Risky business? States issue warnings over high-yielding crypto accounts

State regulators say some interest-bearing crypto accounts with billions of dollars in deposits appear to be unregistered securities that aren’t disclosing their risks to investors.

The warnings are coming from states as varied as New Jersey — a longtime financial outpost — Alabama and Kentucky, which are among states that have already brought actions against BlockFi Lending and its affiliates. The regulators’ focus makes the accounts the latest facet of the burgeoning crypto industry to attract government scrutiny.

Chris Ratcliffe/Bloomberg

These accounts offer yields on deposited Bitcoin and other cryptocurrencies that dwarf the returns from bank savings accounts. In some cases, the firms are offering annual interest rates of more than 7% on U.S. dollar “stablecoins,” which have a price fixed at $1. The national average interest rate for savings accounts is 0.06%, according to a survey by Bankrate.

Some regulators in interviews with Bloomberg said they are seeking information from other interest-paying crypto firms, which they did not name, and could possibly take actions similar to what they brought against BlockFi.

Some firms that pay interest on cryptocurrencies pitch themselves as alternatives to traditional financial products. Gemini Trust, founded by Cameron and Tyler Winklevoss, for example, says its Gemini Earn offers “up to 100x the average national interest rate,” comparing it to bank savings accounts whose deposits are insured by the federal government.

The firms that offer the accounts, including Gemini, and others such as Celsius Network and BlockFi, acknowledge in their disclosures that their accounts carry no such insurance. Some regulators say crypto firms aren’t doing enough to warn of the risks that investors could lose their principal. Some state regulators say the accounts look similar to securities that need to be registered at the state or federal level. Without federal insurance, investors could lose their money if the crypto firms can’t make good on those deposits.

Five state securities regulators in July brought actions against New Jersey-based BlockFi and its affiliates, ordering it to provide more information on its accounts or, in the New Jersey and Kentucky cases, to stop offering some products in the state. New Jersey has delayed the implementation of its cease and desist order three times and on Wednesday announced that BlockFi would have until the end of September to comply.

BlockFi in a statement on Wednesday said it was talking to regulators and that it believed its interest accounts are “lawful and appropriate for crypto market participants. We remain steadfast in our commitment to fight for consumers’ rights to earn interest on their crypto assets.”

In the BlockFi case, “what we as regulators saw was a company promising to pay investors high rates of return in a largely unregulated environment,” said Joe Rotunda, director of the enforcement division at the Texas State Securities Board. “We were not convinced that a federal regulator in the near future was going to do anything to help protect the clients of these firms. We felt we needed to act.”

Rotunda said his agency and those of other states are looking at firms with comparable business models with an eye toward tackling them with similar actions.

Crypto interest accounts have proliferated in the past year. BlockFi, one of the earliest entrants, says it has more than $10 billion in cryptocurrencies deposited earning an annual percentage yield of as much as 8%. Celsius says it has $20.5 billion in “community assets,” while Gemini launched such accounts in February and on Monday said it had $3 billion in deposits.

Federal regulators haven’t yet made substantial moves against the crypto savings accounts but have set their sights on the stablecoin market. Treasury Secretary Janet Yellen has expressed concerns that such coins could pose a risk to the financial system or be used to evade law enforcement. Her department planned to begin meeting with crypto firms and bank trade groups this week to talk about the concerns, according to a person familiar with the matter.

Products offered by firms such as BlockFi and Gemini are centralized at the companies. Regulators have also said they are concerned about yields offered through “decentralized finance,” or DeFi, where loans are brokered between crypto users without an intermediary.

For consumers, the accounts are enticing. At Gemini, for example, an investor can buy “Gemini dollars,” a stablecoin with a fixed $1 price, keep it on deposit and earn an annualized yield of 8.05%. The firm offers similarly high rates on dozens of other cryptocurrencies, including ones like Bitcoin, where the underlying price can rise or fall. The interest is paid in the form of the cryptocurrency that’s deposited.

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Some regulators say they’re concerned that investors aren’t always told what their deposits are used for, in what circumstances they could lose some or all of their principal, and how the crypto firms are making money themselves. Many, if not most, of the products should be registered with securities regulators, they said.

“The point is we need to know what they’re doing with everybody’s Bitcoin and where the money’s going and to have some regulation that accounts for it,” said Joseph Borg, who heads Alabama’s securities regulator and says the state is looking into several other firms with similar activities.

“You know what happens if one of these things fails? People are going to be calling my office and asking, ‘Why didn’t you do something?’” Borg said.

The firms offering crypto interest accounts have varying levels of disclosures around how much risk their investors are taking. Gemini says it partnered with institutional crypto investment firm Genesis Global Trading to offer the accounts and that the deposits are being lent out to institutional investors.

Gemini itself takes a cut, sometimes taking almost half the interest its partners pay, according to its fee schedule. Celsius in its risk disclosure says the company “deploys crypto assets held by it in a variety of income generating activities, including lending them to third parties and transferring them to external platforms and systems.”

Both companies acknowledge in their disclosures that the accounts don’t carry any insurance similar to bank savings accounts and that investors could lose money.

A Celsius spokeswoman declined to comment.

“They use this terminology that suggests it’s like a bank deposit when it’s not that safe at all,” said Alexis Goldstein, a financial policy director for the Open Markets Institute who testified on crypto at the House Financial Services Committee in June.

Gemini CEO Noah Perlman said his firm discloses the accounts’ risks but that no investors have lost money. He said Gemini works with regulators in New York, where it’s based, before launching new products and said he believes Gemini’s interest accounts are substantially different than those of BlockFi.

Gemini doesn’t disclose exactly what the loans are used for, but its partner Genesis says on its website that it offers crypto loans that allow institutional investors to bet that crypto prices will fall, to take advantage of arbitrage opportunities or hedge their risk, among other strategies.

The most recent extension from New Jersey’s state securities regulator gives BlockFi until Sept. 30 to stop offering its accounts in the state or register them as securities. A spokesman for the New Jersey regulator declined to comment. Kentucky brought a similar action that went into effect immediately. Other states have given BlockFi time to show why they shouldn’t be subject to such a restriction.