The trick to understanding the crypto and blockchain space is tracking the right thought leaders and subject matter experts.  It is a very close-knit, passionate community of pioneers, evangelists, and early adopters who have been reporting on and sticking with their overall perspective that–over time–crypto is a strategic game-changer in the storage of value, value creation, and exchange of value globally.  Long term, the conventional wisdom within this community is that the traditional notion of “money” is on the ropes – ripe for the radical disruption many industries and societal conventions experienced during Web 2.0.   Blockchain is also significant over time in areas such as supply chain transparency, asset tracking, digital data ownership, digital sovereignty, and use cases in a sophisticated variety of industry verticals.

OODA has been a member of this community throughout this early stage innovation and evolutionary process, garnering insights from OODAcast conversations with pioneer investors in the asset class such as Bradley Rotter and DeFi journalist and author Camila Russo.  In his interview with Bradley Rotter, OODA CEO Matt Devost shares that he wishes he would have kept up and running the crypto mining hardware he set up many years ago (as a demonstration for the class he was teaching at Georgetown at the time).  Suffice it to say, OODA has had its sleeves rolled up,  monitoring this disruptive and promising technology since its inception.

Details of the BlockFi Settlement with the SEC

“…the positions and terms for each depositor and lender are verifiable on the blockchains they run atop.”

An equal and opposite reaction to the recent onslaught of cybersecurity incidents directed at the Crypto and DeFi marketplace (itemized in our recently released Web3 Cyber Incident Database) are regulatory or market mechanisms designed to enhance the trust relationship between end-users, federal regulators, and the crypto platforms during this evolutionary phase of the Web3 innovation ecosystem.

The recent SEC action against crypto lender BlockFi has been heralded by many in the DeFi innovation community as a seminal moment for the cryptocurrency marketplace.  According to the SEC filing:

• The Securities and Exchange Commission today charged BlockFi Lending LLC (BlockFi) with failing to register the offers and sales of its retail crypto lending product.
• In this first-of-its-kind action, the SEC also charged BlockFi with violating the registration provisions of the Investment Company Act of 1940. To settle the SEC’s charges, BlockFi agreed to pay a $50 million penalty, cease its unregistered offers and sales of the lending product, BlockFi Interest Accounts (BIAs), and attempt to bring its business within the provisions of the Investment Company Act within 60 days.
• BlockFi’s parent company also announced that it intends to register under the Securities Act of 1933 the offer and sale of a new lending product. In parallel actions announced today, BlockFi agreed to pay an additional $50 million in fines to 32 states to settle similar charges.
• According to an SEC investigation (which BlockFi cooperated with ) approx. 24% of institutional crypto asset loans BlockFi made in 2019 were over-collateralized. In 2020, the percentage of over-collateralization was 16%, and in 2021 it was 17%.
• The SEC charged BlockFi with not having the appropriate registration statement filed to offer securities, which made up more than 40 percent of its assets. (1)

This all amounts to a misrepresentation of risk by BlockFi to its investors, including their inability to cover deposits in the case of run assets and deposits, for which the SEC is coming down on BlockFi using tried and true regulatory mechanisms which date back to the 1930s.

As reported by Axios:  “This is the largest-ever penalty against a cryptocurrency firm and the first in which a crypto company was charged with violating the registration provisions of the Investment Company Act of 1940.”

BlockFi is not alone,  as last year Coinbase was also threatened with an SEC Lawsuit over their lending products.

Camila Russo’s website, The Defiant, offers some of the best DeFi coverage.  The Defiant’s Brady Dale highlighted in his reportage the most important takeaway of this entire development in the DeFi space:  “The SEC findings illuminate one of the key differences between centralized financial offerings and those made through decentralized finance lending and saving platforms, where the positions and terms for each depositor and lender are verifiable on the blockchains they run atop.”  It is this disintermediation of verification mechanisms and a trusted,  collective verification mechanism by way of blockchain which is the core disruptive innovation of the crypto and DeFi ecosystem.  That core element of the technology is in no way called into question by this SEC action.

The Crypto Space and DeFi are not Rogue Market Players

“Both the SEC and state-level agreements contain no admission or denial of wrongdoing or liability.”

1/11 HUGE day for @BlockFi and our interest-bearing product, the BIA. We’ve reached a resolution with both the SEC and state regulators that identifies a clear path forward for folks to earn interest on their crypto. My POV below.

— Zac Prince (@CostSegZac) February 14, 2022

The SEC action sets an important precedent for the crypto and DeFi marketplace:  with BlockFi’s cooperation in the investigation and commitment to abide by the settlement, crypto lending accounts are now classified as securities by the SEC, with all the regulation that securities registration entails.

What is important here is the reaction of both BlockFI and the DeFi community to this action by the SEC.  The news cycle on this development is not one of tension between a DeFi market that has a maverick, hacker-esque ethos (that is too opaque and at odds with the traditional monetary system).  This perception of the space lingers for some reason. The reality is quite the contrary.  Innovators in the space are vocal in their response to the SEC filing that, finally, the traditional fiscal and monetary policy decision-makers and regulators will understand the DeFi marketplace has always called for further clear and transparent SEC guidelines.  The response to the SEC action has not been a contentious or negative response on social media.

