Rehypothecation Decoded: How financial institutions Multiply Collateral to Power Global Markets

Rehypothecation allows financial institutions to generate credit by using the same asset to secure multiple transactions. To understand this concept, you must first grasp hypothecation.

Hypothecation occurs when a borrower pledges assets as collateral for a loan—a common practice in lending. This happens when a lender (such as a broker or bank) takes the borrower’s collateral and repledges it to secure its financing. In effect, the lender repurposes the collateral as an asset for further borrowing.

A hedge fund posts securities as collateral with a prime brokerage. The brokerage then uses those securities to back its loans, recycling the same collateral in a new transaction.

Brokers and custodians often use rehypothecation when they provide the initial funds to purchase assets. This process boosts liquidity for traders and the broader market, making capital more accessible to businesses and supporting economic growth. 

Critics argue that rehypothecation destabilizes crypto markets, suppresses Bitcoin’s price, and weakens blockchain security by shifting ownership claims off-chain without settlement. Yet Bitcoin’s value has more than tripled since 2018, suggesting minimal long-term price suppression.

By maximising collateral efficiency, rehypothecation strengthens financial markets, but it also demands strict risk controls to prevent excessive leverage and systemic risks.