What Is Cryptocurrency Lending And Why Regulators Are Against It

September 30, 2021

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What Is Cryptocurrency Lending And Why Regulators Are Against It

Investors become more and more frustrated by the low profitability of brick-and-mortar bank deposits but those who are unwilling to accept market risks, seem to have found a solution: so-called crypto-credit accounts that offer interest rates of 9% and higher.

According to Bloomberg, Celsius Network and BlockFi Inc. believe that such accounts will become a popular digital product that will attract many cryptocurrency investors. Bitcoin trading is considered volatile and risky, so online companies offering pseudo-crypto interest-bearing accounts claim that they offer a more stable source of income for passive investors. Celsius, BlockFi and Gemini interact directly with their clients and pay them interest, calling it “centralized financing”. Some investors get similar returns on deposits in "decentralized finance" or DeFi protocols, where the interest payments are controlled by computer code rather than an intermediary. Lending in cryptocurrencies for interest through DeFi is sometimes referred to as “profitable farming”.

Aspiring crypto firms said they have already collected more than $35 million in crypto deposits. Traditional financial companies and regulators are unhappy. They claim that crypto-credit accounts are much riskier than they seem to be. Also they claim that such accounts are being offered illegally. This rising conflict adds new oxygen to the already raging regulatory tightening and rise questions about the place of cryptocurrencies in the U.S. financial system.

At first glance, crypto credit accounts are very similar to savings accounts sold by banks. But instead of traditional money, they accumulate cryptocurrencies. An investor opens an account, deposits cryptocurrency, and receives interest. Many deposits are nominated in Bitcoins. Also widely used are stablecoins and lesser known cryptocurrencies with higher volatilities. Some accounts offer daily rate changes, while others are featured by fixed interest, implying money being locked for a certain period of time. For example, as is the case with a certificate of deposit.

Crypto credit accounts usually provide yields that outperform traditional banking. The average bank savings rate at the end of August was 0.06% in Europe. The Celsius network, for example, says it can pay 8.88% on deposits in some stablecoins.

This new area of the crypto business is already big and growing rapidly. The above-mentioned Celcius, one of the largest in the industry, said that its total deposits are valued at more than $20 billion. At BlockFi Inc. claim to have over $10 billion in deposits. Gemini Trust Co. started opening accounts in February and says it now has over $3 billion in customer deposits.

The account providers say they use customer deposits to lend to institutional investors at even higher rates. Institutions sometimes have to borrow cryptocurrency to make their own transactions. For example, for short selling or arbitrage. However, regulators have noted that some crypto lending firms are using the money for other activities. The bottom line is that there is no uniform information about what exactly deposits can and cannot be used for, which remains the main and most valid concern to date.