QUESTION
I have been reading your articles about cryptocurrency and mortgage banking. Thank you for providing these articles. I have shared your website with many people, and I get the hard copy of your articles, which I use in our management meetings.
I am a member of senior management and on the Board. We are a large lender and servicer in the northeast, with offices in almost all states. Recently, our servicing CFO asked the Board to consider accepting stablecoins for mortgage payments. Our attorneys gave us a demonstration of the various legal complexities. But I want a high-level outline, such as only you can do!
You should know that most of the Board was not convinced that now is the time to adopt stablecoins (or any crypto) for mortgage payments. We have also been researching crypto-backed mortgages, which seems like a path some of us want to follow. I'm interested in your thoughts on allowing borrowers to make mortgage payments in stablecoin. Maybe, also, you could tell us what you think about crypto-backed mortgages.
Should lenders accept stablecoin for mortgage payments?
Are crypto-backed mortgages a better option?
COMPLIANCE SOLUTION
RESPONSE
The idea of lenders accepting stablecoin for mortgage payments is emerging. Still, it is not a widespread practice and carries significant risks that have prevented adoption by most traditional financial institutions. Some Fintech companies, however, are exploring crypto-backed mortgages, which typically use stablecoins as collateral rather than for monthly payments. For traditional lenders, the risks involved generally outweigh the benefits.
Please get in touch with me to discuss your plans. Legal risk is only one of several risk variables. We can help you develop rollout implementation strategies. The issues involved cover a wide range of variables, such as legal, regulatory, interest rate, liquidity, operational, market, compliance, reputational, strategic, and prepayment risks. Please view my response as a conversation starter.
Here are some recent articles I have published on cryptocurrency vis-à-vis mortgage banking.
· GENIUS Act: Mortgage Banking Ambush,
· Cryptocurrency: Risks to Mortgage Banking,
· Cryptocurrency Dilemma, and
Two
types of lenders
There are two types of lenders in crypto-related mortgage banking. These are:
Traditional Lenders: Traditional financial institutions are highly regulated and cautious with cryptocurrencies. They typically require that any crypto used for mortgage transactions—including stablecoins—be liquidated into U.S. dollars and held in a verifiable bank account for a period of 30 to 120 days.
Fintech Crypto Lenders: A niche market of Fintech firms that specialize in crypto-backed mortgages. These lenders offer loans secured by cryptocurrency collateral, often including major stablecoins. Borrowers pledge their crypto assets, and the lender issues the loan in fiat currency.
Whether a lender should accept stablecoin payments depends on their risk tolerance, regulatory environment, and technological capabilities.
· For traditional banks, the regulatory and operational hurdles are high, and the risks often outweigh the potential benefits. Federal mortgage regulations and investor demands for stable, traditional assets reinforce their current cautious approach.
· For a niche Fintech lender, the calculation is different. By specializing in crypto-backed loans, they build the necessary infrastructure and accept the higher risks for a target demographic.
For most borrowers, the most practical approach today is to convert stablecoins into cash well before applying for a mortgage through a traditional lender. As the regulatory landscape and market maturity evolve, perhaps the widespread acceptance of stablecoin mortgage payments may become more common.
Risks
Before I
discuss some benefits of stablecoin, let's take a look at some of the risks!
Operational Complexity and Cost Risk
Integrating stablecoin payments requires new technology, expertise in blockchain infrastructure, and robust cybersecurity measures, all of which are complex and expensive to implement. The 24/7 nature of crypto markets also puts a strain on operational capacity.
Accepting stablecoins requires managing new systems, digital wallets, and private keys, introducing new points of failure and cybersecurity threats.
Regulatory and Compliance Risk
The regulatory environment for cryptocurrency is still evolving. Lenders would need to develop extensive new procedures for Know-Your-Customer (KYC) and Anti-Money Laundering (AML) compliance, as stablecoins can be used outside traditional banking networks and are attractive for illicit financing.
Risk of Liquidity and Counterparty Risk
Although stablecoins are supposedly designed to be stable, they can temporarily lose their peg to the fiat currency they are supposed to mirror, as has happened during past market turmoil. In a "bank run" scenario, a stablecoin issuer might not be able to honor all redemption requests, exposing the lender to potential losses.
