As and when a new cryptocurrency product is launched, the ecosystem buzzes with excitement, though the BlockFi’s interest-yielding deposit accounts have managed to mark itself as a pioneer in grabbing markets attention.
While BlockFI was founded in 2017, it started offering fiat loans with crypto collateral in January 2018 and it was in January 2019 that the firm grabbed the spotlight with its latest interest-yielding deposit accounts. The said product entices investors with returns of up to 6.2 percent annually for holding their bitcoin or either.
A beta version of the product was launched at the time, and it went fully live on March 5th. The product has been gaining traction since its launch, as per CEO and founder Zac Prince, the firm has already received deposit worth more than $35 million worth of crypto. Around 80% of it in bitcoin since January. A staggering $25 million of that gathered after the March 5 launch.
However, all of the crypto community is not in the happy zone, there have to be some skeptics and there are indeed some fair-share of skeptics. For instance, lawyer Stephen Palley pointed out via his Twitter account that while BlockFi is advertising 6.2 percent, the terms and conditions page of the product mentions that the company can modify the rate at its discretion.
BIG PRINT LANDING PAGE: "We will pay you 6.2 percent interest!"
Fine print terms of service: "We will pay you whatever we decide to pay you." pic.twitter.com/QmdP2AMq6N
— Palley (@stephendpalley) March 5, 2019
Another user pointed out that as the deposits won’t be insured as they would be at a bank, “your upside is limited to 6.2 percent whereas your downside is 100 percent” if BlockFi fails.
Obviously these accounts won't be insured by the FDIC…so if BlockFi's loan business goes bad, I guess that's the end of your crypto savings account.
In essence you're investing in their loan business, except your upside is limited to 6.2% whereas your downside is 100%.
— Ian Fisch (@Ian_Fisch) March 6, 2019
Caitlin Long, a Wall Street veteran went on to note that people who will deposit their crypto with BlockFi, expose themselves to a form of counterparty risk. Reserving the right to rehypothecate clients’ funds, re-lend collateral already pledged to another lender BlockFi may be inviting legal challenges in some U.S. states.
Here's a link: https://t.co/bkGRalVOvH. h/t @ObiWanKenoBit for bringing this to our attention. At least they're open about disclosing it, rather than trying to hide it. I wonder how many customers understand the counterparty risk they're taking on–I didn't see disclosure on that https://t.co/k6RE6WLrcS
— Caitlin Long ? (@CaitlinLong_) March 6, 2019
The System of lending fiat and borrowing crypto
In an interview with Coindesk, Prince talked about the controversial yet clear market interest in the product, how BlockFi’s business works, the company’s policies and how it manages risks,
The firm currently offers two products to retail customers:
- Cryptocurrency-backed loans and
- Crypto-funded interest accounts.
With the former, the consumer borrows U.S. dollars for one year at 4.5 percent interest, the collateral for the same is bitcoin, litecoin or ether. The borrowing limit is set up to 50 percent of what the pledged crypto is worth at the time. As for the interest account, the customer deposits bitcoin or ether with BlockFi and the asset starts to accumulate interest (denominated in crypto) every month.
As aforementioned, the annual compound interest rate for such accounts is kept at a lucrative 6.2%, notably, two to three times better than a U.S.Treasury bond or a U.S. bank saving account yield. However, the terms and conditions explicitly mention that the interest will be calculated by BlockFi at its discretion.
With that concern, Prince was asked if BlockFi utilizes any benchmark to determine the interest rate, similar to how a bank might use an index like LIBOR when setting the rate on a loan. To this Prince simply answered “No.”
He explained that the absence of any formula gives BlockFi the flexibility to change the rate and make it more attractive to potential users, as for now, the product doesn’t make money:
“The rate is a combination of the market and customer acquisition costs. This product will be for some amount of time, probably for for 3 to 18 months, a loss leader. We are OK with losing money for a while. If it was purely formulaic we probably wouldn’t have enough control to make sure it’s attractive enough to a large amount of people to hit our customer acquisition targets.”
