Tesseract in Kauppalehti 2/2021: Digital asset volatility does not affect investor yields

February 2021

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This article was originally posted in Kauppalehti.fi as well as Kauppalehti in print on 22.1.2021. Link to original post (in Finnish) can be found here.

The wildly speculative and volatile cryptocurrency space has given rise to a much stabler market in digital asset backed finance. Among the pioneers of this new industry is the Finnish start-up Tesseract.

This week, the total global market capitalization of all cryptocurrencies rose to 1,400 billion euros. Fast development in digital asset markets has given rise to a number of innovations; thanks to the proliferation of lending and borrowing within the industry, some of the most rapid development over the past two years have happened within digital asset backed finance.

This nascent credit market counts Tesseract among its participants. Tesseract’s business model consists of collecting investments in fiat currency from investors and then extending the capital as loans. In turn, these loans are collateralized in bitcoin or Ethereum. Tesseract was founded in 2017 and reached profitability in 2020.

“A boring business, like conventional retail banking”

Cryptocurrency markets are notorious for their high volatility and even the most popular asset, bitcoin, has yet to convince some financial analysts and the majority of financial regulators. In comparison to high risks associated with cryptocurrency trading, digital asset backed finance is a more stable instrument for investors looking for return on their capital – more mundane, if you will, in every positive way.

“We take pride in being as boring a crypto company as possible”, sums Niklas Lahti, Tesseract’s Chief Operative Officer.

To minimise the capital risk to its investors, loans extended by Tesseract are overcollateralized. “Our business is not, in any level, associated with price speculation in cryptocurrencies. It is much more akin to conventional retail banking”, Mr Lahti says. “Only the underlying asset, bitcoin, is a bit more exotic.”

“If a borrower needs an amount of capital in Euros, for example, he or she can borrow the funds in Euro and provide the collateral in bitcoin or ethereum. In practice, our main product innovation has been in facilitating this collateralization in cryptocurrencies.”

Tesseract is registered within and supervised by the Finnish Financial Supervisory Authority (FIN-FSA).

What effect will the high volatility of bitcoin have for the investments?

“The volatility has practically no impact on the investor’s interest income”, Mr Lahti confirms.

Bitcoin’s price changes – on balance – only affect the value of the collateral. If the price rises, for example, a borrower who has provided a collateral in bitcoin can demand back a part of it.

“The situation is comparable to having taken a mortgage on a property and afterwards the value of the property having doubled. In this case, the borrower is in a good negotiating position against the bank to re-write the conditions of his or her mortgage.”

The untapped potential of digital asset backed finance

The prime analyst of crypto lending markets, Credmark, calculated last summer that the global crypto credit market had grown to over 10 billion dollars (over 8 billion euros).

According to Mr Lahti, Tesseract has hundreds of millions of euros worth of assets under management at the moment. One of the company’s Finnish customers is Coinmotion with whom Tesseract has created a joint bitcoin interest account service.

Mr Lahti describes Tesseract’s borrower clientele as consisting mainly of institutional investors already working within the cryptocurrency industry. The borrowers come mainly from the United States and Asia and a few are based in Europe as well.

What level of interest income can investors expect?

“You can consider the interest levels provided by our investment products considerably higher than those of conventional, purely collateralized debt obligations”, Mr Lahti says. “It is almost impossible to achieve a higher return on investment on a fully collateralized loan.”

He goes on to state that current low interest level in general markets are only part of the reason to why demand in digital asset backed finance has emerged rapidly.

“The main reason is that cryptocurrency markets are already so substantial. In comparison, size of the fixed income market adjacent to them has been worth only a few dozen billions of dollars so far.”

Mr Lahti evaluates that this relative difference in size constitutes a true market opportunity which will likely be filled at some stage.

“Digital asset backed finance will evolve drastically when, for example, big financial institutions join the market. Tesseract’s company mission is to stay in the spearhead of the industry’s technological progress and to offer ever more innovative investment products in developing crypto credit markets.”

Will the market demand extend beyond companies within cryptocurrency sphere?

“In past few months, we have seen a number of previously uninterested big names in finance commit a portion of their portfolio to crypto markets and seek ways to make most of their investment”, Mr Lahti explains.

“Traditionally, there has been exactly two options for cryptocurrencies – buy or sell. We are offering a third one: to hold, while also accruing considerable interest income.”