BlockFi facing regulatory heat, a sign of possible crypto lending regulations?

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BlockFis’s turbulent 2021 continued into the second half of the year as state regulators in the United States began cracking down on the company’s interest-bearing crypto accounts. The move likely marks another operational headache for the non-bank lender in a year of substantial fundraising and public listing plans interspersed with controversies and technical errors.

State regulators that prey on interest-bearing crypto accounts can also be an indicator of possible federal regulations targeting the cryptocurrency lending market. Indeed, such a scenario might be possible given the current focus on digital currency regulation in America.

From shrinking centralized crypto lenders, attention could shift to their decentralized counterparts, especially against the backdrop of financial rhetoric like 9/11 attributed to decentralized finance (DeFi) by members of Congress. Indeed, MakerDAO founder Rune Christensen recently warned that a U.S. crackdown on the industry would be a clean target 10 times harsher than China reported muzzling private-sector tech giants.

Cease and desist

BlockFi received cease and desist notices from three states in the United States in July alone. Regulators in New Jersey, Alabama and Texas have accused the company of offering unlicensed securities.

This seemingly coordinated regulatory review would depend on the BlockFis crypto savings and credit product in which users can deposit their cryptocurrencies into interest-bearing accounts, known as BlockFi Interest Accounts (BIA), and use them as collateral to earn cash. ready. Regulators in those states say the product constitutes an unlicensed securities offering.

It all started earlier in July when the New Jersey Bureau of Securities issued a cease and desist order on BlockFi, ordering a moratorium on new account openings by the company. Originally slated to go into effect on July 22, the order has been delayed for a week and has now been pushed back for a month as part of ongoing talks between BlockFi and the New Jersey regulator.

In a statement posted on the company’s website, BlockFi CEO Zac Prince assured customers that the company is continuing its dialogue with regulators. Prince pointed to the New Jersey Bureau of Securities’ decision to postpone its action against BlockFi as giving credit to the company’s efforts to overcome current regulatory hurdles.

Alabama quickly followed suit with a show cause order, alleging that BlockFi was funding its crypto lending business through the sale of unlicensed securities. The company has 28 days from the date of the notice to justify not serving a cease and desist order, as it did in New Jersey.

As previously reported by Cointelegraph, Texas has also joined the regulatory campaign against BlockFi. The Texas Securities Board plans to hold a hearing in October to decide whether to ban BlockFi from offering crypto lending services in the state.

As is the case in New Jersey and Alabama, regulators in Texas say that the fact that BlockFi operates as a crypto company does not exclude it from securities law. In another statement on its website, BlockFi disagreed with the idea that BIAs are securities.

According to Prince: Ultimately, we see this as an opportunity for BlockFi to help define the regulatory environment for our ecosystem. In June, the CEO of BlockFi argued that regulatory interest was a net positive for the crypto ecosystem.

Is the crypto loan market on the radar?

BlockFi’s current regulatory issues also raise the broader issue of crypto lenders which appear to be under closer scrutiny by regulators. Judging by the exact wording in the notices served by New Jersey and Alabama, regulators in those states appear to have classified BIAs as a product rather than an account.

Although it is a non-bank entity, there is an argument to be made that BlockFi offers what is akin to the usual savings account provided by banks, although in the case of BlockFis, for Bitcoin (BTC), Ether (ETH) and stablecoins. By mixing user deposits, the company is able to offer loans to retail and institutional clients.

Depositors are encouraged to achieve annual returns of up to 8.5% for stable coins pegged to the dollar and around 4% for BTC deposits, which is several orders of magnitude higher than the 0.03% on average for dollar accounts. American savings. Besides the high interest rates, depositors also have access to loan facilities against their crypto deposits.

By treating BIAs as a commodity, it’s possible for regulators, like those in New Jersey and Alabama, to assert that BlockFi’s interest-bearing crypto loan accounts are considered securities. Meanwhile, such a designation is generally not given to certificate of deposit (CD) accounts, although the latter behave in much the same way as a security under the definitions set out in the Securities Act of 1933.

However, it is important to note that these actions are based on unique state laws and may have nothing to do with federal mandates. The jurisdictional diversity of the Americas, which often leads to a patchwork of regulations along state borders, is a common compliance barrier for crypto companies and the fintech industry in general.

So, in the absence of federal warrants that can offer some form of preemption, BlockFi and crypto lenders may soon be faced with more onerous state laws. In a conversation with Cointelegraph, Dean Steinbeck, president and general counsel of blockchain development company Horizen Labs, said regulatory action against companies like BlockFi is inevitable, adding:

Unfortunately, I think it’s only a matter of time before federal regulators take on centralized crypto banks that offer their users fixed interest on crypto deposits. Regulators can choose to target these investments as unregistered securities offerings or as illegal banking activity depending on which agency decides to pursue these claims.

Commenting on the possible path for such regulatory actions, Steinbeck said that since interest-bearing instruments are already well-regulated commodities, there might not be a need for specialized legal policies regarding their crypto counterparts. Regulators just need to clarify what regulatory regime governs these types of crypto deposits and loans, Steinbeck added.

So far, the United States Securities and Exchange Commission has limited its involvement in monitoring the crypto lending space to investigations and charges against a handful of companies operating in the market. However, with the increased attention given to the U.S. cryptocurrency industry by some members of Congress, an SEC ruling on whether crypto lending products are securities could be a possibility in the future. .

BlockFis eventful 2021

Crypto lending took off in 2019 and, prior to DeFi summer 2020, was arguably one of the fastest growing markets in the entire crypto industry. BlockFi reportedly manages more than $ 14.7 billion in assets from its crypto-interest-bearing accounts and has reached a valuation of around $ 3 billion, following a $ 350 million Series D funding in March.

In June, the company announced plans for another round of investments by major lenders and private investors that could see its valuation approaching $ 5 billion. Earlier this year, as Bitcoin and the crypto market skyrocketed to new price highs, BlockFi customers appeared to be earning record interest payments on their crypto and stablecoin deposits.

Related: A Trade War Misstep? China cedes crypto battlefield to US banks

However, it hasn’t been smooth sailing for the company in 2021, with a few incidents that arguably could be described as public relations nightmares. Ahead of the company’s $ 350 million round of funding in March, around 500 of its customers were reportedly victims of racist and vulgar email attacks. In May, the company mistakenly sent outsized payments to the winners of a promotional campaign, some people reportedly received hundreds of Bitcoin.

The regulatory heat of BlockFis in the second half of 2021 also coincided with a period of low activity for the company in terms of the flow of funds to and from miners and exchanges. Data from on-chain analytics platform CryptoQuants, inter-entity flows show minimal activity between BlockFi and miners and crypto exchanges over the past month, with company reserves also at their lowest level since the first quarter of 2020.

After raising hundreds of millions of dollars in multiple fundraisers, BlockFi is reportedly considering a public listing to join the ranks of multi-billion dollar publicly traded crypto companies. It is not clear how current regulatory issues might be factored into the company’s bid to go public.

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