Crypto lending companies in the hot seat: new regulations coming?

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A number of states in the United States including Kentucky, Texas, Alabama, Vermont, New Jersey, and more recently New York have cracked down on crypto lending. Depending on one’s perspective, these may resemble acts of collective desperation or a harbinger of things to come.

Asked about the crackdown on crypto lending companies like BlockFi and Celsius, Firat Cengiz, a senior lecturer in law at the University of Liverpool, told Cointelegraph: “The crypto regulatory space is becoming increasingly heated, and not just in the United States but also in the rest of the world. “She added that a new regulatory approach is emerging and, as such,” the crypto market will no longer be an example of a market. free regulated only by the “invisible hand of the market”. ”

“DeFi and stablecoins – rather than exchange or store of value coins such as BTC or ETH – will be the primary target of emerging regulations,” Cengiz continued. “For example, the EU’s draft regulation will ban interest on stable coins,” which some say calls most central financial and banking institutions into question.

But, Cengiz doesn’t necessarily consider the New York State Attorney General’s mid-October shutdown of two anonymous crypto lending platforms operating in the state due to “illegal activity” as part of this global trend. “New York State has historically tried to assert a political point of view by targeting crypto,” she said. Meanwhile, others have noted that James is expected to run for state governor, so almost anything she does at this point has a political aspect to it.

Is the crypto loan legitimate?

New York State isn’t alone in raising its eyebrows when it comes to crypto lending, however. Alabama, Kentucky, New Jersey and Texas have issued cease and desist orders against BlockFi Inc., a New Jersey-based cryptocurrency lender in July and Celsius in September. Both are said to have “illegally offered unregistered securities in the form of high interest accounts used to finance their lending and proprietary trading”.

Investors often don’t realize that the 8-9% interest they earn on their crypto deposits – at a time when traditional bank savings rates are well below 1% – carries some risk, that is – that is, their entire stake can be wiped out if the project is hacked or collapses, regulators have suggested.

“They are right,” Lee Reiners, executive director of the Global Financial Markets Center at Duke University School of Law, told Cointelegraph. “The marketing around many of these yield products gives the impression that they are similar to guaranteed yield savings accounts, when in fact they are not.” They also don’t come with FDIC insurance like traditional bank savings accounts.

Others have claimed that the (sometimes) double-digit rates paid for crypto deposits cannot be sustained during a sharp drop in crypto prices, and especially during a bear market. That is, they are just “artifacts of an artificially inflated crypto market,” as Kevin Werbach told Roll Call.

“Of course, the returns have to come from somewhere,” said Reiners, former supervisor of the Federal Reserve Bank of New York, adding:

“If you lend crypto to a DeFi protocol or a centralized company, what do they do with it to generate that 8% or 9% interest rate that you get? Well, they only use it to trade other coins which is profitable when the market is going up. But, if the crypto prices fall, these returns cannot be sustained. Regulators struggle to keep pace

Anne Termine, government law enforcement and investigative practice partner at Bracewell LLP and former chief prosecutor of the Commodities Futures Trading Commission (CFTC), said “there is no easy answers “on the crypto regulatory front, but the amount of money invested in the crypto space now causes regulatory dialogue to proceed at a more frenetic pace, telling Cointelegraph:

“In any industry, innovation comes first and regulation comes second. What is happening here is that innovation is happening at such a speed that regulators are struggling to keep up.

When it comes to lending issues, some in the crypto community assert, “Just because we have a better product than what banks can offer doesn’t make us illegitimate … it doesn’t mean we’re pure fraud.” and simple, “she added. And not all crypto protocols need to be tared with the same brush. The big players in the space are often fairly sophisticated companies that take consumer protection seriously,” Termine added.

