her account.
An important keyword to know now is hypothecation. Hypothecation means that the asset owner can keep his or her asset (in our case, the crypto). Still, if the terms of the smart-contract are not met, Nexo can liquefy part or all of the assets on behalf of the user, sell them to the market to cover the loan's value and interest to be paid. Nexo's oracle will do margin-calls as appropriate to keep the LTV below the 83.3% threshold at all times if the user doesn't intervene to keep the LTV higher through other means.
So the risk of default is inherently on the user's side, not on Nexo's. There are other risks related to the assets' liquefication and the sale of the assets to the market that we will discuss later.
Institutional Lending Desk
Hedge funds and other institutions can borrow digital assets like Bitcoin for their arbitrage activities. The offerings and contractual obligations of these offerings are not discussed transparently by Nexo. It's fair to assume that large institutions have to back-up their digital borrowings with more than double or even triple the borrowed value in fiat currencies.
The institutional services are a highly lucrative segment that Nexo focuses on.
Joining the exchange game with other major players like Binance or Poloniex, Nexo created its own exchange. Nexo enables its customers to swap seamlessly between 75+ crypto and fiat currencies.
The Big Deal - The Nexo Token
The big difference between the other established crypto-credit-line companies like BlockFi or Compound is the NEXO token. This is a brilliant piece of financial engineering, which we will now look at in detail.
At the core of value are supply and demand. In the past, the utility of Bitcoin and other crypto-currencies was not clear. Bitcoin became a store of value; thus, its price is now roughly $50k per coin.
Nexo's Oracle is at the core of this supply and demand scheme. It creates a real utility within its ecosystem with the NEXO token through its Loyalty Program.
Offering loans with varying interest rates depending on how much NEXO the user stores within his/her account. Moving from 11.9% APR to 5.9% APR is a powerful incentive for the user to buy Nexo on the Nexo platform.
As a side note, 30 days is the minimum time-duration that the user will be charged as interest even if the user paid back the loan within a shorter period of time. For example, the user pays back the loan after 20 days but will be charged the additional interest for the remaining 10 days from the 30-day period.
It's important to emphasize that the Nexo tokens paid as interest to the user will be within the Nexo ecosystem. Nexo's Oracle will buy Nexo from the market and store it on the user's Nexo account.
I call Nexo's oracle the Price-Appreciation-and-Safety-System. Not only did Nexo create an incentive to hold Nexo Tokens to reduce the APR rates, but they also increase the interest rate on savings if the user chooses to get paid out in Nexo instead of the currency that the user stored.
Let's say the user deposits 1000 XRP (XRP-USD) to his/her account and decides to receive the interest payments in Nexo instead of XRP to enjoy the extra 2% interest. Nexo clearly states that the interest is initially received in XRP, which will then be converted to USD and then converted to NEXO tokens on the market.
This is very important because Nexo's Oracle will then repurchase the NEXO token from the market, which reduces the circulating supply, creates its own demand, and appreciates the token's value.
That's why I said that the "Nexo Oracle" is a brilliant piece of financial engineering. Nexo creates its own demand by offering its customer utility within its ecosystem and incentivizing the use of Nexo.
Now, we have to talk about Nexo's Buyback Program. Nexo states that they will buy NEXO tokens worth $12 million in 2021 to maintain liquidity and price stability within the market. It's not clear where the buyback funds will come from or if part of the buyback comes from the Price-Appreciation-and-Safety-System discussed above. We know that Nexo buys its own tokens from the market for the interest payments in Nexo, but we aren't sure if this also accounts for the buyback program.
When considering leaving your crypto in Nexo, there are multiple risks you should be aware of.
1. Risk of default - inherently on the user's side
2. Currency Risk
3. Special Nexo Situation: Interest Rate Risk - which leads to higher default risk
4. If scale large enough, a large decrease in crypto could tickle an avalanche effect in the smart contracts and depress market prices even further.
Nexo is not FDIC insured. An FDIC insured bank covers the depositor's assets in case the bank defaults.
Nexo is not a classical bank, and default risk is not the same as with banks. When a bank lends money to an individual, there is no guarantee that the individual can pay back the principal. Normally, in this case, the bank seizes the person's collateral (house, car, etc.) to cover the principal. If, like in 2007/2008, many people default simultaneously, the bank could default. The FDIC insurance would cover the assets or at least part of it of the depositors.
Nexo is not a bank (yet? see the AMA from Feb. 26 where Antoni Trenchev teases the possibility of such a license in 2021, at least for Europe.) Nexo doesn't lend to people without covering the loan with the collateral (LTV 50%). And since the collateral is much more liquid than the collateral in the banking sector (2007/2008 real estate), Nexo can quickly liquefy the assets and cover the loan.
And most importantly, Nexo has shown that the system works! Nexo will liquefy the assets to cover the loans, no matter what. The following is a letter from the Nexo help center after the crash in February/March 2020, where a customer complained over the liquidation of his/her assets due to the crash and missing notification from Nexo at the time.
The Currency and interest rate risk
A problem that is not as present in the classical banking sector is currency risk. Nexo takes currency as collateral and pays the loan in another currency. So due to the highly liquid property of the assets, we can create multiple scenarios.
Because the user wants to keep the original currency, they'll buy only enough Nexo to move to the highest bracket. To calculate which bracket a user will move to, we use the following calculation.
Percentage Nexo of total Assets = Nexo / (Nexo + Other Asset)
In the diagram, I explain how a small percentage of Nexo and a sudden price fluctuation can influence the user's loyalty bracket.
Worst Case Scenario - The Avalanche Effect - Applies to all Crypto-Credit-Line Platforms
If crypto prices decrease rapidly, Nexo's oracle will be triggered by the LTV-ratios within the smart-contracts and sell the assets at any price to cover the loans. This will inherently depress market prices even further, and the larger the institutions like Nexo, BlockFi, or Compound become, the stronger this avalanche could look like.
This would trickle an effect similar to the financial crisis in 2007/2008, just in crypto.
The whole idea of Bitcoin to me was and still is that I have the power to keep my digital asset in self-custody. So I keep a major part of my holdings in cold-storage. But it's very neat to receive some interest on my crypto with the help of platforms like Nexo and BlockFi. That's why I allocated part of my holdings in crypto, gold, and fiat on these platforms to enjoy the price appreciation and interest.
Nexo built a platform that endorses the value of its own token. They create a utility for their customers and incentivize buying NEXO tokens and earning their interest in NEXO. I will keep a very close eye on the platform and possible regulations. A viable and in my opinion, risk is that different governments could impose regulations on Nexo's system and reduce the utility of its token.
This article was written by
Analyst’s Disclosure: I am/we are long BIT-USD, NEXO-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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