Putting a Block on BlockFi

03 Aug 2021

Centralized Finance giant BlockFi is currently dealing with serious scrutiny from four different states over its interest-bearing account. What are the implications of this? And what does it ultimately mean for DeFi?

The Lowdown

Maybe you’ve already been following the controversy over BlockFi ‘s recent regulatory woes, but just in case you haven’t, let’s briefly summarize the situation as it currently stands:

So BlockFi is a billion dollar Centralized Finance (or CeFi) company that basically functions as a crypto-version of a bank. If that doesn’t already start ringing alarm bells in your head, then you probably have a stronger constitution than most.

Anyway, they have this interest-bearing account, aptly named the BlockFi Interest Account (BIA) that lets users earn up to 7.5% APY on their crypto with interest accruing daily. And according to BlockFi’s site, there are no hidden fees, no minimum balances and no reasons to wait…

Unfortunately the states of New Jersey, Alabama, Texas and, more recently, Vermont, don’t share BlockFi’s sentiments…at all. According to a Market Insider article by Isabelle Lee, New Jersey, Texas and Alabama have accused BlockFi of failing to register their interest-bearing account with state regulators and that they ‘may be unregistered securities offerings.’

Over the coming days and weeks, BlockFi is due to face continued scrutiny and difficulties as these four states crack down on its business activities. Meanwhile BlockFi’s CEO, Zac Prince , maintains that BIAs are indeed legal and above board.

So Why BlockFi?

That really is the question on everyone’s minds right now. They definitely aren’t the only CeFi company in the cryptosphere, so why all the heat? Well, a little digging goes a long way, and some of the answers seem to be evident in this Cease and Desist Order issued to BlockFi by the New Jersey Bureau of Securities .

Point 9 on page 3 of the Order states that ‘The purported interest rates advertised by BlockFi are well in excess of the rates currently being offered by short-term investment grade fixed income securities or on bank savings accounts.’ It’s definitely a lot more than the latter. Right now, the APY on a standard Bank of America bank account is just 0.01%. ‘Well in excess’ is clearly an understatement.

But wait, there’s more! Point 25 on page 9 of the Order reveals that BlockFi’s terms effectively mean that investors relinquish all control over their cryptocurrency and that BlockFi may use these invested funds as it sees fit. As a result, anyone signing up for a BIA is a passive investor.

And get this: BlockFi doesn’t disclose any of the information about how funds are being used to its investors, or at least the New Jersey Bureau of Securities alleges.

The Order goes on to disclose that, while BlockFi does abide by the rules with regards to some of its loan products, ‘the BlockFi BIAs are not currently registered with any federal or state securities regulator.’ The Order therefore concludes that BlockFi sold unregistered securities and that it must cease and desist these activities on July 22nd 2021 (this date has since been amended to July 29th).

But again, why BlockFi in particular? It may simply be that the platform caught the attention of regulators first, but to assume that other platforms and crypto exchanges will simply be given carte blanche is naive at best. In fact, Binance has been the target of a veritable regulatory assault in recent weeks while Coinbase is facing security class action over its Nasdaq listing.

This doesn’t mean the BlockFi case should just be ignored. Quite the contrary, in fact. DeFi and CeFi companies alike should watch the BlockFi case closely since whatever rulings are made here could have far-reaching implications for Decentralized Finance and the crypto industry as a whole.

Bad News for DeFi?

According to an article by Andrew J. Bruck, the Acting Attorney General of New Jersey, BlockFi is a ‘decentralized finance platform,’ but if we’re being real here, BlockFi is anything but decentralized. Don’t believe me? Well, try out this Twitter post for size:

The above comment is in response to a Coindesk article by Preston J. Byrne that alleges that, since BlockFi is in the crosshairs of regulators, DeFi is next. And the main reason for this? Simply that some DeFi, uh…isn’t:

Aa Byrne goes on to articulate, if a system runs entirely on-chain with the aid of client side software, which cannot be altered without fundamentally reorganizing the chain, that is DeFi in the ‘truest sense.’ Of course not everyone agrees with this definition, but we’re not here to debate all the fineries of DeFi.

