US Securities and Exchange Commission Chairman Gary Gensler has repeatedly said the crypto markets are like the “Wild West,” with insufficient protections for investors. A presidential working group has cautioned that some crypto platforms were allowing investors to make risky high-leverage bets. And the Treasury Department has called for legislation requiring some crypto issuers to be insured just as banks are.
Their warnings are much needed. The trouble is, few people seem to be paying attention.
An SEC order this week against BlockFi, a prominent crypto lending firm, highlights the perils for ordinary investors hoping to make easy returns from cryptocurrencies. In this case, BlockFi, which promises high yields to investors willing to lend their digital tokens to the platform, misstated the amount of collateral that third-party borrowers had put up against their loans, exposing the original retail investors to heavy potential losses. BlockFi agreed to pay a $100 million penalty to settle allegations that it had illegally sold interest-bearing accounts without properly registering them as securities with the SEC, a move that would have required more disclosure to investors.
The company was able to attract investors to the platform in the first place because it advertised interest rates as high as 9.5% on its website last year. There were caveats in disclosures accompanying the transactions, fine print that too few investors take the time to read.
BlockFi isn’t alone in marketing these types of products. A web search for “crypto interest-bearing accounts” yields several ads offering annualized interest rates of 8% to 13% for lending out crypto deposits. Such high rates inevitably lure vulnerable savers who might not know the full risks these investments entail.
A fundamental problem facing ordinary investors is that high-yield crypto accounts don’t offer the same protections as traditional bank and brokerage accounts. The Federal Deposit Insurance Corp. covers funds up to a certain amount in the event of bank insolvency, while the Securities Investor Protection Corp. offers similar safeguards in the case of a broker default. But crypto investors generally are on their own.
Fortunately, the SEC has started to take steps to protect crypto investors. Earlier this week, the agency issued a special bulletin warning that investors could face losses if crypto lending companies holding tokens were to fail or go bankrupt.
High-yield crypto investments might work out fine when markets are stable. But what happens when there is a major dislocation? If hedge funds or other institutional investors renege on their commitment to return assets, it could cause cascading losses for interest-bearing crypto-account holders.
The current high-yield crypto market is eerily reminiscent of the early days of the 2008 financial crisis, when Icelandic banks offered high yields to global retail investors. In that case, the banks had taken inordinate risk in questionable housing investments, leaving them unable to meet their obligations when investors began withdrawing their money en masse.
Retail investors should be wary about the promise of sky-high returns. If it sounds too good to be true, it often is.