How are regulations affecting the DeFi market?

DeFi market

What is going on with all these crypto companies coming under heavy SEC investigation?

BlockFi, for example, is paying $100 million $50 million to the SEC, and an additional $50 million to over 30 states for giving out interest and operating as a non-Registered Investment Company. 

Now, it’s no secret that crypto companies and the SEC don’t exactly see eye to eye. And that’s a problem because it seems like the SEC wants to regulate crypto by labeling these lending products as securities. 

Now, just this morning, BlockFi sent out an email to everyone, that there are going to be huge changes coming to interest rate-bearing accounts. And unfortunately, BlockFi is not the only company that the SEC is targeting, they’re also heavily pressuring Celsius, Gemini, CoinBase.

They threatened Coinbase with a lawsuit if they didn’t cancel the land product. So things are heating up. 

What are all of these new changes in the United States and how this will affect people’s personal accounts?

And even if you’re not a customer of BlockFi, this is super important because this will affect the whole industry. To sum up BlockFi’s latest announcement: transferring any new assets inside of BlockFi will no longer be eligible to earn interest. So who does this affect? The citizens that are under US federal regulation. 

So if you’re not a US citizen, this does not affect you, and everything works exactly the same way. But if you are and you do have a BlockFi account that’s earning interest, then your account will still be fine. Nobody will delete it, and the interest that you’re getting paid right now as far as all of the cryptos you have will still continue to be paid. But any new crypto that you transfer inside of your account will no longer pay any interest. 

Also, if you’re creating a new account in the future, your account will not be eligible to earn interest until BlockFi applies with the SEC and receives approval. 

Your BlockFi account has two wallets, the BIA the BlockFi interest account, and the trading wallet. Up until now, you could have all of your trading activity inside of your trading wallet. And then when you were ready, you could move that crypto inside of your interest account in habit earn interest. But now that won’t work. The moment your crypto leaves your interest account, you will not be able to move it back to have it earn more interest. That account you have right now that’s still earning interest is grandfathered in. But the moment assets leave that account, you will not earn interest. 

How did BlockFi get in trouble with the SEC in the first place, you ask? 

The reason that the SEC is becoming involved now is that these crypto companies that pay us an interest are becoming more and more popular. Some of them, for example, can pay us as high as almost 10% payout. That’s more money than you would expect to make in the stock market per year. And the way they can do this is by charging their clients a high interest. The clients are supposedly institutions and big companies. But we don’t know that for sure. We just have to take their word for it. Because SEC has not regulated these companies. And as long as there’s a demand for crypto, there will always be a demand for liquidity and stable coins. 

Another important point to remember is that crypto is competing with big banks. 

And crypto is technically winning because the national average on a savings account is yielding 0.6% per year. So of course these crypto companies are becoming so popular that the SEC appears on the horizon every time without a single fail. 

Maybe the SEC is starting to worry that these high-interest rates are not sustainable?

The answer is yes and no high-interest rates can exist in crypto because of strong demand. If there’s no demand because of a crypto bear market or winter, that’s when the demand goes down and the prices fall. And when prices fall, people get scared. When people get scared, there’s less of an appetite to take risks and borrow money. And that’s why liquidity and stable coins become less desirable. So rates go down. This is also true in the opposite direction where the market goes up. People get FOMO they want to buy in, they have more risk, they have an appetite. So they borrow more money, interest rates go up.  

Moving forward BlockFi says that as soon as the SEC approves their registration, that’s when they can start paying interest. I’m not holding my breath about this because at the bottom of their disclosures page, here’s what they said we have not yet filed or confidentially submitted a registration statement with the SEC and there can be no assurance that such a registration statement, when filed, will be declared effective. 

The BIA has not been registered under the Securities Act. All of this means is that they haven’t even filed their application yet. And even if they did, there’s no guarantee the SEC would allow it. 

BlockFi did recently publish an article saying that they have the intent to file, and we are inclined to believe them. But it’s still strange because this is not a new problem, which suggests that the process is going to take a really long time because BlockFi is still trying to figure it out with the SEC. And that is still a risk we should be aware of. 

That brings us to the ultimate point of this article, which is:

What happens if the President of the US says that you can’t make interest in crypto anymore? 

All forms of crypto lending are some form of security if something like that were to come to action, the first thing that would happen is prices would fall very hard and very fast. And that would be bad because it would trigger a wave of liquidations or sell-offs. And that would drop the price, which would trigger another wave of liquidations and sell-offs until we get a price spiral that just keeps dropping again, and again, however that’s not even the biggest threat. 

The biggest threat is whether the stable coins will still be worth $1 if something like this were to happen because a lot of people joined the crypto space to earn interest. But if the government all of a sudden announces that people can’t do that anymore, the first thing that would most likely happen is people would run for the exit as they desperately try to convert their stable coins to dollars, and we would get a run on the bank. 

And that would be catastrophic.

If there’s not enough liquidity, because people are too busy selling everything and no one is buying, then it’s very possible that the price of a stable coin drops below the $1 benchmark.

One of the measures we have to protect against this from happening is long transaction times. Ever noticed anytime you move crypto from one place to another, a lot of times they make you wait 24 hours? That’s partly because they want to protect your identity. But the real reason is that they want to make sure people aren’t just going to run to the bank and sell everything leaving the accounts empty. 

So the way they do this is something the industry calls “over-collateralization”. And this is just a fancy word, meaning that any loan is backed by more money than what is borrowed. So for example, if you want to borrow $100 from a friend, your friend will ask you to give them $200 of your money first, that way, your loan is collateralized two-to-one. And the more your loan is collateralized, the safer you are. Because if you choose not to pay your friend back, it’s okay since they get to keep $200 of your money. And you still get to run your business. And there’s still enough liquidity. That’s how it’s supposed to work in a regulated environment. 

But crypto is not regulated, which means that we have to trust these companies to make sure they’re honest in telling us exactly how safe our loans are. We’re lending our money out, thus that’s how those companies pay us that interest. 

Going back to the SEC settlement disclosure document, there’s one quote in there that is alarming.

It says block five misrepresentations about over-collateralization are serious. 

The document does go on to say that the hundred million dollar fine is still a lot of money. The blocked fine did overstate exactly how over-collateralized those loans are, because of course they would tell us our money is safer than it actually is. Certainly, BlockFi is not the only company that does this. But that is why the SEC sets off the alarm. It aims to regulate the crypto space. 

If the government allows companies to do whatever they want, that could potentially hurt a lot of people. That’s why establishments like SEC need to ensure that those companies are doing everything appropriately. 

Although BlockFi is a pioneer in the field and has tons of support from early adopters, the regulations are ultimately a good thing, because they help protect people. Also, regulations require financial institutions like BlockFi to disclose all of the important information. So if you want to earn interest on your deposits, you should be able to know exactly where your money is being lent out how much it’s over collateralized and where that money is being allocated to, so that you can assess that safety risk for yourself. 

But as far as the price goes, in the short term, expect some market volatility, as people wait to see what the US President does with his executive order. 

But in the long term, this is not a reason to run and sell everything because this is a process that crypto needs to go through historically, legally, financially. As for SEC, their actions aim at helping, understanding, and it’s just unfortunate that sometimes big banks do get in the way when they start “bribe lobbying”. But eventually, everything works itself out because crypto does not need anyone’s permission. 

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