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 nearly $11.8 billion in deposits on May 17, while BlockFi Inc. in mid-June reported 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 do they afford the high yields?
The companies that offer the accounts say they are able to lend customer deposits to other institutional investors at even higher rates. These institutions sometimes borrow cryptos to execute their own transactions, such as betting that the price of cryptos will drop or to take advantage of price differences in other financial instruments. It is difficult to know what crypto credit companies are investing in because there are no uniform rules allowing them 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 can simply be computer code, rather than an intermediary, that handles borrowing, lending, and interest payments. Lending crypto to earn interest through 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, that is used by that coin.
5. Why have some crypto lending companies run into problems?
Lending money for someone else’s investments can be risky because if their bets go sour and they can’t pay you back, you’re left with nothing. Celsius, Babel, and Vauld all blamed crypto market conditions for their liquidity issues. Celsius made a large investment in a token called stETH which allowed it to stake on the Ethereum blockchain and earn additional returns via DeFi. The sharp decline 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. In June, it halted withdrawals in 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 now?
Crises at Celsius and others could accelerate regulatory repression. 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, which is not always the case in DeFi transactions.
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
