Savers frustrated with the paltry yields offered by banks in recent years appeared to have found a solution: so-called crypto lending accounts that can pay interest rates of 18% or even more. Millions piled into these products, introducing a whole new cohort of investors to cryptocurrencies. Some came to regret their move after crypto lending firms Celsius Network, Babel Finance and Vauld succumbed to a meltdown in digital assets and halted customer withdrawals.
1. What is crypto lending?
At first blush, crypto lending accounts look a lot like savings accounts offered by banks, but with cryptocurrencies instead of traditional money. An investor opens an account, deposits cryptocurrency and earns interest. Many deposits are in Bitcoin, while other investors use stablecoins -- tokens whose price is often pegged at $1. Others use lesser-known, more volatile cryptocurrencies. The accounts typically 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 up for a fixed period.
2. How big is crypto lending?
It’s still tiny compared with traditional banking, but it’s been growing fast. Celsius said it had close to $11.8 billion worth of deposits on May 17, while BlockFi Inc. in mid-June declared deposits of more than $10 billion. Gemini Trust Co. began offering accounts in February 2021 and said last August it had more than $3 billion in deposits.
3. How do they afford the hefty returns?
The firms that offer the accounts say they’re able to lend customer deposits to other institutional investors at even higher rates. These institutions sometimes borrow crypto to execute their own trades, such as betting that the price of crypto will fall or to take advantage of price differences in other financial instruments. It’s hard to know what the crypto lending firms are invested in as there aren’t uniform rules for them to disclose what exactly deposits can and can’t be used for. The same goes for decentralized-finance, or DeFi, instruments that also lure crypto investors with sky-high 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 just be some computer code, rather than an intermediary, that manages borrowing and lending and interest payments. Lending out crypto to earn interest via DeFi is sometimes called yield farming. That 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 did some crypto lending firms run into trouble?
Lending money for someone else’s investments can be risky because if their bets turn 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 problems. Celsius made a big investment in a token called stETH that allowed it to stake on the Ethereum blockchain and earn additional returns through DeFi. The sharp drop in the value of crypto assets in May left stETH trading at a discount and the token became more illiquid. That made it harder for Celsius to raise money for redemptions when users wanted to withdraw their funds. In June, it halted withdrawals in an apparent effort to ward off the digital equivalent of a bank run.
6. What have regulators done about crypto lending?
Regulators and investor advocates worry that consumers don’t understand that they’re taking on much more risk than they would in a bank savings account. Because the crypto accounts aren’t FDIC insured, customers can lose their deposits if a firm goes bust, is hacked, or otherwise loses its customers’ funds. Few of the firms offering the accounts first sought approvals from US federal regulators, and that already led to a backlash. In July 2021, securities regulators for Alabama, Texas, New Jersey, Kentucky and Vermont brought actions against BlockFi alleging that the company was offering unregistered securities. Several of the same states brought actions 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 the SEC’s approval for accounts that pay clients high yields for lending out their crypto as part of a record $100 million settlement with federal and state securities watchdogs.
7. What could change now?
The crises at Celsius and others may accelerate the regulatory crackdown. Financial watchdogs appear to view crypto lenders as some of the lowest hanging fruit in their attempt to bring law and order to the broader crypto industry. After all, with firms like Celsius and BlockFi there’s a clear entity to sue, which is not always the case in DeFi transactions.
8. What happens if crypto accounts are deemed securities?
The designation opens the firms up to an entirely new regime of registrations and disclosure requirements to make the products safer. That would probably mean higher costs for the crypto firms, and possibly the end of those gargantuan returns for investors.
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