In order to increase its user base quickly, BlockFi plans to roll out new products every six months. To raise capital for the same, the firm has already gone through several venture funding rounds, the largest one was led by Mike Novogratz’s Galaxy Digital – raising $52.2 million.) Prince explained:
“We believe that we will be able to continue raising venture capital supporting the growth and at a certain point down the road [when] we’re a much bigger company, maybe we’re a public company, then we can say: ‘Ok, we turn to profit now.’ We anticipate being able to raise larger and larger amounts of venture capital for a while, at least for the next couple of years.”
Another non-advertised action that BlockFi does is to lend crypto to financial institutions, Prince explained:
“We don’t really think of it being a product. We think of this as of something we need to do to be able to deliver our product to our core customer, which is retail.”
This element enables BlockFi to earn crypto, that can be used to pay interest to its retail depositors. Namely, most of the $35 million in deposit gathered is lent to institutional borrowers. Though the exact ratio is not disclosed, a bigger part of each deposit goes to the lending business and a smaller part stays as a reserve.
Prince added that the firm does not hold the cryptographic private keys controlling the funds, Gemini Trust, founded by Cameron and Tyler Winklevoss, has the custody for BlockFi’s clients and the power to move crypto from the depositors to the institutional borrowers. As per Prince, the BlockFi’s borrowers mostly belong to two groups, people trading bitcoin futures, and traditional financial institutions, i.e. majorly proprietary trading firms and market makers.
As for the terms of borrowing crypto, it varies on a case-by-case basis, the interest rate can be between 4 and 12 percent, and the fiat collateral can be between 110 and 150 percent of the loan amount. Individual ISDA agreements, a standard document governing over-the-counter derivatives transactions, governed the relationships with borrowers
While the terms for each loan vary, BlockFi reserves the right to call in the loan with one’s week’s notice, notably, the same amount of notice a depositor can give to withdraw crypto. The said clause ensures the company will always have enough crypto to meet withdrawal requests.
As and when the prices make a drastic shift towards the negative end, clients’ collateral will shrink, too, and the loan-to-value (LTV) ratio of the loans will rise from 50 percent to a higher number. On the other hand, if prices soar, institutional crypto borrowers will find their loans much more expensive to pay back. But Prince asserts that BlockFi has taken several measures to mitigate these risks.
As for the fiat loans, if at some point the amount of cash a retail client borrowed becomes equal to 70 percent of the collateral instead of 50 percent, to return to a safer LTV ratio, BlockFi will contact the client and give them 72 hours to either pay back the loan, add more collateral or take no action.
The third option will entail that BlockFi will sell a part of the collateral on an exchange or through an OTC desk and use it to pay down the loan and get the LTV “back into the safe zone,” as the terms and conditions page puts it. A similar mechanism works when institutional investors borrow crypto.
When the price of bitcoin goes up, and what they borrowed ends up costing more relative to the amount of cash collateral, BlockFi will contact them and ask them to add more cash. If the bitcoin price hits a certain preset level, which also varies from borrower to borrower, BlockFi can use the collateral to buy bitcoin and close out the loan. The terms for institutions, again, are highly dependent on the level of trust a particular client has. As Prince put it:
“If, say, JP Morgan wanted to borrow a million dollars from us, we probably wouldn’t need to take any collateral.”
Prince added that the loans are structured in a manner that if needed, BlockFi can chase after the deeper pockets behind a borrower.
“We’re making sure that we have passed through to a parent entity if we’re facing a subsidiary, in terms of a default.”
Legal and regulatory
Prince asserts that in case the borrower defaults, taking them to court isn’t a big problem. He elaborated:
“The legal structure we use to lend someone crypto is no different than we would use, say, to lend somebody USD secured by Japanese yen.”
BlockFi is a licensed lender in the states that require such regulatory compliance, the cash loans are now available in 47 U.S. states. BlockFi’s director of marketing Brad Michelson told CoinDesk:
“The biggest state we don’t support is Nevada because it requires you to have an office in the state, which isn’t something we plan on doing in the near term.”
He didn’t name the other two excluded states. The interest accounts are available worldwide, except the states of New York Connecticut and Washington and in any countries sanctioned by the U.S., the U.K. or the E.U. BlockFi doesn’t hold a New York State BitLicense and thus it lends but won’t take deposits there. Prince explained:
“For the crypto loans, we don’t believe we need a BitLicense. For the interest accounts, we don’t believe we need one either, but our opinion on that is not strong enough for us to offer it here.”