BlockFi’s language in its press release, on the matter -“BlockFi Enters Landmark Resolution with Federal and State Regulators Providing Clarity on Pathway for Crypto Interest Securities” – is not some half-hearted public relations stunt trying to turn a negative into a positive.  Rather, they clarify the progress the resolution represents for the entire industry, such as:

• BlockFi is the first participant in the new regulatory framework for the crypto sector
• A new product, BlockFi Yield, will be in the registration process with the U.S. Securities and Exchange Commission.
• Zac Prince, CEO, and Founder of BlockFi, said: “From the day we started BlockFi, we have always known that strong engagement with regulators would be critical for the adoption of financial services powered by cryptocurrencies. Today’s milestone is yet another example of our pioneering efforts in securing regulatory clarity for the broader industry and our clients, just as we did for our first product – the crypto-backed loan. We intend for BlockFi Yield to be a new, SEC-registered crypto interest-bearing security, which will allow clients to earn interest on their crypto assets.”
• BlockFi cooperated with the government’s investigation and implemented remediation actions. Both the SEC and state-level agreements contain no admission or denial of wrongdoing or liability.

What’s Next?

“Some people won’t like the outcome, but that is one of the risks that come with seeking regulatory clarity.”

• The Market is Sorting Itself Out:  In a blog post from the company, BlockFi clarified further: “With [this] resolution, we are leading the creation of a new regulatory landscape for crypto and our clients. What’s along this path?  Put simply – [the] increased regulatory clarity we’ve been hoping for. We were the first crypto company to receive a state-level license to issue crypto-backed loans to U.S. consumers in 2018 and this is the next major example of how we prioritize cooperation with regulators.”  Crypto evangelist Anthony Pompliano, in his substack post Why BlockFi’s $100 Million Settlement Is A Watershed Moment For Crypto Industry lauded the settlement: “….the critics of the crypto industry have long claimed that it was opaque, filled with criminal activity, and a systemic risk if there was too much adoption. BlockFi’s resolution will create adherence to the highest degree of transparency, audibility, and risk management that is available in public markets. Regulators will have direct oversight of the product and company, which negates the critic’s argument around opaque operations.”
• Regulation is Now Part of the Equation – but only Part:  “…the BlockFi resolution showcases the maturity of the business. In order to succeed in the crypto industry, companies are going to be required to have expertise in technology, finance, and regulation. Most teams have native experience in technology and finance, but BlockFi’s ability to navigate this regulatory environment will likely serve them well as they continue building one of the leading businesses in the industry. Everyone from customers to public market investors are likely to have increased confidence in the companies that can build the regulatory muscle needed to thrive in a fast-paced, ever-changing industry.”
• Pushback is Vital:  “Pomp” (as Pompliano is known by his loyal podcast listeners) does contextualize that not everyone is content with the regulatory action:  “Some people won’t like the outcome, but that is one of the risks that come with seeking regulatory clarity. Now that the rules around this type of product are clear, every company in the industry will be able to offer this functionality to their users with the confidence that they are playing within the regulatory guidelines.”  Pomp has skin in the game:  According to TechCrunch “BlockFi has raised $450 million in funding from investors since its inception. Its latest round was a $350 million Series D last March that valued the company at $3 billion, led by Bain Capital Ventures, partners of DST Global, Pomp Investments and Tiger Global.”  Pomp Investments is his investment wing.  Still, we think his analysis and commentary are thorough and balanced.  Pomp is one of many voices.  The market will sort out solutions somewhere in the middle of all the advocacy and push back.  Some platforms will stay on the edge – pushing innovation devoid of government intrusion.
• A Crypto SEC?:  In October of last year, Coinbase called for the creation of a new cryptocurrency regulator.
• Overregulation is Always a Risk:  Governments do not have a great track record in an understanding of their role (if any?) in disruptive innovation and technology. Matt contextualized this issue through the prism of national security in his recent post:  Is Bitcoin a National Security Risk?
• Cybersecurity issues still remain:  As the data from the OODA Loop Web3 Cyber Incident Database makes clear:  developers and leaders of Web3 projects, including DeFi applications, need to leverage best practices for the protection of infrastructure, have contracts and code independently analyzed, protect against insider attacks, and evaluate overall posture through the use of Red Team techniques.

https://oodaloop.com/archive/2022/02/16/web3-cyber-incident-database/

Related Reading:

Black Swans and Gray Rhinos

Now more than ever, organizations need to apply rigorous thought to business risks and opportunities. In doing so it is useful to understand the concepts embodied in the terms Black Swan and Gray Rhino. See: Potential Future Opportunities, Risks and Mitigation Strategies in the Age of Continuous Crisis

Explore OODA Research and Analysis

Use OODA Loop to improve your decision making in any competitive endeavor. Explore OODA Loop

Decision Intelligence

The greatest determinant of your success will be the quality of your decisions. We examine frameworks for understanding and reducing risk while enabling opportunities. Topics include Black Swans, Gray Rhinos, Foresight, Strategy, Stratigames, Business Intelligence and Intelligent Enterprises. Leadership in the modern age is also a key topic in this domain. Explore Decision Intelligence

Disruptive/Exponential Technology

We track the rapidly changing world of technology with a focus on what leaders need to know to improve decision-making. The future of tech is being created now and we provide insights that enable optimized action based on the future of tech. We provide deep insights into Artificial Intelligence, Machine Learning, Cloud Computing, Quantum Computing, Security Technology, Space Technology. Explore Disruptive/Exponential Tech

Security and Resiliency

Security and resiliency topics include geopolitical and cyber risk, cyber conflict, cyber diplomacy, cybersecurity, nation state conflict, non-nation state conflict, global health, international crime, supply chain and terrorism. Explore Security and Resiliency

Community

The OODA community includes a broad group of decision-makers, analysts, entrepreneurs, government leaders and tech creators. Interact with and learn from your peers via online monthly meetings, OODA Salons, the OODAcast, in-person conferences and an online forum. For the most sensitive discussions interact with executive leaders via a closed Wickr channel. The community also has access to a member only video library. Explore The OODA Community

About the Author

Daniel Pereira

Daniel Pereira is research director at OODA. He is a foresight strategist, creative technologist, and an information communication technology (ICT) and digital media researcher with 20+ years of experience directing public/private partnerships and strategic innovation initiatives.