When asked if regulators were right that savings rates of 8-9% may sound too good to be true, Cengiz responded. “Yes, of course, there are definite gaps in consumer protection in the crypto market.” It is still not clear, from a legal perspective, to what extent lending or borrowing from a decentralized finance protocol (DeFi) counts as a financial contract under current financial consumer protection rules. she said, adding:

“However, the answer to this should not be to bring highly political individual cases, but to take legislative action to provide sufficiently clear regulatory guidance to both consumers and suppliers. I find it difficult to categorize the types of individual actions you mention as genuinely stemming from consumer protection incentives. “

Reiners, for her part, has little patience with the position that state attorneys general like Letitia James are simply trying to score political points or protect legacy banks. “The crypto community always acts like it’s a victim whenever something like this happens when in reality the regulators are just doing their job and enforcing the law. And frankly, I don’t see how to tackle crypto companies scoring “political points.” It’s not like there is an anti-crypto lobby with votes to be had.

“A dangerous game”

“There is nothing new under the sun,” Geoffrey Goodell, associate researcher at University College London and deputy executive director of the UCL Center for Blockchain Technologies, told Cointelegraph. “Companies are looking for sources of capital and investors are looking for sources of return. In this case, companies are using the language of asset custodians to suggest security that does not exist, while avoiding traditional regulatory barriers to such activities. He added that since investors are keen to earn high returns, the situation turns into a “dangerous game that we have seen many times before.”

“The problem with any cryptocurrency not backed by central banks is the volatility and potential loss of the investment,” Laura Gonzalez, associate professor of finance at California State University in Long Beach, told Cointelegraph. She added that “there is an important trade-off between risk and return,” and investors should exercise caution when entering this space.

Others have suggested that by going after companies like Celsius, BlockFi and others, regulators are simply grabbing the fruit at their fingertips. It can be more difficult to crack down on more decentralized lending projects where no individual or company is clearly in charge.

Cengiz acknowledges that decentralized platforms could present “significant problems and complications” for law enforcement agencies, including locating the jurisdiction responsible for the investigation, deciding the applicable law and identifying those responsible:

“Successful enforcement of decentralized platforms will require a very strong international network between enforcement agencies, which we don’t see in any other area of ​​law. ”

“That said, there are times when crypto platforms become a target of the law by blindly ignoring regulatory advice,” Cengiz added. An example: the UK’s Financial Conduct Authority (FCA) ordered Binance to cease all operations because Binance did not seek FCA authorization “under very clear regulatory guidelines.”

Global regulatory dialogue

“We are seeing a lot of movement between governments, not only at the federal level but globally and certainly also at the state level,” said Termine. “The crypto community is asking: can we please coordinate on this.”

Is the same debate going on in other countries? Termine said “Absolutely”, all over the world and especially with regard to the Bank of England (BOE). Its deputy governor, Jon Cunliffe, drew comparisons between the current cryptocurrency boom and the rise of subprime mortgages in the United States in 2008, just before the financial collapse.

Indeed, the crypto market value, which reached $ 2.5 trillion in mid-October, was roughly double the value of the subprime market in 2008 – $ 1.2 trillion – which shows that “you don’t have to factor in a lot of the financial industry to trigger financial stability issues,” Cunliffe said.

Termine viewed the BOE vice governor’s remarks as a good example of the growing “fervor” on the part of regulators around the world to deal with cryptocurrencies. Cengiz told Cointelegraph:

“Regulators do not appear to fully understand the dynamics of the crypto market, and the actions they take are likely to discourage at least some consumers from participating in an emerging and potentially very efficient and innovative investment market.”

She added that the goal should be regulations that “protect citizens from the usual dangers of the crypto market such as financial complexity, fraud, cyber attacks, etc. without compromising innovation ”.

Reiners was asked if there were any circumstances under which he would support the crypto loan, to which he said, “If this facilitates real economic activity. But for now, all it does is make crypto speculation even easier. But from a legal point of view, if these products are offered outside banks, they must be registered as securities.

Related: Crypto Breaks Wall Street’s ETF Barrier: A Turning Point Or A Stopper?

In short, the cryptocurrency and blockchain industry is “no longer something that can no longer be ignored” by regulators, said Termine, who worked for nearly 20 years at the CFTC. “Ten years ago, it seemed like it was a fad,” the province of software engineers said in a dark corner of the world.

No one took seriously the idea of ​​an open decentralized financial network. “But 10 years later, there is over $ 2 trillion in market value floating in this space, and regulators around the world need to sit down and say, ‘We can’t watch anymore. “”

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