For years, the crypto industry and the SEC have disagreed on whether crypto products that pay an interest-like yield are securities. That changed Monday when the SEC and BlockFi announced a deal to bring crypto lending in from the cold and turn it into a regulated product.
BlockFi agreed in a settlement with the SEC to pay a $100 million penalty for selling its crypto-lending product without registering it as a security. And it also said it plans to file with the SEC to register its BlockFi Yield product as a security.
The SEC had made its views on crypto lending clear in September when it forced Coinbase to drop its planned Lend product. That came a month after SEC Chairman Gary Gensler made a speech at the Aspen Security Forum in which he said that these products are securities and should be regulated as such.
While the SEC has other crypto issues on Gensler’s to-do list, such as regulating crypto exchanges, crypto lending seems to be at the top right now. According to some legal experts, that’s because it’s a slam-dunk issue for the SEC, where it doesn’t have to wait for congressional action and can instead rely on existing law, a legal principle called the Howey Test and a 2004 Supreme Court case.
BlockFi is one of the largest players in crypto lending and has been offering the service for some time, so it makes sense that the SEC would go after it. There are others such as Celsius and Nexo that offer similar services. Others convert fiat currency that customers deposit into stablecoins, on which there are a variety of ways to offer attractive yields.
With BlockFi agreeing to settle, it’s likely other companies offering crypto lending will either try to make their products compliant or face SEC inquiries.
There are only a small number of regulated crypto yield products, such as Circle’s Circle Yield and Compound Labs’ Treasury product. But unlike BlockFi’s, those are institutional products only open to accredited investors.
The SEC has approved some other crypto products, in January greenlighting a stock exchange, BOX Exchange, which uses blockchain technology. It also last year approved two bitcoin futures ETFs, Proshares Bitcoin Strategy ETF and the Valkyrie Bitcoin Strategy ETF, but hasn’t approved any ETFs that invest directly in cryptocurrencies.
The SEC’s work is far from done. One question it will face in reining in crypto lending: How do you regulate something that is not a company? A lot of crypto lending is happening in Web3’s DeFi (decentralized finance), meaning it’s outside of the conventional corporate structures the SEC is used to dealing with.
Many crypto-lending services operate as decentralized protocols, with no one company controlling them. Individuals working on them are often based overseas and may not be U.S. citizens. Some of the protocols were originally started by a company, but governance of the protocol is often shifted to token holders. As a result, it’s unclear how the SEC could shut these products down, even if it wanted to.
Investors will go where yields are high. Despite the Fed’s signaling of rate hikes, rates for traditional savings accounts are still relatively low. There is now more than $200 billion in total value locked or deposited on DeFi services. More investors, including large institutional entities, are making bets on DeFi. One product, Aave Arc, allows institutional investors to invest in DeFi with whitelisted counterparties.
Regulators haven’t directly addressed DeFi products. However, the SEC has reportedly looked at some companies that helped start DeFi protocols, such as Uniswap Labs, the company behind decentralized crypto exchange Uniswap.
The downside of the emerging regulatory regime for crypto lending is that it may send the savviest investors looking for the highest yields from truly decentralized services, out of the reach of regulators. But the upside is that SEC scrutiny and the resulting stamp of approval may bring a broader base of financial consumers looking for trustworthy products into the mix.