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- BlockFi Wealth Management
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Bitcoiners have managed to reinvent banking, and it is every bit as ugly as you’d expect. Thanks to crypto startup BlockFi, you now get crypto interest accounts and crypto backed loans. These kind of services have been provided by traditional banks for centuries, but have so far been missing in the cryptocurrency space. One can only wonder why, as it obvious that when Satoshi wrote the Bitcoin whitepaper, he clearly intended to incentivize the creation of Bitcoin banks to topple the traditional financial system. But after 10 years, the long wait is finally over, and we’re finally getting access to traditional banking in Bitcoin, albeit in a much more dangerous form.
In essence BlockFi’s offering boils down to two services. Users can either deposit cryptocurrencies (currently limited to Bitcoin and Ether) in an interest account, or use them (including Litecoin) as collateral for a USD denominated loan. Especially the interest account has attracted a lot of attention, as BlockFi is promising an interest rate of six percent (compounding monthly) annually, to be paid in Bitcoin or Ether. According to BlockFi, this “is an easy way for crypto investors to earn bitcoin while they HODL”. Unfortunately, the six percent isn’t fixed, and per the terms of service BlockFi may choose to change the rate to whatever they feel like every month. When asked on Twitter, BlockFi founder Zac Prince confirmed that the company currently has no fixed methodology for setting interest rates.
We don’t have a fixed formula at this time – we have a value at BlockFi “clients not customers”. I think the examples need to be better. Accounts are fully denominated in crypto. Should be updated today
— Zac Prince (@BlockFiZac) 6 maart 2019
If you thought that sounded bad, wait until you read the rest of the terms. Interest accounts are not “covered by insurance against losses”, and BlockFi also has the right do whatever they want with your money. They will “will lend, sell, pledge, rehypothecate, assign, invest, use, commingle or otherwise dispose of funds and cryptocurrency assets to counterparties”, but don’t worry, they will put in their “best efforts to prevent losses”. Oh, and in case of a hard fork, don’t expect to get your share of the newly created currency unless explicitly announced.
The fun doesn’t stop there, as we’re now getting to the second product offered by BlockFi: crypto-backed loans. These loans are ideal for any bagholder that has “a need for funding but don’t want to sell their crypto to reach those goals”. Basically, if you’re still suffering from FOMO despite an overall drop in cryptocurrency prices by about 80-90% over the past year, then you’re the ideal candidate to receive such a loan.
If you believe the market will continue to move lower or sideways, you’re better off selling your cryptocurrency for USD, as you’ll have to post a minimum of twice the value of the loan in cryptocurrency as collateral. Plus, on the way down, you’d be facing the additional risk of being margin called (meaning you’ll have to add more collateral), while that might be tricky to provide if you just used your loan (which you needed because you didn’t have the cash at hand) to pay for an illiquid asset or worse (e.g. something unrecoverable like travelling the world). In that case, BlockFi will sell off (a portion of) your assets to restore the loan-to-value rate. Not your keys, not your Bitcoin.
But even if you believe the market will move up, and it actually happens, you might end up facing an unexpected surprise. Because BlockFi is giving out fiat loans, but only raising cryptocurrencies to fund them, they will be required to sell a portion of their cryptocurrencies to be able to provide the USD loans. This is the simple result of the chosen business model. It forces BlockFi to operate on fractional reserves for their cryptocurrency holdings. You could argue that this isn’t unlike traditional banks either, but the volatility of cryptocurrency prices is what makes for an explosive situation. This can make the company’s performance go sour quickly.
Consider the following example: BlockFi raises 100 BTC valued at $400,000. They need $100,000 for requested loans, so 25 BTC are converted to USD. The BTC price subsequently goes up to $20,000. The 75 BTC BlockFi was holding are then worth $1,500,000, but BlockFi also still owes 25 BTC to the borrowers that posted this as collateral. These borrowers will only repay the USD value of their loan, which is $100,000. With this amount, BlockFi can only buy back 5 BTC rather than 25. To repay the remaining 20 BTC BlockFi will have to suffer a $400,000 loss. The company could be bankrupt before you’re capable of recovering your money.
It is ironic that die-hard Bitcoin supporters like Anthony Pompliano, whose life motto is “Long Bitcoin, Short the Bankers!”, have thrown their weight behind BlockFi Wealth Management. The company mimics a traditional bank, but can only be expected to so properly under adverse price conditions (although the loans lack a use case in this situation). Maybe their new motto is secretly “Long Banks, Short Bitcoin!”.
- Interest on Bitcoin and Ether deposits
- Interest rate determined at random
- Hard forks not supported by default
- Unclear business model