Since my nontrivial deposits at the cryptocurrency lending firm BlockFi have been blocked (maybe forever) from withdrawal, I keep an eye on news from that front. My main source of information has been missives from BlockFi itself, in which management portrays itself as being very careful with customer funds; it was only the shocking, unforeseeable collapse of the FTX exchange that forced the otherwise sober and responsible BlockFi into its recent bankruptcy. I have believed that view of things, since that is all I knew.
However, Emily Mason at Forbes has poked around behind the scenes, including finding insiders willing to talk (off the record) about less-savory doings within BlockFi. The title of her recent article, BlockFi Employees Warned Of Credit Risks, But Say Executives Dismissed Them, pretty much says it all. The article starts out:
In its bankruptcy filing last week, New Jersey-based BlockFi attempted to paint itself as a responsible lender hit by plummeting crypto prices and the collapse of crypto brokerage FTX and its affiliated trading firm, Alameda.
That is the view I have held up till now. However, Mason then goes on to note:
But a closer look at the company’s history reveals that its vulnerabilities likely began much earlier with missteps in risk management, including loosened lending standards, a highly concentrated pool of borrowers and unsustainable trading activity.
To keep this blog post short, I will just paste in a few excerpts where she fleshes out her case:
While the company regularly touted a sophisticated risk management team, current and former employees indicate in interviews that risk professionals were dismissed by executives preoccupied with delivering growth to investors. As early as 2020, employees were discouraged from describing risks in written internal communications to avoid liability, a former employee states.
Ouch. Not a good sign.
Until August 2021, BlockFi advertised that loans were typically over-collateralized. But large potential borrowers were often unwilling to meet those requirements, a cease and desist order brought by the Securities and Exchange Commission against BlockFi in February states. The availability of uncollateralized capital from competing companies like Voyager created stiff competition in the lending field.
Under pressure to continue growing and delivering yields, BlockFi began lending to these parties with less collateral than publicly stated without informing customers on the amount of risk involved with interest accounts, according to the SEC order which resulted in a $100 million fine for the company. As a result, BlockFi paused access to its interest accounts in the U.S.
Wait, that is MY money they were messing with. Now I am really annoyed.
In addition to lowering its collateral requirements, BlockFi’s due diligence process had flaws, former borrowers say. Available credit for borrowers was decided based on their assets, but BlockFi and other lenders failed to investigate both the size and quality of potential borrowers’ holdings. Like Voyager and other crypto lenders, BlockFi accepted unaudited balance sheets from hedge funds and proprietary trading firms former borrowers say, leaving room for manipulation on the borrower side.
In the due diligence process, lenders like BlockFi and Voyager did not examine whether borrowers’ balance sheet assets were denominated in dollars or less liquid tokens like FTX-issued FTT.
… The revelation that Alameda’s balance sheet was mostly FTT tokens was the news that set off the unraveling of both Alameda and FTX and triggered contagion effects across the industry. In early November, Alameda defaulted on $680 million in loan obligations to BlockFi, according to the bankruptcy filing.
Some BlockFi employees reportedly warned of the shakiness of the parties to whom clients’ finds were being loaned. Management dismissed these concerns because the loans were “collateralized”, but as noted above, the extent of that collateral was *not* what we clients were told:
… An internal team at BlockFi also raised concerns that the borrower pool was too concentrated among a pool of crypto whales, including mega hedge funds Three Arrows Capital and Alameda, another former employee states. Management responded that the loans were collateralized, according to the employee.
This is a very common scenario in finance: In search of profits, management cuts corners and takes more risks with client funds than they were telling the clients. Maybe Sam Bankman-Fried will up with cell-mates from BlockFi.
Because BlockFi survived the Luna/Terra collapse some months ago and because I believed the steady stream of reassuring pronouncements from BlockFi management, I only withdrew a third of my funds back in the summer. But as it turns out, that withdrawal was apparently bankrolled by a big loan to BlockFi from Bankman-Fried’s FTX; but FTX is now caput. So the odds of my ever seeing the rest of my funds are slim indeed:
In BlockFi’s bankruptcy filing and in public statements made by its CEO, Zac Prince, the company points to its survival through the collapse of the Terra/Luna ecosystem and subsequent shuttering of Three Arrows Capital as evidence of strong management. But that endurance four months ago was made possible through a $400 million credit line from now-defunct FTX, which allowed the firm to meet panicked withdrawal requests from depositors. When FTX folded in early November, BlockFi lost its lending back stop and could no longer meet fresh waves of withdrawal requests.
One lesson learned: If there is a reasonable chance of a panic, it can pay to be the first to panic, not the last.
So…. are there any players in the crypto space that are still investment worthy? Or is this the final nail in the coffin of Crypto 1.0?
I am no expert here, but my read is that Binance is solid. I think they simply hold clients’ deposits — it’s really not that hard, just don’t get cute. But it’s just that everyone else played around with clients’ funds in an attempt to make a buck. This is always an issue with custodied assets, whether crypto or otherwise. But whether you can buy stock in Binance , I don’t know. They promote their own in-house token , BNB, which may (or may not) rise in value.
Coinbase also does not lend out customers’ assets, but as a company Coinbase is losing money, with no good path to profitability. You can buy stock in it ( COIN) but it keeps going down.
For the moment, you can buy into Ethereum coin at Coinbase, and let them “stake” it for you, and you can earn like 6% interest on that. (Without going into details, staking on Ether chain is a pretty safe bet, better than lending it out). But…(a) Coinbase is probably not stable long term, and (b) the price of the Ethereum you are holding flops up and down.
Much easier to just buy some shares in , say Ares Capital ARCC and sit back and collect 10% dividends with no fuss.