Savers frustrated with the paltry yields offered by banks in recent years appeared to have found a solution: so-called crypto lending accounts that pay interest rates as high as 18%. Millions piled into these products offered by upstart firms including Celsius Network, introducing a whole new cohort of investors to cryptocurrencies. Now it appears some of those eye-popping returns may have been too good to be true. After amassing more than $20 billion in assets, including many people’s life savings, Celsius plunged into a solvency crisis that shook confidence in the largely unregulated world of crypto finance.
1. What is crypto lending?
At first blush, crypto lending accounts look a lot like savings accounts offered by banks, but with cryptocurrencies instead of traditional money. An investor opens an account, deposits cryptocurrency and earns interest. Many deposits are in Bitcoin, while other investors use stablecoins — tokens whose price is often pegged at $1. Others use lesser-known, more volatile cryptocurrencies. The accounts typically pay interest in the same currencies that are deposited. Some have rates that change daily. Others offer a fixed rate and the money is locked up for a fixed period.
2. How big is crypto lending?
It’s still tiny compared with traditional banking, but it’s been growing fast. Celsius said it had close to $11.8 billion worth of deposits on May 17, while BlockFi Inc. declared deposits of more than $10 billion. Gemini Trust Co. began offering accounts in February 2021 and said last August it had more than $3 billion in deposits.
3. How can they afford the hefty returns?
The firms that offer the accounts say they’re able to lend customer deposits to institutional investors at even higher rates. These institutions sometimes need to borrow crypto to execute their own trades, such as betting that the price of crypto will fall or to take advantage of price differences in other financial instruments. But regulators have said they believe some crypto lending firms are using the money for other business activities. Some may be investing customer funds in riskier crypto projects, making a profit on the bets and pocketing the difference. The bottom line is that there aren’t uniform rules for firms to disclose what exactly the deposits can and can’t be used for. The same goes for decentralized-finance, or DeFi, instruments that also lure crypto investors with sky-high interest payments.
4. How does crypto lending differ from DeFi?
Celsius, BlockFi and other crypto lending companies deal directly with their customers and pay them interest. With DeFi, it’s just some computer code, rather than an intermediary, that manages the interest payments. Lending out crypto to earn interest via DeFi is sometimes called yield farming. That in turn is different from staking, where holders of a cryptocurrency let their tokens be used to help order transactions on the blockchain, or digital ledger, that is used by that coin.
5. What happened with Celsius?
The trouble began after Celsius made a big investment in a staking token called stETH. StETH lets people — and companies like Celsius — stake on the Ethereum blockchain and earn additional returns through DeFi. A sharp drop in the value of crypto assets in May left stETH trading at a discount and the token became more illiquid. That made it harder for Celsius to raise money for redemptions when users wanted to withdraw their funds. On June 12, Celsius announced it was halting withdrawals because of “extreme market conditions,” an apparent effort to ward off the digital equivalent of a bank run.
6. What have regulators done about crypto lending?
Regulators and investor advocates worry that consumers don’t understand that they’re taking on much more risk than they would in a bank savings account. Because the crypto accounts aren’t FDIC insured, customers can lose their deposits if a firm goes bust, is hacked, or otherwise loses its customers’ funds. Few of the firms offering the accounts first sought approvals from US federal regulators, and that already led to a backlash. In July 2021, securities regulators for Alabama, Texas, New Jersey, Kentucky and Vermont brought actions against BlockFi alleging that the company was offering unregistered securities. Several of the same states brought actions against Celsius. Coinbase Global Inc. planned to offer similar accounts but dropped that proposal after the Securities and Exchange Commission said it might sue the company. BlockFi announced in February that it would seek the SEC’s approval for accounts that pay clients high yields for lending out their crypto as part of a record $100 million settlement with federal and state securities watchdogs.
7. What could change as a result of Celsius’s problems?
The crisis at Celsius may accelerate the regulatory crackdown. Financial watchdogs appear to view crypto lenders as some of the lowest hanging fruit in their attempt to bring law and order to the broader crypto industry. After all, with firms like Celsius and BlockFi there’s a clear entity to sue, rather than just some computer code as in some DeFi transactions. The SEC already more or less put an end to a boom in what were known as initial coin offerings, or ICOs, by entrepreneurs hoping to launch the next Bitcoin, when it ruled that most of the tokens counted as securities — shares of endeavors where investors pool funds and get returns that depend on the actions of others.
8. What happens if crypto accounts are deemed securities?
The designation opens the firms up to an entirely new regime of registrations and disclosure requirements to make the products safer. That would probably mean higher costs for the crypto firms, and possibly the end of those gargantuan returns for investors.
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