What is crypto lending and how did BlockFi promise to change it?

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Savers frustrated by the paltry returns offered by banks in recent years seem to have found a solution: so-called crypto loan accounts that pay interest rates of up to 18%. Millions have accrued in these products offered by upstarts including Celsius Network, introducing a whole new cohort of cryptocurrency investors. It now appears that some of those stunning returns were too good to be true. After amassing over $20 billion in assets, including many people’s savings, Celsius plunged into a solvency crisis that shook confidence in the largely unregulated world of crypto finance.

1. What is crypto lending?

At first glance, crypto loan accounts look a lot like savings accounts offered by banks, but with cryptocurrencies instead of traditional cash. An investor opens an account, deposits cryptocurrency and earns interest. Many deposits are in Bitcoin, while other investors use stablecoins – tokens that are often priced at $1. Others use lesser-known and more volatile cryptocurrencies. Accounts generally pay interest in the same currencies that are deposited. Some have rates that change daily. Others offer a fixed rate and the money is locked in for a set period.

2. How big is the crypto loan?

It’s still tiny compared to traditional banking, but it’s grown rapidly. Celsius said it had almost $11.8 billion in deposits on May 17, while BlockFi Inc. said deposits of more than $10 billion. Gemini Trust Co. began offering accounts in February 2021 and said last August that it had more than $3 billion in deposits.

3. How can they afford high returns?

The companies that offer the accounts say they are able to lend customer deposits to institutional investors at even higher rates. These institutions sometimes need to borrow crypto to execute their own transactions, such as betting that the price of crypto will drop or to take advantage of price differences in other financial instruments. But regulators said they believe some crypto credit companies were using the money for other business activities. Some may invest client funds in riskier crypto projects, making a profit on bets and pocketing the difference. The bottom line is that there are no uniform rules for companies to disclose exactly what deposits can and cannot be used for. The same goes for decentralized finance, or DeFi, instruments that also attract crypto investors with exorbitant interest payments.

4. How does crypto lending differ from DeFi?

Celsius, BlockFi, and other crypto lending companies deal directly with their customers and pay them interest. With DeFi, it’s just computer code, rather than an intermediary, that handles interest payments. Lending crypto to earn interest via DeFi is sometimes referred to as yield farming. This in turn is different from staking, where holders of a cryptocurrency let their tokens be used to help order transactions on the blockchain, or digital ledger, which is used by that coin.

5. What happened with Celsius?

The problems started after Celsius made a large investment in a staking token called stETH. StETH allows people – and businesses like Celsius – to stake on the Ethereum blockchain and earn additional returns through DeFi. A sharp drop in the value of crypto assets in May left stETH trading at a discount and the token became more illiquid. This made it harder for Celsius to raise funds for redemptions when users wanted to withdraw their funds. On June 12, Celsius announced it was halting withdrawals due to “extreme market conditions,” an apparent effort to stave off the digital equivalent of a bank run.

6. What have regulators done regarding crypto lending?

Regulators and investor advocates worry consumers may realize they’re taking far more risk than they would with a bank savings account. Since crypto accounts are not FDIC insured, customers can lose their deposits if a company goes bankrupt, is hacked, or loses customer funds. Few of the companies offering the accounts sought approval from US federal regulators first, which has already caused a backlash. In July 2021, securities regulators in Alabama, Texas, New Jersey, Kentucky, and Vermont filed suits against BlockFi alleging the company was offering unregistered securities. Several of the same states have filed suits against Celsius. Coinbase Global Inc. planned to offer similar accounts, but dropped that proposal after the Securities and Exchange Commission said it might sue the company. BlockFi announced in February that it would seek SEC approval for accounts that pay customers high returns for lending their crypto in a record $100 million settlement with market watchdogs. federal and state securities.

7. What could change as a result of the Celsius problems?

The crisis at Celsius could accelerate the regulatory crackdown. Financial watchdogs seem to view crypto lenders as some of the lowest fruit in their bid to bring law and order to the broader crypto industry. After all, with companies like Celsius and BlockFi, there is a clear entity to pursue, rather than just computer code like in some DeFi transactions. The SEC has already more or less ended a boom in so-called initial coin offerings, or ICOs, by entrepreneurs hoping to launch the next bitcoin, when it ruled that most tokens matter like securities – shares of endeavors where investors pool funds and earn returns that depend on the actions of others.

8. What if crypto accounts are considered securities?

The designation opens companies up to a whole new regime of registrations and disclosure requirements to make products safer. That would likely mean higher costs for crypto firms, and perhaps an end to those gargantuan returns for investors.

More stories like this are available at bloomberg.com

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