In its bankruptcy filing last week, New Jersey-based BlockFi attempted to paint itself as a responsible lender hit by plummeting crypto prices and the collapse of crypto brokerage FTX and its affiliated trading firm, Alameda. But a closer look at the company’s history reveals that its vulnerabilities likely began much earlier with missteps in risk management, including loosened lending standards, a highly concentrated pool of borrowers and unsustainable trading activity.
Like so many digital asset companies, crypto lender BlockFi let itself get swept up in the 2021 crypto frenzy. As bitcoin’s price rose sharply that year, BlockFi started expanding aggressively to meet investor demand. As of March 2021, BlockFi’s assets under management swelled to more than $15 billion, up from $1 billion the year before. In the first six months of 2021, it hired an average of more than 75 people per month, according to LinkedIn data, as its valuation hit $4.25 billion.
While the company regularly touted a sophisticated risk management team, current and former employees indicate in interviews that risk professionals were dismissed by executives preoccupied with delivering growth to investors. As early as 2020, employees were discouraged from describing risks in written internal communications to avoid liability, a former employee states. This picture stands in contrast to last week’s bankruptcy filing, in which the company states that “since its founding, BlockFi has been focused on providing best-in-class financial services and offering (sometimes creating) industry-leading protections.”
BlockFi positioned itself as a bank-like institution that was a safe placefor retail investors to store their funds and earn interest, but the company used retail deposits for questionable lending and unsustainable trading activities, says Ram Ahluwalia, CEO of digital asset investment advisor Lumida. “What they were really doing, these retail depositors, is they were financing a hedge fund,” says Ahluwalia, who worked in credit risk analysis and management before crypto.
Until August 2021, BlockFi advertised that loans were typically over-collateralized. But large potential borrowers were often unwilling to meet those requirements, a cease and desist order brought by the Securities and Exchange Commission against BlockFi in February states. The availability of uncollateralized capital from competing companies like Voyager created stiff competition in the lending field.
Under pressure to continue growing and delivering yields, BlockFi began lending to these parties with less collateral than publicly stated without informing customers on the amount of risk involved with interest accounts, according to the SEC order which resulted in a $100 million fine for the company. As a result, BlockFi paused access to its interest accounts in the U.S. (The company agreed to entry of the cease and desist order and payment of the fine without admitting or denying the SEC’s findings.)
“From inception, BlockFi worked to constantly evolve and refine all corporate governance practices, including bringing in specialized and seasoned risk expertise as the firm grew,” a BlockFi representative said in response to Forbes’ request for comment.
In addition to lowering its collateral requirements, BlockFi’s due diligence process had flaws, former borrowers say. Available credit for borrowers was decided based on their assets, but BlockFi and other lenders failed to investigate both the size and quality of potential borrowers’ holdings. Like Voyager and other crypto lenders, BlockFi accepted unaudited balance sheets from hedge funds and proprietary trading firms former borrowers say, leaving room for manipulation on the borrower side.
In the due diligence process, lenders like BlockFi and Voyager did not examine whether borrowers’ balance sheet assets were denominated in dollars or less liquid tokens like FTX-issued FTT. When asked to address detailed questions about these failings, a BlockFi representative responded with a statement that: “BlockFi’s institutional counterparties undergo a full due diligence and underwriting analysis which includes a review of their operation and financial statements, with focus on leverage and liquidity.”
The revelation that Alameda’s balance sheet was mostly FTT tokens was the news that set off the unraveling of both Alameda and FTX and triggered contagion effects across the industry. In early November, Alameda defaulted on $680 million in loan obligations to BlockFi, according to the bankruptcy filing.
An internal team at BlockFi also raised concerns that the borrower pool was too concentrated among a pool of crypto whales, including mega hedge funds Three Arrows Capital and Alameda, another former employee states. Management responded that the loans were collateralized, according to the employee.
In addition to lending to institutions, a large revenue driver for BlockFi before this year was a popular arbitrage trade leveraging an investment vehicle called Grayscale BitcoinBTC -1.5% Trust, which is designed to offer investors bitcoin exposure on traditional markets. For years, GBTC traded at a premium relative to the value of underlying bitcoin. Investment firm Grayscale let institutional investors contribute bitcoin to the trust in return for shares. The shares could eventually be sold to profit from the difference between their price and bitcoin. At one point, BlockFi held over 5% of the trust’s shares.
That strategy began to unravel in February 2021 when GBTC shares began selling at a discount, while a portion of BlockFi’s holdings were locked up by an SEC rule that prohibited holders from selling their GBTC until six months after their purchase. This turned the profitable arbitrage into a money loser, leading to big losses for BlockFi.
The next month, BlockFi began cutting yields on interest-bearing accounts holding bitcoin, reducing the highest promised interest rate from 6% to 4% between March and June of 2021. Shortly after, the company replaced Bank of AmericaBAC -0.2% veteran Rene Van Kesteren as chief risk officer with another traditional finance hire, Yuri Mushkin. By July 2022, BlockFi CEO Zac Prince stated the company no longer held GBTC shares and was unwinding loans where shares of the fund were held as collateral.
In BlockFi’s bankruptcy filing and in public statements made by its CEO, Zac Prince, the company points to its survival through the collapse of the Terra/Luna ecosystem and subsequent shuttering of Three Arrows Capital as evidence of strong management. But that endurance four months ago was made possible through a $400 million credit line from now-defunct FTX, which allowed the firm to meet panicked withdrawal requests from depositors. When FTX folded in early November, BlockFi lost its lending back stop and could no longer meet fresh waves of withdrawal requests.
By Emily Mason, Forbes Staff