How BlockFi’s Regulatory Troubles Could Set a Precedent for All of DeFi

The Texas State Securities Board has filed for a hearing with BlockFi, over its crypto interest accounts. This is not the first time that BlockFi has been hit with legal troubles, as New Jersey has just issued a Cease and Desist, and the Alabama Securities Commission has issued a Show Cause Order, all relating to the same matter. The regulatory actions that will soon unfold could set the stage for the future of DeFi in the eyes of US regulators.

Issues Over BlockFi’s Interest Accounts

Let’s examine why BlockFi is facing this legal action. New Jersey (BlockFI’s home state), Alabama, and Texas have all taken issue with its BlockFi Interest Accounts (or BIAs). All three state regulators are treating these less like accounts and more like securities. The problem has arisen because companies can only sell securities if they are registered, but as BlockFi has never treated their BIAs as securities, they have never registered them as such. 

BlockFi has made it clear that they will be fighting these actions and defending their position that these are not securities, and that they are merely interest accounts. They have also noted that they will remain operational for all their existing clients.

Taking a look at some of the legal documentation, we can see why some regulators are concerned with these interest accounts. The Texas State Securities Board has argued that BlockFi has violated Section 7 of the Securities Act by offering securities without permission to Texans, and Section 12 of the Securities Act by selling securities within Texas without being registered as dealers or agents. 

However, for this to be true, BIAs would first need to be identified as securities. The Texas State Securities Board noted that Section 4.A of the Securities Act uses a broad definition:

“[to] include investment contracts, notes, and evidences of indebtedness– broad categories of products that capture the endless number of unique and innovative investment schemes continuously introduced into the market”. 

This is the issue at hand. Under this definition, BIAs certainly do seem like securities. Although, it is slightly more complex than that, as you can earn interest on fiat savings accounts issued by banks, and yet these are not considered securities. The main difference here may be that bank-issued savings accounts are seen as having minimal risk, whereas certain regulators may be treating BlockFi’s accounts as more risky due to them relating to cryptocurrencies (one of the most volatile asset classes in existence). 

This might seem trivial, but the SEC has spent a great deal of time and resources trying to draw distinctions between saving and investing, and they have argued before that the primary difference is that investing is risky, whereas saving has almost no risk at all. This is consistently discussed throughout the SEC’s guide to saving and investing. 

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What Does BlockFi’s Situation Mean for DeFi?

BlockFi may be a centralized financial company, but these regulatory actions may still have a negative impact on the DeFi landscape. It is no understatement that crypto lending is one of the biggest aspects of DeFi, with the main reason being that DeFi offers high interest on yields. This has led to many people earning money through the act of yield farming, which is where you gain a return for however much crypto you deposit into a service or pool. 

The issue is that, if BIAs are found to be securities, then practically every DeFi lending service could also get counted as one. This would leave these DeFi platforms in a strange position, as they cannot ever become registered as they are not exactly issued or handled by any entity.

The fact that DeFi tools and solutions are not issued by any individual could be the one thing that saves them from regulatory pressure, as Section 4 of the Securities Act requires agents, issuers, or brokers to register their securities. If something has no issuer, then it could be argued that it is not a security. 

This is a positive sign for DeFi, but it might not stop the SEC, and state regulatory bodies, from chasing after this industry. In fact, despite this fact, the SEC has spoken this year about DeFi, suggesting that they consider it as part of its jurisdiction. 

The SEC will not be able to shut down any DeFi project, as they run on blockchains rather than on centralized machines, and the SEC may be unable to legally define any DeFi lending options as a security, but it might not stop them from discouraging developers from making such services in the first place. The SEC could easily pressure developers and programmers located in the US against maintaining their lending platforms.  This would certainly pour cold water over the tremendous growth that DeFi has seen in recent times.

In the worst-case scenario, the SEC could even consider the makers of a DeFi platform as an issuer or dealer, and place the onus on them to register their services as securities. This would put DeFi in a state of limbo, as one of the hurdles of registering a security is that you must then monitor and scrutinize whoever uses those securities, which is an impossibility when creating a system that runs without any human intervention. 

While BlockFi is a more of a hybrid, but heavily CeFi project, the fact that regulatory bodies are going after it marks bad news for decentralized projects as it calls into question the nature of all crypto lending options. If the results of these actions are negative, then it spells bad news for DeFi, as they could be next in line to face regulatory woes.

Do you think BlockFi’s interest accounts should be considered as securities? Let us know in the comments!