What is rehypothecation?

The reuse of assets a customer pledged as collateral, most often by lending them out again.

Platforms that did this in crypto turned customer deposits into loans, and several failed when the loans went bad. Terms of service and reserve reports are where the practice shows up, when it is disclosed at all.

The word comes from traditional finance, where it is a normal and regulated activity with limits and disclosure attached. Its arrival in crypto lending was neither limited nor disclosed in most cases, which is why the same mechanism that quietly funds securities markets became the thing that emptied several platforms.

How it works

1. You deposit an asset, either as collateral for a loan or into a yield product.
2. The platform's terms grant it the right to use that asset. This is often a single clause, and it is the clause that decides everything.
3. The platform lends the asset to a trading firm, posts it as collateral elsewhere, or deploys it into a strategy, and earns a spread over what it pays you.
4. Your balance still displays in full. What you now hold is a claim on the platform, not the asset.

The failure mode is a chain rather than a single event. The same asset can back several obligations at once, so when one borrower fails the shortfall propagates to everyone whose claim rested on it. Withdrawals then fail not because the platform is dishonest but because the asset is somewhere else and cannot be recalled in time.

The distinguishing question is legal, not technical: are the assets held in segregated accounts as your property, or on the platform's balance sheet as its own? A proof of reserves snapshot does not answer this, because assets can be present and still pledged.

Example

Illustrative. You deposit $50,000 of Bitcoin into a yield account paying 6%. The platform lends it to a trading firm at 10% and keeps the spread. The firm posts it as collateral for a leveraged position elsewhere.

The market moves, the firm is liquidated, and the collateral is taken by its counterparty. Your $50,000 still shows on the platform's dashboard, because the dashboard reads a database. When you request a withdrawal, there is no Bitcoin to send.

You are then an unsecured creditor of the platform, ranking behind secured lenders, for an asset you believed you owned. The 6% was the compensation for that risk, and it was not disclosed as such.

Why it matters when you buy

Any product paying you a yield on a deposited coin is doing something with that coin, and the terms of service say what. Read the clause about use of assets before the rate. Stablecoin yield risks covers how to interrogate a published rate, and protecting yourself from an exchange collapse covers what happens when this goes wrong.

Related terms

counterparty risk — what you take on instead of the asset; segregated accounts — the arrangement that prevents it; proof of reserves — does not prove assets are unencumbered; custodian — who should be holding it; prime broker — where the practice concentrates; qualified custodian — the regulated standard.

Questions

How do I know whether a platform does this?

Read the terms of service for a clause granting rights to use, lend, pledge, or rehypothecate customer assets. Yield products almost always contain one, because the yield has to come from somewhere.

Does a reserve report rule it out?

No. A snapshot can show assets present that are simultaneously pledged elsewhere, and it says nothing about obligations that are not customer balances. Segregation is a legal arrangement that has to be stated separately.

Is it always improper?

No. It is regulated and disclosed in traditional finance with limits attached. The problem in crypto has been doing it without segregation, without disclosure, and without the capital to absorb a loss.