What is rehypothecation, and why does it matter in crypto?

Rehypothecation is what happens when a lender takes the collateral you pledged and uses it for itself: to lend to someone else, to back its own borrowing, or to sell and replace later. It is legal and common in parts of finance. In crypto lending, it is the reason several large lenders could not give their clients’ assets back in 2022.

The definition

To hypothecate an asset is to pledge it as security for a loan while remaining its owner, as you do with a house under a mortgage. To rehypothecate is what the lender does next, if the contract allows it: it takes the asset you pledged and puts it to work for itself.

Rehypothecation turns your collateral into the lender’s working capital. It earns the lender extra income, which can make loans cheaper or yields higher. It also changes your position. Instead of an owner whose asset is held for safekeeping, you become someone who is owed an asset: a creditor, exposed to the lender and to everyone the lender passed your asset to.

Pledge, reuse, title transfer

Most collateral arrangements fall into one of three families. The words differ from one contract to another; the questions to ask are always the same.

• A pledge

  You give the asset as security and remain its owner. The lender holds it, and may sell it only under the conditions of the agreement.

  Owner

  You

  Lender’s use

  None: it holds the asset as security

  If the lender fails

  Your asset is identifiable as yours

• A pledge with a right of reuse

  You remain the owner on paper, but the contract lets the lender lend, pledge or sell the asset and return an equivalent one later.

  Owner

  You, until the lender uses it

  Lender’s use

  Lend, pledge or sell it on

  If the lender fails

  You are usually owed an equivalent asset

• A title transfer

  Ownership passes to the lender, which only promises to return equivalent assets when the loan ends.

  Owner

  The lender

  Lender’s use

  Anything it chooses

  If the lender fails

  You are a creditor among others

Simplified. The exact position of a client depends on the law that governs the contract and on its wording, especially in an insolvency.

In traditional finance

Rehypothecation is a long-standing feature of brokerage. When you borrow on margin, your broker can typically reuse the securities in your account to finance itself, and the practice is regulated rather than banned. In the United States, broker-dealers may reuse a client’s securities up to 140% of what the client owes them. In the European Union, financial instruments received as collateral may be reused only with the provider’s prior express consent, given after a written explanation of the risks and consequences.

The risk is not theoretical. When Lehman Brothers collapsed in 2008, clients of its London broker-dealer whose assets had been rehypothecated discovered that those assets were no longer held for them: they had to claim them as creditors, in an administration that lasted years.

How crypto lenders used it

Many crypto lenders adopted the same model and took it further. Coins deposited or pledged by clients were lent to trading firms, posted as collateral elsewhere or deployed in decentralised finance to earn a return. That return paid for the interest offered to depositors and for the lenders’ own margins. The terms of use typically made it possible through clauses granting the platform ownership of the coins, or the right to use, lend or pledge them.

For borrowers, the model meant that the bitcoin pledged against a loan was not necessarily sitting in a vault. It could be one link in a chain of loans, each depending on the next borrower’s ability to repay.

What happened in 2022

When crypto prices fell sharply in 2022 and several large borrowers failed, lenders that had reused client assets could no longer meet withdrawals. Celsius paused withdrawals in June 2022 and filed for Chapter 11 bankruptcy protection in the United States in July. Voyager Digital filed the same month. BlockFi filed in November, after the collapse of the FTX exchange.

In the Celsius case, the bankruptcy court ruled in January 2023 that the coins held in its interest-bearing accounts belonged to the company under its terms of use, which left those customers as unsecured creditors. Across these cases, customers’ assets became part of court proceedings that lasted many months, and in some cases more than a year.

How to spot it in the terms

Rehypothecation is rarely called by its name. Read the sections on collateral, custody and ownership, and look for the following.

Why proof of reserves is not enough

After 2022, many platforms began publishing proofs of reserves: snapshots showing that they hold certain assets at a given moment. They are useful, but they show only one side of the balance sheet. A proof of reserves does not show what the platform owes, nor whether the assets it shows are pledged elsewhere, and a snapshot says nothing about the day after.

A collateral address dedicated to your loan answers a narrower but more useful question, at any time and without asking anyone: is my collateral still where it should be? Our page on proof of collateral shows how to check it.

Questions to ask a lender

1. Do I remain the owner of my collateral, or does title pass to you?
2. Can you lend, pledge, stake or sell my collateral, and under which clause?
3. Is my collateral segregated, at an address I can check myself?
4. Will I get back the same coins, or equivalent ones?
5. Do you run a yield or interest programme with client assets?
6. Who holds the keys, and can a single person move the funds?
7. What happens to my collateral if you become insolvent?

Our approach

At Lombard Private, your collateral is pledged to secure your loan, and that is all it does. It sits at an on-chain address created for your loan, in multi-signature cold storage where no single person can move it, and it is never lent, staked, pledged or rehypothecated: rehypothecation is excluded by contract. You can check the balance at any time on a public block explorer, without asking us, and you get the same coins back when you repay.

The trade-off is deliberate. We earn our income from the interest you pay, not from what we could do with your coins. See how we hold collateral on our custody page.