On February 14, the SEC announced a settlement with BlockFi Lending LLC (BlockFi), a crypto service provider, further showing the increased legal scrutiny in this area in terms of regulatory action, joining the Consumer Financial Protection Bureau (CFPB)’s settlement with Lendup Loans, LLC (LendUp) and civil suits such as that involving PoolTogether, Inc (PoolTogether).
The SEC raised issues such as the presence of alleged false statements and investor protection, and charged the company with violating laws such as the Securities Act of 1933 and the Investment Company Act of 1940. Additionally, BlockFi agreed to pay penalties and fines totaling $100 million.
While it may be true as SEC Chair Gary Gensler stated, that the matter involved “the first case of its kind with respect to crypto lending platforms,” it is also important to note that the SEC didn’t find fault with the use of crypto-backed loans themselves, but instead with matters relating to procedure, such as the failure to register its lending product, which were capable of being remedied.
This was arguably, similarly seen to be the case in terms of the nature of the Complaint brought against PoolTogether and in the CFPB’s settlement with LendUp, which is significant as underlying innovative approaches and the use of new technology can presumably continue once brought into compliance with applicable laws and regulations.
The Innovative Approaches used by BlockFi, PoolTogether and LendUp
According to its site, BlockFi offers “USD loans collateralized by [users’] crypto assets,” explaining that the company provides U.S. dollars in exchange for users providing Bitcoin (BTC), Ether (ETH), or Litecoin (LTC) as security for repayment.
It further explains that obtaining a crypto-backed loan is “similar to obtaining a traditional collateralized loan,” with crypto holdings serving as collateral in the place of a more traditional personal asset.
Its stated goal is to “provide credit services to markets with limited access to simple financial products,” and says that it differs from other crypto service providers by “pairing competitive rates with institutional-quality benefits.”
According to its website, PoolTogether as a protocol, is a “decentralized open source blockchain based prize savings account,” that offers all depositors a chance to win prizes without needing to risk their deposited funds.
Said to replicate “no-loss lotteries,” the process involves selling “tickets” not limited by geography, with interest earned on such ‘deposits’ by “automatically [routing them] to other decentralized finance protocols like Aave.” Then prizes are generated from this interest, with the goal of enabling people to save money at the same time.
Protocols like Aave are said to be “fully liquid,” with deposits being able to be withdrawn at any time. To ensure that loans are not defaulted upon, borrowers from Aave must “deposit collateral that is greater in value than what they are borrowing.”
LendUp, which according to its site is no longer lending or servicing loans, had provided loans online to consumers primarily for personal, family, or household purposes, with a unique “LendUp Ladder,” that sought to allow borrowers to ‘climb’ up to loans of higher amounts at lower interest rates through behaviors such as the repayment of loans on time and the taking of free courses. According to the company, this set them apart from traditional payday lenders who “treat all their customers the same,” and it had received funding from Google Ventures, Andreessen Horwitz and Kleiner Perkins among others.
Key Issues Raised
Whether referred to as investors, consumers, borrowers, or users, the individuals and entities allegedly put at risk were a major focus in all three cases.
The risk in the BlockFi matter from the perspective of the SEC concerned alleged false statements and a potential lack of transparency and information that could impact investors. This was especially the case as the company provided its lending product, BlockFi interest Accounts, directly to the public.
According to the SEC, BlockFi allegedly “made a false and misleading statement for more than two years on its website concerning the level of risk in its loan portfolio and lending activity.”
The agency also took the position that the failure of the company to follow registration and disclosure requirements could potentially deprive investors of the information and transparency needed to “make well-informed decisions in the crypto asset space.”
The above actions and omissions were said by the SEC to violate the Investment Company Act of 1940 and the Securities Act of 1933.
The civil lawsuit against PoolTogether is one of the first to be brought and the Complaint notes the potential risk to investors, stating that at the time of its filing there were 14 ‘lotteries’ in operation with more than 11,900 users participating. The Company is also able to accept deposits worldwide and it can be further noted that it has the far-reaching goal to ultimately replace savings accounts as well as lotteries.
More specifically, while the company claims on its site that funds deposited by users are not at risk, albeit with qualifying language on other parts of the site, the Complaint takes the position that “all of the money delivered to PoolTogether [by a user] is at risk of loss.”
The qualifying language by PoolTogether includes statements that there is risk while users are supplying digital assets to the PoolTogether protocol, and that the protocol itself is provided ‘as-is’ and at a user’s own risk and without warranties of any kind.
The Complaint goes much further and says that those who purchase tickets from the company must be aware of the following:
- The simple act of sending cryptocurrency to PoolTogether is remarkably expensive
- Only large deposits in PoolTogether or deposits that are left for a very long time could possibly have the expected value
- PoolTogether keeps up to 50% of each weekly prize as a “reserve” which may never be paid out;
- A “gas” fee is required due to the significant computing power required by each transaction
- In some cases, it could take decades after the initial deposit to receive it back; and that
- PoolTogether may never offer a positive expected value
The case also examines basic issues of accountability, such as whether the company can be held accountable for the actions of its protocol, and if so, to what degree. It also notes that investors allegedly don’t have to provide information about themselves, further raising accountability and even potential national security issues, although interestingly, the case arguably also shows the potential for better accountability through the use of cryptocurrency’s ability to keep a publicly accessible record of every transaction and the enhanced ability to communicate with each user, among other things.
When it comes to LendUp, the CFPB also put its focus on borrower protection in its action against the company. As in the case with BlockFi and PoolTogether, allegedly false and/or misleading statements were present, with the agency saying in a statement that LendUp “claimed to offer larger loans at lower rates to repeat borrowers who ascend its “LendUp Ladder,” but that “many borrowers who reached higher LendUp Ladder levels did not, in fact, receive these promised benefits.”
Specifically, the agency said there were tens of thousands of borrowers who were allegedly charged the same or higher interest rates as those on lower Ladder levels as well as those denied access to loans despite moving up the Ladder. In some instances, the company was said to have unilaterally reduced the maximum loan amount available to borrowers who had maintained their Ladder level.
For the above, the agency had charged the company with violating the Consumer Financial Protection Act. LendUp was also charged under the Equal Credit Opportunity Act for allegedly failing to provide timely and accurate notices to borrowers, a behavior capable of harming borrowers.
Corrective Action and Moving Forward
As part of the settlement with the SEC, BlockFi has agreed to attempt to bring its business within the provisions of the Investment Company Act and to register the offer and sale of new lending products under the Securities Act of 1933. The company already has a new product that complies with these laws in the works, stating that it “intends for BlockFi Yield to be a new SEC-registered, crypto interest-bearing security, which will allow clients to earn interest on their crypto assets.” It also described the settlement as “providing regulatory clarity and a path forward for clients across the United States who want to earn interest on their crypto assets.”
The PoolTogether action is still unfolding. However, given the nature of the allegations as mentioned above, one distinct course of action it could take could be to seek to qualify as one of the entities authorized to create prize-linked savings accounts. Also, as mentioned above, the PoolTogether protocol actually shows the potential enhanced ability to have greater accountability and transparency.
As mentioned above, LendUp is no longer lending or servicing loans. However, from a legal standpoint, it could have presumably continued to use its innovative Ladder approach by correcting the procedural deficiencies cited by the CFPB, which could have potentially been of real benefit to individuals and families.