Sun Sentinel Palm Beach Edition
Crypto firms acted like banks ahead of stunning implosions
NEW YORK — Over the past few years, a number of companies have attempted to act as the cryptocurrency equivalent of a bank, promising lucrative returns to customers who deposited their bitcoin or other digital assets.
In a span of less than 12 months, nearly all of the biggest of those companies have failed spectacularly. Last week, Genesis filed Chapter 11, joining Voyager Digital, Celsius and BlockFi on the list of companies that have either filed for bankruptcy protection or gone out of business.
This subset of the industry grew as cryptocurrency enthusiasts were looking to build their own parallel world in finance, untethered to traditional banking and government-issued currencies. But lacking safeguards, and without a government backstop, these companies failed in domino-like fashion. What started with one crypto company collapsing in May spilled over onto one crypto lending firm and then the next.
Further, government regulators started clamping down on crypto lending companies’ ability to advertise their services, saying that their products should have been regulated by securities regulators.
The collapse is reminiscent of the 2008 financial crisis, but on a smaller scale. There are no worries the crypto firms’ collapse will impact the broader economy.
Crypto lending companies like Voyager, Genesis and BlockFi were trying to do what banks do in traditional finance: take in crypto deposits, give depositors a dividend, and then make loans to earn a profit. It’s what the banking industry has done for hundreds of years, but with government-sanctioned currencies.
The biggest drawback to crypto lending is the lack of safeguards. There is no deposit insurance, government stopgap, or even a privately run entity to protect depositors if their crypto bank were to fail. This was fine when crypto prices were surging because the collateral banks were accepting was increasing in value. Demand for crypto deposits was so high, firms were willing to pay a yield of 10% of more on depositors’ crypto holdings.
But then crypto prices started falling and kept falling. Bitcoin plunged from over $65,000 in November 2021 to below $17,000 last November. As a result, much of the underlying collateral these firms were holding became worth less than the loans they had issued, effectively making several “crypto banks” insolvent.
The first two crypto lending firms to collapse were Celsius and Voyager Digital. The companies had been exposed to both falling crypto prices as well as risky loans made to crypto hedge funds like Three Arrows Capital, which went out of business in June.
BlockFi, another crypto lender, turned to thencrypto giant FTX and its founder Sam Bankman-Fried for a rescue. Bankman-Fried gave BlockFi a financial lifeline, one of several moves that earned Bankman-Fried plaudits as a savior or financial backstop for the crypto industry.
But FTX’s own bankruptcy in November, caused by high-risk lending to its affiliated hedge fund Alameda Research, caused BlockFi’s financial lifeline to wither. In a show of how intertwined these crypto lenders became, Genesis made billions in loans to Alameda.
Saddled with bad loans, many of these high-tech firms experienced a very old phenomenon: Depositors wanted their money back, and a bank run started.
As for what’s next, the tens of thousands of customers at these crypto lending firms are now waiting to see if their assets can be recovered or found in bankruptcy court, which could take months or even years. At Genesis, more than $900 million in customer funds are locked up in bankruptcy.
Further, the crypto industry seems to coming around to the idea of some sort of regulation.