Crypto Firms Acted Like Banks, Then Crumbled Like Dominos

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NEW YORK (AP) Over the past few years, a number of companies have attempted to act as the cryptocurrency equivalent of a bank, promising lucrative returns to customers who deposit their bitcoin or other assets digital.

In less than 12 months, almost all of the biggest of these companies failed spectacularly. Last week, Genesis filed for Chapter 11, joining Voyager Digital, Celsius and BlockFi on the list of companies that have filed for bankruptcy or gone out of business.

This subset of the industry grew as cryptocurrency enthusiasts sought to create their own parallel world in finance, unrelated to traditional banks and government-issued currencies. But without safeguards and without government support, these companies failed like a domino. What started with the collapse of a crypto company in May spilled over to one crypto lending company and then to the next.

Additionally, government regulators began restricting the ability of crypto credit companies to advertise their services, claiming that their products should have been regulated by securities regulators.

The collapse is reminiscent of the 2008 financial crisis, but on a much smaller scale. There is no concern that the collapse of these crypto firms will impact the wider economy.

Crypto lending companies like Voyager, Genesis, and BlockFi were trying to do what banks do in traditional finance: take deposits of crypto, give depositors a dividend on their stored crypto, and then make loans to make a profit. This is what the banking industry has done for hundreds of years, but with government approved currencies.

The biggest downside of crypto loans is the lack of collateral. There is no deposit insurance, government stopgap, or even private entity to protect depositors in the event their crypto bank fails. It was good when crypto prices rose because collateral banks accepted loans that rose in value in exchange.

The demand for crypto deposits was so high that companies were willing to pay a return of 10% or more on depositors’ crypto holdings.

But then crypto prices started falling and continued to fall. Bitcoin, for example, fell from over $65,000 in November 2021 to under $17,000 last November. As a result, much of the underlying collateral these firms held fell short of the loans they had issued, rendering several crypto banks insolvent.

Celsius and Voyager Digital were the first two crypto credit companies to collapse. The companies had been exposed to both falling crypto prices as well as risky loans to crypto hedge funds like Three Arrows Capital, which was forced to liquidate and cease operations in June.

BlockFi, another crypto lender, turned to then-crypto giant FTX and its founder Sam Bankman-Fried for rescue. Bankman-Fried gave BlockFi a financial lifeline, one of many moves that have earned Bankman-Fried plaudits as a savior or financial backer for the crypto industry.

But FTX’s own bankruptcy in November, caused by high-risk loans to its affiliate hedge fund Alameda Research, caused BlockFis’ financial lifeline to wither. BlockFi’s own bankruptcy has become inevitable. In a demonstration of the intertwining of these crypto lenders, Genesis made billions in loans to Alameda.

Struggling with bad debts, many of these high-tech companies experienced a very old phenomenon: depositors wanted their money back and a bank run began.

AND AFTER?

The tens of thousands of customers of these crypto lending companies are now waiting to see if their assets can be recovered or found in bankruptcy court, which could take months or even years. At Genesis, more than $900 million in client funds are now tied up in bankruptcy.

It is unclear if crypto lending will see a comeback anytime soon. After the failure of FTX, crypto exchange giant Binance announced that it would create its own fund to provide bailout funding to a struggling crypto business, an idea that originated in the central bank or government-sponsored deposit insurance.

Moreover, the crypto industry seems to be moving towards the idea of ​​some kind of regulation, which would provide minimum guarantees to depositors or investors that currently do not exist. Several bills were pending in Congress last year, but with Republicans shifting control in the House of Representatives, it’s unclear whether the broader GOP has an interest in regulating the crypto industry. .

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