How BlockFi’s $100M SEC Settlement Creates New Standard for DeFi
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How BlockFi’s $100M SEC Settlement Creates New Standard for DeFi

Will legislators take heed from the SEC in how it treats digital assets and simply enact its practices?
Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.

While Congress holds hearings on how to define digital assets, the SEC took this task upon itself recently. The first major ruling is that common DeFi lending protocols must register as securities products—something that’s notably not applicable to banks.

Agenda-Setting Settlement Ruling Against BlockFi

On February 14, 2022, the Securities and Exchange Commission (SEC) dropped its charges against BlockFi. The popular FinTech company specialized in streamlining lending products to the public, at much higher interest-bearing rates than banks. However, because these products are cryptocurrency-based, the SEC interpreted them to violate the Investment Company Act of 1940.

Simply put, the SEC charged BlockFi for selling unregistered securities, despite the lack of legislative framework on what can be considered a security in the crypto world.

Nonetheless, instead of fighting the SEC’s interpretation, BlockFi decided it was worth settling the charges instead. In summation:

  • $50 million agreed on as a penalty for unregistered offers and sales of a lending product. Namely, its BlockFi Interest Accounts (BIAs).
  • Another $50 million to pay fines across 32 states for settling similar charges. BlockFi has been battling individual states throughout the last year, resulting in certain services being unavailable to American citizens.

This totals to $100 million BlockFi has to pay the SEC and other regulatory agencies. For the crypto/FinTech space, the severity of the fine is a new milestone. This is no coincidence, as the SEC hints that fines serve as legislating through penalizing. In other words, the SEC is setting a new standard that others should follow in this hazy area of poorly defined digital assets.

“Crypto lending platforms offering securities like BlockFi’s BIAs 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

How Does a $100 Million Settlement Compare to the Non-Blockchain World?

Last year, in fiscal 2021, the SEC issued $3.9 billion in fines. This was a 20% decrease from 2020 when the SEC charged a record $4.7 billion. The bulk of these fines comes from settlement agreements.

When dealing with the SEC, most companies choose to settle in order to avoid the costly legal process and remove business operating uncertainty. Furthermore, the SEC has the authority to negotiate not only settlements but waivers as well, which are granted exemptions made for the greater market good.

“Unfortunately, the public discussions about the SEC’s waiver decisions sometimes do not recognize these important distinctions and can take on a political tone that can blur the analysis.”

Mary Jo White, 31st SEC Chair from 2013 to 2017.

In the world of US finance, it is commonly said that paying SEC fines is the cost of doing business. One of the largest ones was issued in 2010 to Goldman Sachs at $550 million for misleading its investors about subprime mortgage products. More recently, in December 2021, JPMorgan had to pay $125 million for failure to keep records that violated federal securities laws.

Interestingly, the SEC doesn’t just penalize. In 2020, the agency rewarded a record $114 million to whistleblowers, dipping from its deep settlement treasury. Overall, by placing BlockFi in the same range as JPMorgan, both the crypto maturity and regulations are lining up with each other.

The question is, what are the implications of this record-busting $100 million BlockFi settlement?

BlockFi’s Disrupting Influence

The settlement itself is no surprise given that the SEC had previously forced Coinbase to give up on its Lend program, effectively identical to BlockFi Interest Accounts (BIAs). And this happened despite Coinbase’s tight entanglement with law-enforcement agencies.

Alongside DeFi protocols, both companies are making the banks look bad by offering up to 15x higher interest-bearing accounts. While the high-end national savings account average is 0.06% in banks, these FinTech vanguards are offering up to 9.25% across various stablecoins and cryptocurrencies.

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BlockFi became particularly successful due to its massive venture capital (VC) funding of $450 million so far, led by Bain Capital Ventures, which allowed the company to simplify and streamline the platform. One only needed to deposit a sum in chosen cryptocurrency and wait for yields.

There are multiple reasons why there is such a huge disparity between banks and these FinTech platforms:

  • The demand on the borrowing side is greater than the lending supply.
  • Borrowers, mostly from the corporate sector, have high collateral, allowing BlockFi to outcompete banks.
  • As a streamlined platform with fewer operating costs than banks, BlockFi gives more of its cut to account holders, making it much more compelling.

The difference is, banks offer the same lending products as BlockFi, but don’t have to register them as securities. However, they do offer FDIC insurance, while BlockFi doesn’t. This is where the SEC saw its entry point to rebalance the waning usefulness of banks.

The agency interpreted the pre-WWII laws, when no digital technology existed, to apply to BlockFi’s interest-yielding accounts. In the absence of legislation that would align with the nature of digital assets, the SEC took this leeway to its maximum. After all, the current SEC Chair happens to be Gary Gensler, a former Goldman Sachs banker.

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BlockFi’s Settlement: A De Facto Regulatory Clarity

As previously noted by the SEC itself, the stated goal of such a high fine is to set a precedent for other DeFi/FinTech platforms to follow. By nature, business is an exercise in planning, therefore, regulatory clarity is critical for those plans to even emerge. Moving forward, just like BlockFi, companies will have to:

  • Choose between catering to US citizens or focusing on international ones. The latter is in a much better customer position, as BlockFi never interrupted its service for non-US accounts.
  • Register their product as a security, which means acting as a publicly-traded company via S-1 form under the Securities Act of 1933. This would give the SEC oversight over its operations.

The good news is that companies that follow the second route will completely neutralize the likes of Sen. Elizabeth Warren and her “shadowy faceless groups of super-coders”. This line of argument falls flat when a platform is fully auditable and transparent in all of its operations.

Moreover, there is clearly a pent-up demand for high-yielding interest rate accounts. More flexible FinTech firms like BlockFi have the expertise to make it profitable even under the greater regulatory burden. Hence, why the $100 million settlement transpired in the first place.

In light of this, it remains to be seen how truly decentralized platforms will perform in the future. If one goes by social media dynamics, decentralized platforms tend to remain by the wayside, while centralized ones gain more and more customers over time because of greater perceived legitimacy.

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Do you think it will be harder or easier for US citizens to access DeFi services? Let us know in the comments below.