Cryptocurrency’s move into banking stirs alarms

BlockFi, a fast-growing financial startup whose headquarters in Jersey City, N.J., are across the Hudson River from Wall Street, aspires to be the JPMorgan Chase of cryptocurrency.

It offers credit cards, loans and interest-generating accounts. But rather than dealing primarily in dollars, BlockFi operates in the rapidly expanding world of digital currencies, one of a new generation of institutions effectively creating an alternative banking system on the frontiers of technology.

“We are just at the beginning of this story,” said Flori Marquez, 30, a founder of BlockFi, which was created in 2017 and claims to have more than $10 billion in assets, 850 employees and more than 450,000 retail clients who can obtain loans in minutes, without credit checks.

But to state and federal regulators and some members of Congress, the entry of cryptocurrency into banking is cause for alarm. The technology is disrupting the world of financial services so quickly and unpredictably that regulators are far behind, potentially leaving consumers and financial markets vulnerable.

In recent months, top officials from the Federal Reserve and other banking regulators have urgently begun what they are calling a “crypto sprint” to try to catch up with the rapid changes and figure out how to curb the potential dangers from an emerging industry whose short history has been marked as much by high-stakes speculation as by technological advances.

In interviews and public statements, federal officials and state authorities are warning that the crypto financial services industry is in some cases vulnerable to hackers and fraud and reliant on risky innovations. In August, the crypto platform PolyNetwork briefly lost $600 million of its customers’ assets to hackers, much of which was returned only after the site’s founders begged the thieves to relent.

“We need additional authorities to prevent transactions, products and platforms from falling between regulatory cracks,” Gary Gensler, chairman of the Securities and Exchange Commission, wrote in August in a letter to Sen. Elizabeth Warren, D-Mass., about the dangers of cryptocurrency products. “We also need more resources to protect investors in this growing and volatile sector.”

The SEC has created a stand-alone office to coordinate investigations into cryptocurrency and other digital assets, and it has recruited academics with related expertise to help it track the fast-moving changes.

BlockFi has already been targeted by regulators in five states that have accused it of violating local securities laws.

Treasury Secretary Janet Yellen and Fed Chairman Jerome Powell have also voiced concerns, even as the Fed and other central banks study whether to issue digital currencies of their own.

The cryptocurrency banking frontier features a wide range of companies. At one end are those that operate on models similar to those of traditional consumer-oriented banks, such as BlockFi or Kraken Bank, which has secured a special charter in Wyoming and hopes by the end of this year to take consumers’ cryptocurrency deposits — but without traditional Federal Deposit Insurance Corp. insurance.

On the more radical end is decentralized finance, which is more akin to Wall Street for cryptocurrency. Players include Compound, a company in San Francisco that operates completely outside the regulatory system. Decentralized finance eliminates human intermediaries such as brokers, bank clerks and traders, and instead uses algorithms to execute financial transactions, such as lending and borrowing.