BlockFi Facing Regulatory Heat, A Sign Of Possible Regulations For Crypto Lending?


BlockFi’s eventful 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 means another operational headache for the non-bank lender in a year of large fundraising and listing plans punctuated by controversy and technical errors.

State regulators scrambling for interest-bearing crypto accounts can also serve as a beacon for possible federal regulations targeting the cryptocurrency loan market. Indeed, given the current focus on digital currency regulation in America, such a scenario could be possible.

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From restricting centralized crypto lenders, the focus could shift to their decentralized counterparts, particularly in the context of rhetoric like “Finance 9/11,” which members of Congress attribute to decentralized finance (DeFi). In fact, MakerDAO founder Rune Christensen recently warned that a US crackdown on the sector would be a “self-target” ten times more serious than China’s reports of silencing the private sector tech giants.

Failure and Failure

BlockFi were served cease and desist letters from three US states in July alone. Regulators in New Jersey, Alabama and Texas have accused the company of offering unlicensed securities.

This seemingly coordinated regulatory review has reportedly relied on BlockFi’s crypto savings and loan product, which allows users to deposit their cryptocurrencies into interest-bearing accounts called BlockFi Interest Accounts (BIAs) and use them as collateral to obtain loans. Regulators in these states say the product is an offering of unlicensed securities.

It all started in early July with the New Jersey Bureau of Securities issuing a cease and desist order to BlockFi and ordering a moratorium on new account openings by the company. The order, which was originally scheduled to go into effect on July 22, was delayed by a week and has now been brought forward by another month amid 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 decision by the New Jersey Bureau of Securities to postpone its lawsuit against BlockFi in order to give credence to the company’s efforts in overcoming current regulatory hurdles.

Alabama soon followed suit, claiming BlockFi funded its crypto lending activities through the sale of unlicensed securities. The company has 28 days from the date of notification to provide reasons why it should not be served an injunction, 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 BlockFi should ban the offering of crypto credit services in the state.

Like New Jersey and Alabama, Texas regulators say the fact that BlockFi is acting as a crypto business doesn’t preclude it from securities law. In another statement on its website, BlockFi spoke out against the notion that BIAs are securities.

According to Prince: “Ultimately, we see this as an opportunity for BlockFi to define the regulatory environment for our ecosystem.” Back in June, the CEO of BlockFi argued that the regulatory interest was a net benefit for the crypto ecosystem.

Crypto Lending Market On The Radar?

BlockFi’s current regulatory issues also raise the bigger problem that crypto lenders are apparently being scrutinized by regulators. Judging from the exact wording in the New Jersey and Alabama Notices, it appears that regulators in those states have classified BIAs as a product rather than an account.

Although it is a non-bank entity, it can be argued that BlockFi offers something like the usual bank savings account – albeit in the case of BlockFi for Bitcoin (BTC), Ether (ETH) and stablecoins. By pooling user deposits, the company can offer loans to private and institutional customers.

Depositors are encouraged with annual returns of up to 8.5% for dollar-pegged stablecoins and around 4% for BTC deposits, which is several orders of magnitude higher than the average 0.03% for US savings accounts. In addition to high yielding, depositors also have access to credit facilities against their crypto deposits.

By treating BIAs as a product, it is possible for regulators like those in New Jersey and Alabama to state that BlockFi’s interest-bearing crypto credit accounts are considered securities. Typically, such a designation is not given to a Certificate of Deposit (CD) accounts, although the latter behave similarly to a security under the definitions of the Securities Act of 1933.

It is important to note, however, that these measures are based on unique state laws and may not have anything to do with federal mandates. America’s legal diversity, which often results in a patchwork of regulations along state lines, is a common compliance hurdle for crypto companies and the general fintech industry in general.

Therefore, given the lack of federal mandates that could offer some sort of right of first refusal, BlockFi and crypto lenders could soon grapple with more burdensome state laws. Speaking to Cointelegraph, Dean Steinbeck, President and General Counsel of blockchain development company Horizen Labs stated that regulatory action against companies like BlockFi was inevitable, adding:

“Unfortunately, I think it is only a matter of time before federal regulators prosecute central ‘crypto banks’ that are offering their users fixed rates on crypto deposits. Regulators may target these investments as unregistered securities offerings or illegal banking activities, depending on the particular authority pursuing these claims. “

Regarding the possible path for such regulatory action, Steinbeck stated that since interest-bearing instruments are “already well-regulated products,” they may not require specific legal guidelines for their crypto counterparts. “The regulators only need to clarify which regulatory regime governs these types of crypto deposits and loans,” added Steinbeck.

So far, the US Securities and Exchange Commission has limited its crypto loan oversight activities to investigations and charges against a handful of companies operating in the market. With the increased focus on the American cryptocurrency industry by some members of Congress, however, a future decision by the SEC on whether or not crypto credit “products” are securities may be possible.

BlockFis eventful 2021

Crypto lending picked up speed in 2019 and was arguably one of the fastest growing markets in the entire crypto sector prior to DeFi summer 2020. BlockFi reportedly manages over $ 14.7 billion in assets from its interest-bearing crypto accounts and is valued at approximately $ 3 billion following a Series D funding round of $ 350 million in March.

In June, the company announced plans for another round of investment from leading financiers and private investors, valued at nearing $ 5 billion. Earlier this year, as Bitcoin and the crypto market skyrocketed to new highs, BlockFi customers appeared to be earning record interest payments on their crypto and stablecoin deposits.

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However, 2021 didn’t go smoothly for the company, with a few incidents that could arguably be described as public relations nightmares. Prior to the company’s $ 350 million financing round in March, around 500 of its customers were reportedly victims of racial and vulgar email attacks. In May, the company mistakenly sent oversized payments to ad campaign winners, with some people allegedly receiving hundreds of Bitcoin.

BlockFi’s heat of regulation in the second half of 2021 also coincided with a period of low activity for the company regarding the flow of money to and from miners and exchanges. The data from the on-chain analytics platform CryptoQuant shows minimal activity between BlockFi and miners and crypto exchanges over the past month, with the company’s reserves also at their lowest level since Q1 2020.

BlockFi has raised hundreds of millions of dollars in multiple rounds of fundraising and is reportedly aiming for a public listing in order to join the ranks of multibillion-dollar publicly traded crypto firms. It’s not clear how the current regulatory issues could affect the company’s IPO.