BlockFi Agrees to Pay $100 Million Fine for Risky, Unregistered Investments

Cryptocurrency is an unregulated corner of the financial market. Because cryptocurrency markets are unregulated, uncertainty surrounds how governments and regulators will monitor and oversee cryptocurrency transactions.

On February 14, 2022, BlockFi became the subject of a Securities and Exchange order in which they agreed to pay $100 million in penalties to 32 states. These states allege BlockFi sold a security without registering the product with the SEC, as required by the Securities Exchange Act of 1933. BlockFi has also agreed to register their crypto lending product — BlockFi Interest Account, or BIA — with the SEC.

This is the first penalty of its kind. SEC Chair Gary Gensler stated, “[This] settlement makes clear that crypto markets must comply with time-tested securities laws, such as the Securities Act of 1933 and the Investment Company Act of 1940. It further demonstrates the Commission’s willingness to work with crypto platforms to determine how they can come into compliance with those laws.

What is BlockFi and How Does Crypto Lending Work?

BlockFi is a startup cryptocurrency exchange, where crypto investors go to buy and sell their digital currency. It also serves as a crypto lending platform. Digital investors with large amounts of crypto can lend their crypto holdings in order to earn high interest. This type of lending is known as “yield farming.” It can come with huge returns, but the risks are especially high. Investors have little recourse if their investments disappear. The SEC wants to make sure that investors understand these risks by making more information about BlockFi Investment Accounts public.

The SEC threatened to sue Coinbase if they offered a similar lending product, and Coinbase withdrew its plans. Other platforms have stated that they intend to sue the SEC and challenge its authority over cryptocurrency. In response, BlockFi CEO Zac Prince averred that’s not the path his company would take. He described BlockFi’s thinking to The Wall Street Journal, saying, “let’s find the right path within whatever existing frameworks we need to facilitate the products and services that add value to our clients.’”

What the SEC Wants the Public to Know

The SEC did not simply order BlockFi to pay a fine. The regulator also alleged that BlockFi had misled its investors and made a misleading statement on its website concerning the risk of its lending activity. This statement allegedly remained on the site for more than two years. The SEC also alleges that BlockFi operated for more than 18 months as an unregistered investment company.

What Makes a Product a “Security”?

The SEC defines a security as an investment contract — a monetary investment in a common enterprise meant to generate profit from the efforts of others. For a product to be a security, investors must have a “reasonable expectation” that their investment will generate interest. According to the order, BlockFi promised investors a variable interest rate.

The interest accounts were not simply accruing interest, as money would in an interest-bearing savings account. The cryptocurrency was lent to other crypto companies and the BIA account holders hoped to make a profit based on the efforts of those crypto companies.

According to the order, BlockFi also promoted the BIAs as investments. In an announcement, BlockFi stated that BlockFi investments could offer “‘an industry-leading 6.2% [annual percentage yield.,’ compounded monthly.” The order also states that on January 1, 2021, BlockFi allegedly advertised that it had “distributed more than $50 million in monthly interest payments to [its] clients.”

Cryptocurrency and a Lack of Regulation

Regulators have emphasized that their lack of regulation in the cryptocurrency space exposes investors to more potential harm. Additionally, if crypto fails, there is no insurance to protect investors. If a bank fails, the government’s FDIC insurance protects the customer’s money.

Cryptocurrency users also run the risk of a scam. If the borrower turns out to be a scammer who makes off with their crypto, there is very little recourse to recover the lost funds.

Because BlockFi now plans to register a security, the company must make information about its financials public. It cannot sell its investment product until it has completed the registration process with the SEC.

When a security registers with the SEC, they must disclose:

• The company’s properties and business
• A description of the security to be offered for sale
• Information about company management
• Financial statements certified by independent accountants.

These disclosures can be uncomfortable for companies that do not have strong financials, which helps the SEC prevent potentially risky securities from being offered to the public.

Should I Invest in Cryptocurrency?

Investors should know that as of March 2022, no cryptocurrency has registered as a security with the SEC. If you do invest in a cryptocurrency, you should only invest money you are prepared to lose. Because of its unregulated nature, cryptocurrency is especially vulnerable to scams.