Crypto firms acted like banks, then collapsed like dominoes


NEW YORK (AP) — In recent years, a number of companies have tried to act as the cryptocurrency equivalent of a bank, promising lucrative profits to customers who deposited their bitcoin or other digital assets.

In a span of less than 12 months, almost all the largest companies have failed spectacularly. Last week, Genesis filed for Chapter 11, joining Voyager Digital, Celsius and BlockFi on the list of companies that filed for bankruptcy or went out of business.

This subset of the industry grew as cryptocurrency enthusiasts sought to build their own parallel world in finance untethered to traditional banking and government-issued currencies. But lacking guarantees and without government backing, these companies failed like dominoes. What started with the collapse of a cryptocurrency company in May spread to one cryptocurrency lending company and then the next.

Additionally, government regulators began clamping down on the ability of crypto lending firms to advertise their services, saying their products should have been regulated by securities regulators.

The collapse is reminiscent of the 2008 financial crisis, but on a much smaller scale. There are no concerns that the collapse of these crypto companies will affect the broader economy.

Crypto lending companies like Voyager, Genesis, and BlockFi were trying to do what banks do in traditional finance: accept crypto deposits, give depositors a dividend on their stored crypto, and then lend for profit. It’s what the banking industry has done for hundreds of years, but with government-approved currencies.

The biggest drawback of crypto loans is the lack of collateral. There is no deposit insurance, government stopgap, or even private entity to protect depositors if their crypto bank fails. This was fine when cryptocurrency prices rose because the collateral banks accepted in exchange for the loans increasing in value.

Demand for crypto deposits was so high that companies were willing to pay a return of 10% or more on depositors’ crypto.

But then the prices of cryptocurrencies started to fall and kept falling. Bitcoin, for example, plummeted from over $65,000 in November 2021 to under $17,000 last November. As a result, much of the underlying collateral these companies held was worth less than the loans they had issued, leading to the insolvency of several “crypto banks.”

The first two crypto lending companies to crash were Celsius and Voyager Digital. The companies had been exposed both to falling cryptocurrency prices and to risky loans made to cryptocurrency hedge funds like Three Arrows Capital, which was forced to liquidate and shut down in June.

BlockFi, another cryptocurrency lender, turned to then-crypto giant FTX and its founder, Sam Bankman-Fried, for bailouts. Bankman-Fried gave BlockFi a financial lifeline, one of several moves that earned Bankman-Fried plaudits as a savior or financial backer for the cryptocurrency industry.

But FTX’s own bankruptcy in November, caused by subprime loans to its hedge fund affiliate Alameda Research, caused BlockFi’s financial lifeline to dry up. BlockFi’s own bankruptcy became inevitable. In a display of just how intertwined these crypto lenders became, Genesis made billions in loans to Alameda.

Saddled with bad loans, many of these high-tech companies experienced a very old phenomenon: Depositors wanted their money back, and a run on the banks began.

WHATS NEXT?

The tens of thousands of clients of these crypto lending firms are now waiting to see if their assets can be recovered or they file for bankruptcy, which could take months or even years. At Genesis, more than $900 million in client funds are now bankrupt.

It is unclear if crypto lending will see a return any time soon. After FTX floundered, cryptocurrency exchange giant Binance announced that it would create its own fund to provide bailout financing for a troubled cryptocurrency company, an idea that has its roots in government-sponsored central banking or insurance. of deposits.

Furthermore, the crypto industry seems to accept the idea of ​​some kind of regulation, which would provide a minimum of guarantees to depositors or investors that does not exist at the moment. There were several bills pending in Congress last year, but with control shifting to Republicans in the House of Representatives, it’s unclear whether the GOP as a whole has an interest in regulating the crypto industry.

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