Rehypothecation

Understanding Rehypothecation

Rehypothecation is a technique used to generate credit by using assets as collateral for multiple financial transactions. To grasp the concept of rehypothecation, it is important to first understand hypothecation.

Hypothecation is the act of pledging assets as collateral for a debt, which is a common practice in lending. Rehypothecation, on the other hand, involves using the hypothecated collateral as an asset itself and offering it as collateral when seeking a loan.

For instance, a hedge fund may post securities with a prime brokerage as collateral. The brokerage can then utilize its conditional right to those hypothecated securities as an asset to secure its own loan applications.

Rehypothecation is commonly employed when the broker-custodian has provided the principal money to purchase the assets initially. This practice helps to create liquidity for individual market participants and the overall market, thereby increasing access to capital for businesses and providing social benefits.

In the digital economy, rehypothecation has been criticized for destabilizing the crypto space, suppressing BTC prices, and undermining the security of blockchain by taking ownership claims off-chain that have not been realized. However, the fact that Bitcoin’s value has more than tripled since 2018 suggests that the effects of price suppression have been minimal.

Author: Gunnar Jaerv serves as the chief operating officer of First Digital Trust, a technology-driven financial institution in Hong Kong that supports the digital asset industry and serves financial technology innovators. Prior to joining First Digital Trust, Gunnar founded several tech startups, including Peak Digital in Hong Kong and Elements Global Enterprises in Singapore.