Rehypothecation is a process where brokers use the assets collateralized by clients for their own benefit.
Rehypothecation is a way of generating credit from assets and allowing multiple financial transactions to be collateralized by the same asset. To understand rehypothecation, one must understand what hypothecation is.
Hypothecation is the process of pledging assets as collateral for a debt. This is a common practice in lending. In the case of rehypothecation, it is a process of using hypothecated collateral as an asset in itself and offering that as collateral when seeking a loan.
An example of rehypothecation is of securities that have been posted with a prime brokerage as collateral by a hedge fund. The brokerage can then use its conditional right to those hypothecated securities as an asset to hypothecate its own loan applications.
Rehypothecation is utilized in situations where the broker-custodian has loaned the principal money to purchase the assets in the first place. It helps to create liquidity for individual market participants and across the market, increasing access to capital for businesses and delivering social benefits.
In the digital economy, rehypothecation has been said to destabilize the crypto space, suppress BTC prices and reduce the efficacy of blockchain security by taking claims to ownership off-chain that have not materialized. Bitcoin has more than tripled in value since 2018, suggesting price-suppression effects have been minimal.
Gunnar Jaerv is the chief operating officer of First Digital Trust — Hong Kong’s technology-driven financial institution powering the digital asset industry and servicing financial technology innovators. Prior to joining First Digital Trust, Gunnar founded several tech startups, including Hong Kong-based Peak Digital and Elements Global Enterprises in Singapore.
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