While stablecoins are supposed to maintain a 1-to-1 peg with a fiat currency like the U.S. dollar, major stablecoins have experienced temporary "de-pegging" events during market stress. A significant de-pegging could impact a lender’s asset values and expose them to risk.
The challenge widens when a lender faces risk from the stablecoin issuer, who must maintain adequate reserves and honor redemptions to back the stablecoin value.
In a market panic, a "run on the stablecoin" could occur, where a mass of investors attempts to redeem their holdings simultaneously, potentially causing a liquidity crisis that could spill over into the broader financial system.
Customer Protection Risks
Unlike deposits at federally insured banks, stablecoins lack FDIC insurance or other federal protections. This could create significant liability for lenders if customers lose funds due to an issuer's failure or a security breach.
Accounting and Reconciliation Risks
Reconciling digital asset transactions with traditional ledgers is complex, and the potential for technical bugs or human error creates operational risk.
Payment System Risks
Stablecoin-based payment systems introduce new issues, such as credit and settlement risks, particularly for decentralized arrangements that lack a single entity responsible for risk management.
Benefits of Stablecoin Payments
Improved Payment Speed and Cost
Stablecoin payments offer near-instant settlement at a lower cost than many legacy payment systems. This would be most advantageous for cross-border transactions. Transactions on a blockchain can settle in minutes, significantly faster than the days it can take for traditional payment methods like wire transfers.
Transparency and Automation
The use of blockchain technology offers end-to-end traceability and visibility of transactions. It also enables programmable payments through smart contracts, which can automate and streamline the process. Also, stablecoins often have much lower transaction fees compared to credit card processing fees, which can be a key driver for broader business adoption.
Increased Accessibility
Stablecoins could expand access to mortgage payments for the unbanked or underbanked, who might not have traditional bank accounts. It could also appeal to tech-savvy customers who prefer using digital currencies for transactions.
Crypto-backed Mortgages
Instead of using stablecoins for monthly payments, a more common and currently accepted practice is using stablecoins (or other cryptocurrencies) as collateral for a mortgage. This model shifts the transaction from a regular payment to a collateralized loan, which mitigates many of the risks for the lender.
Your Board may be more interested in the crypto-backed mortgage because it offers several features that are economically beneficial or disadvantageous. I will highlight three salient and substantive features.
Over-Collateralization
Lenders typically require the borrower to pledge crypto assets worth 150% or more of the loan amount. This provides a buffer against the crypto's price volatility.
Fiat-based loan
The actual mortgage is a standard loan disbursed in U.S. dollars. The stablecoin collateral is held in escrow, so monthly payments are made in fiat currency, and the lender avoids the operational and regulatory burdens of processing crypto payments.
Risk Mitigation
The crypto-backed mortgage allows the lender to operate within the established fiat financial system while still engaging with crypto-rich borrowers. But, if the crypto collateral's value drops too much, the borrower receives a "margin call" to post more collateral or face liquidation.
CONCLUSION
It seems to me that, for a traditional mortgage lender, accepting stablecoin payments presents a complex and high-risk proposition due to substantial regulatory, operational, and liquidity hurdles, among other things. While the potential for faster, cheaper payments exists, these are largely outweighed by the challenges and lack of established frameworks.
At this time, the most likely path for lenders to engage with digital assets is through crypto-backed mortgages, which use stablecoins as collateral rather than for direct payments. This strategy allows lenders to serve crypto-rich clients while largely remaining within the traditional financial system.
While some Fintech lenders accept stablecoin payments, traditional mortgage lenders generally do not due to numerous risks. For most federally-backed mortgages in the U.S. (for instance, loans backed by Fannie Mae, Freddie Mac, FHA, and VA), borrowers must convert cryptocurrency into U.S. dollars and then "season" the funds in a bank account before they can be used for a down payment or reserves.
Jonathan Foxx, PhD, MBA, the Chairman & Managing Director of Lenders Compliance Group, authored this article.