What BlockFi’s Regulation Really Means for DeFi

The Future of Regulation in Decentralized Finance

In short— the SEC hit BlockFi with a $100 million fine for failing to register the offers and sales of its retail crypto lending product. BlockFi allows you to earn interest on your crypto and take out USD loans against it. BlockFi’s products are not backed by US federal laws and regulations so technically customers accounts are not as safe as they would be with a Bank. The product offered by BlockFi is considered a security and therefore should be regulated as such by the SEC. (see SEC press release here)

This is the first regulation seen in the decentralized finance space since its inception. BlockFi has branded itself as an alternative to a “high yield” savings accounts offered by traditional banks, usually offering less than 1% interest for customers. BlockFi’s 4 - 8% interest on crypto assets is a no brainer when compared to traditional banks, but is this to good to be true?

BlockFi is not a bank and cannot fully “insure” a customer. BlockFi and Gemini (its custodian) are not FDIC or SIPC insured. However, Gemini does have a very large crypto holding and is regulated by the New York State Department of Financial Services.

BlockFi does not fall under the DeFi category as it’s products are controlled by a central entity. BlockFi falls under Centralized Finance (see DeFi vs CeFi here). Decentralized finance at its simplest form is the elimination intermediaries from the banking process. DeFi gives an individual direct access to participate in lending, borrowing, and trading through decentralized exchanges, not owned by a single entity. (read up on defi vs traditional banking). BlockFi is an entity that controls the lending and borrowing process bridging the gap back to traditional finance.

The SEC is slowly tightening its grip on regulating the CeFi/DeFi space. BlockFi is now creating a new SEC complaint product for US customers called BlockFi Yield (see BlockFi’s response here). This regulation is bringing the likes of BlockFi and CeFi back to traditional finance norms. There are no details of this new BlockFi Yield product, however if one were to assume the interest would be much closer to 1%, like traditional high yield accounts. The regulation provided by the SEC in BlockFi’s case has set a precedent that will apply to the other major players like FTX and Coinbase. Gurbir S. Grewal, Director of the SEC’s Division of Enforcement left a message for other lending platforms, “Crypto lending platforms offering securities like BlockFi’s BIAs should take immediate notice of today’s resolution and come into compliance with the federal securities laws.”

Those following the space saw regulation from the SEC coming, BlockFi has openly stated since their inception that they have been open to speaking with regulators regarding their financial products. This is good for protecting the clients of BlockFi, security is always important when creating new financial products and bringing the everyday person into crypto.

However, this is slowly chipping away at DeFi. First, “CeFi” institutions will be regulated and the movement back to traditional finance will occur. FTX and Coinbase will be next in terms of regulation for their interest bearing products, just like BlockFi.

How this spills over into DeFi is what I am most curious about. The space is not regulated yet and decentralized exchanges like Uniswap, SushiSwap, PancakeSwap, Curve and the like are still open to US users. Individuals can still contribute to all parts of banking in DEXes without the need of an intermediary. DeFi challenges traditional finance at its core, big banks and regulators do not like this challenge, so regulation of DEXes are inevitable. In what form? We will have to wait and see, but I can imagine DEXes becoming not accessible for US based users. I do not see regulation like this coming in the near term future (under 1 yr), however when this regulation comes it will be a large blow to the crypto market, particularly decentralized finance and ETH.

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