So does this all bode badly for DeFi? Not necessarily. In fact there are some in the cryptosphere who believe that the BlockFi case is exactly why DeFi is actually needed:

Guzmán’s observation is definitely one to take into consideration when looking at the implications of the BlockFi case. Unless you’re trusting and using the protocol itself, it ain’t DeFi. Is BlockFi DeFi? No. If smart contracts are not handling exchanges, and if participants aren’t making transactions directly with one another, it technically isn’t DeFi.

The consensus seems to be that centralization attracts regulation. It’s inevitable. If someone is running a financial services business and making money in the process, they will need to abide by certain rules and regulations. The potential consequences of failing to comply range from mild to severe, so if found guilty of what New Jersey and the other three states claim, BlockFi could well find itself in hot water sooner than later…but again, this depends on the ruling.

Yield Farming vs. BlockFi’s BIA

When considering BlockFi’s BIA and the 7.5% APY, you may well think that’s a great return. However, in the realm of DeFi, many would consider this a feeble rate at best. In fact, some DeFi aficionados are earning up to 100% APY and, in some extreme cases, up to 1,000%. Insane, right?

How then can BlockFi be on the chopping block but not DeFi platforms? First off, there are a few key differences. In simple terms, yield farming involves users locking up some or all of their cryptoassets into a smart contract which in turn lends them to other users. As a result, users earn interest on their locked amounts.

Now, remember how the whole BlockFi case means that anyone signing up is a passive investor? Well guess what? Anyone involved in yield farming knows (or at least should know) exactly what they are doing. They are therefore active investors. Yield farming is not easily accomplished and requires a good deal of strategizing and timing in order to be successful.

Yield farming is peer-to-peer (P2P) with no intermediaries while BlockFi’s BIA is handled by BlockFi with funds being used as they see fit. These activities and ‘products’ are by no means the same. Yield farming also comes with numerous risks including impermanent loss, decreasing interest rates as liquidity pools become more popular and some pools turning out to be scams (or in other cases, end up getting hacked). If things go south on DeFi, there is no customer help desk to help you get your moola back.

So No Regulations for DeFi?

Uh well, we wouldn’t say that. However, regulating DeFi is much more complicated than regulating centralized entities. The question is, as Carlo de Meijer puts it in a Finextra article , ‘What is there to regulate?’

For real, how do you regulate something that doesn’t really belong to anyone? Without getting into the gory details, we’ll summarize why DeFi regulation is very difficult to implement:

  • No intermediaries or third-parties
  • Decentralized networks mean there is basically no need for interactions with the legacy financial system
  • Governance tokens make classification challenging
  • DeFi runs on lines of code that execute automatically and are accessible via the internet
  • Sources of information regarding private and non-private cryptos beyond one or two transactions is extremely difficult to track and determine

Of course, DeFi may be tricky to regulate, but it’s not necessarily impossible. Having said this, DeFi has been created to bypass regulations and find solutions to longstanding issues within our financial system. Any form of regulation will therefore need to be balanced and well-thought-out lest DeFi simply evolve further to once again circumvent regulations and become even more difficult to control.

The Verdict

Regulation for crypto has been discussed for years, but it seems for many entities in the cryptosphere, that regulation is finally here. Crypto is not something governments and traditional entities can ignore anymore, and with the economic woes brought on by the Coronavirus, solutions are direly needed.

The results of the BlockFi case will certainly be important for DeFi and the world of crypto as a whole. However, not all regulation is necessarily bad, and with decentralization and anonymity, regulation is becoming much more difficult to institute.

My thoughts? It’s ultimately good news. Adversity is the mother of innovation, and so with new challenges come new solutions. Crypto has unleashed massive vaults of human potential and is opening up new paradigms for people all over the world. DeFi is far from dead: it’s alive and well and will still evolve considerably in the months and years to come.

Brynn is the Content Manager at ARK.io, lead DeFi writer for MarketSquare and die-hard metalhead. When not researching yield farming, he spends his time crushing demons in DOOM or shredding his favorite axe.

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