The record-breaking $100-million fine could mark the dawn of a new era for crypto lending platforms.

It might seem unlikely that BlockFi founder and CEO Zac Prince would describe a prosecution that resulted in a $100-million fine for his company as “a win not only for BlockFi but for the broader cryptocurrency industry,” but that is indeed what he said. And, he might be right, although it remains to be seen for now. 

The settlement

Founded in 2017, BlockFi is a New Jersey-based crypto financial institution with a team of 850 and one million clients worldwide. Its popular BlockFi Interest Account product, with half a million users, including 407,000 in the United States, was the object of a cease and desist order from the Securities and Exchange Commission (SEC) and 32 state attorneys general on July 20, 2021. A statement at that time by the NJ Attorney General’s Office alleged that BlockFi was “selling unregistered securities in the form of interest-earning cryptocurrency accounts that have raised at least $14.7 billion worldwide.”

On Feb. 14, the SEC announced that it had charged BlockFi with “failing to register the offers and sales of its retail crypto lending product.” BlockFi was also charged with misleading investors by stating that its institutional loans were “typically” over-collateralized when, in fact, no more than 24% of the loans ever were. In the order instituting proceedings, it is noted that this is “an operational oversight” that happened after it became clear that large financial institutions were simply unwilling to overcollateralize their loans.

Finally, a settlement was reached under which BlockFi agreed to pay a $50 million penalty to the SEC and another $50 million to the 32 states without admitting wrongdoing or liability. In addition, BlockFi would “attempt to bring its business within the provisions of the Investment Company Act within 60 days.” In the meantime, U.S. clients cannot add funds to their BlockFi Interest Accounts and new accounts cannot be opened in the U.S. or by U.S. persons. The company said it would create a new SEC-compliant lending product, BlockFi Yield, and BlockFi Interest Accounts will be converted to the new product.

First past the post

There is BlockFi’s win: It will be regulated.

Troutman Pepper partner Stephen Piepgrass, whose areas of focus include state attorneys general, called the progression of events “the natural evolution of any business.”

“First they operate in a gray regulatory space, then those who can comply come into the light,” Piepgrass told Cointelegraph. By being the first to reach regulation, BlockFi can “help negotiate new conditions” to its advantage.

Piepgrass assures that there is more still going on behind the scenes with efforts by the SEC and state attorneys general to regulate crypto lending. Some activity has already been seen. Coinbase was dissuaded from opening its Coinbase Lend product by the threat of an SEC lawsuit last year. Celsius, Gemini and Voyager Digital are known to be under SEC review.

“Crypto lending platforms offering securities like BlockFi’s [Interest Accounts] should take immediate notice of today’s resolution and come into compliance with the federal securities laws,” Gurbir S. Grewal, director of the SEC’s Division of Enforcement and former New Jersey attorney general, said in the announcement of the settlement. “Adherence to our registration and disclosure requirements is critical to providing investors with the information and transparency they need to make well-informed investment decisions in the crypto asset space.”

Rocky path to compliance

Not everyone agrees that this is an unalloyed win for the cryptocurrency industry or for cryptocurrency users. SEC commissioner Hester Peirce, in a dissenting statement on the BlockFi settlement, pointed out potential outcomes that would be somewhat less than victorious. “Rather than forcing transparency around retail crypto lending products,” she wrote, “today’s settlement may stop them from being offered to retail customers in the United States.”

Peirce also noted the complexity of meeting the provisions of the Investment Company Act and called the proposed 60-day timeframe, even with a 30-day extension, “extremely ambitious.” She could have added that there is no guarantee that the new BlockFi Yield product will be approved.

Philip Moustakis, former SEC Division of Enforcement senior counsel and currently counsel at Seward & Kissel, called the BlockFi prosecution “a shot across the bow of crypto lending platforms.” The case is important, he said, as BlockFi is the first “sizable, significant” crypto lender to be prosecuted.

Moustakis told Cointelegraph he would have liked to see a “more explicit pathway to compliance.” Without “a broad-based enforcement action […] with concrete carrots and sticks,” he said, the SEC may be forced to investigate crypto lending platforms individually.

For the SEC, Moustakis said, the BlockFi case represents “the next level of difficulty” in its ongoing push to regulate cryptocurrency. The $100-million fine is being hailed as the largest ever paid by a cryptocurrency company.

It will take some time to see the full impact of the SEC’s prosecution of BlockFi. But, the repercussions have already started. Nexo reportedly stopped paying interest to U.S. users of its Earn Interest product on Feb. 18. The company said its Earn Interest product “in its current form will not be available for new clients, until the restructuring of the Earn Interest Product and the registration process with the relevant regulatory bodies are finalized, as per the recently received guidance.”

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