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Crypto’s Rapid Move Into Banking Elicits Alarm in Washington

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BlockFi, a fast-growing financial start-up whose headquarters in Jersey City are across the Hudson River from Wall Street, aspires to be the JPMorgan Chase of cryptocurrency.

It offers credit cards, loans and interest-generating accounts. But rather than dealing primarily in dollars, BlockFi operates in the rapidly expanding world of digital currencies, one of a new generation of institutions effectively creating an alternative banking system on the frontiers of technology.

“We are just at the beginning of this story,” said Flori Marquez, 30, a founder of BlockFi, which was created in 2017 and claims to have more than $10 billion in assets, 850 employees and more than 450,000 retail clients who can obtain loans in minutes, without credit checks.

But to state and federal regulators and some members of Congress, the entry of crypto into banking is cause for alarm. The technology is disrupting the world of financial services so quickly and unpredictably that regulators are far behind, potentially leaving consumers and financial markets vulnerable.

In recent months, top officials from the Federal Reserve and other banking regulators have urgently begun what they are calling a “crypto sprint” to try to catch up with the rapid changes and figure out how to curb the potential dangers from an emerging industry whose short history has been marked as much by high-stakes speculation as by technological advances.

In interviews and public statements, federal officials and state authorities are warning that the crypto financial services industry is in some cases vulnerable to hackers and fraud and reliant on risky innovations. Last month, the crypto platform PolyNetwork briefly lost $600 million of its customers’ assets to hackers, much of which was returned only after the site’s founders begged the thieves to relent.

“We need additional authorities to prevent transactions, products and platforms from falling between regulatory cracks,” Gary Gensler, the chairman of the Securities and Exchange Commission, wrote in August in a letter to Senator Elizabeth Warren, Democrat of Massachusetts, about the dangers of cryptocurrency products. “We also need more resources to protect investors in this growing and volatile sector.”

The S.E.C. has created a stand-alone office to coordinate investigations into cryptocurrency and other digital assets, and it has recruited academics with related expertise to help it track the fast-moving changes. Acknowledging that it could take at least a year to write rules or get legislation passed in Congress, regulators may issue interim guidance to set some expectations to exert control over the industry.

BlockFi has already been targeted by regulators in five states that have accused it of violating local securities laws.

Regulators’ worries reach to even more experimental offerings by outfits like PancakeSwap, whose “syrup pools” boast that users can earn up to 91 percent annual return on crypto deposits.

Treasury Secretary Janet L. Yellen and Jerome H. Powell, the chair of the Federal Reserve, have also voiced concerns, even as the Fed and other central banks study whether to issue digital currencies of their own.

Mr. Powell has pointed to the proliferation of so-called stablecoins, digital currencies whose value is typically pegged to the dollar and are frequently used in digital money transfers and other transactions like lending.

“We have a tradition in this country where, you know, where the public’s money is held in what is supposed to be a very safe asset,” Mr. Powell said during congressional testimony in July, adding, “That doesn’t exist really for stablecoins.”

The cryptocurrency banking frontier features a wide range of companies. At one end are those that operate on models similar to those of traditional consumer-oriented banks, like BlockFi or Kraken Bank, which has secured a special charter in Wyoming and hopes by the end of this year to take consumers’ deposits and custody of their cryptocurrency holdings — but without traditional Federal Deposit Insurance Corporation insurance.

On the more radical end is decentralized finance, or DeFi, which is more akin to Wall Street for cryptocurrency. Players include Compound, a company in San Francisco that operates completely outside the regulatory system. DeFi eliminates human intermediaries like brokers, bank clerks and traders, and instead uses algorithms to execute financial transactions, such as lending and borrowing.

“Crypto is the new shadow bank,” Ms. Warren said in an interview. “It provides many of the same services, but without the consumer protections or financial stability that back up the traditional system.”

“It’s like spinning straw into gold,” she added.

Lawmakers and regulators are worried that consumers are not always fully aware of the potential dangers of the new banklike crypto services and decentralized finance platforms. Crypto deposit accounts are not federally insured and holdings may not be guaranteed if markets go haywire.

People who borrow against their crypto could face liquidation of their holdings, sometimes in entirely automated markets that are unregulated.

BlockFi’s extraordinary growth — and the recent crackdown by state regulators — illustrates the fraught path of cryptocurrency financial services companies amid confusion about what they do.

BlockFi’s business is not dissimilar to that of a regular bank. It takes deposits of cryptocurrencies and pays interest on them. It makes loans in dollars to people who put up…



Read More: Crypto’s Rapid Move Into Banking Elicits Alarm in Washington

2021-09-06 16:31:00

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