The downfall of the crypto unicorn BlockFi: a decline after being investigated by the SEC, followed by missteps with 3AC and FTX

Author: Joy, PANews

Another crypto unicorn has fallen. After being "acquired" by FTX for less than five months, BlockFi collapsed in the wreckage of FTX and officially filed for bankruptcy on November 28.

From public information, the direct cause of BlockFi's downfall was stepping into the two biggest pitfalls of the year: Three Arrows Capital and FTX. Essentially, the long-term high-interest business model was not viable in the rapidly changing crypto market, and the lax management did not prepare for the arrival of a new bear market. Once the first domino of liquidity within the system fell, it marked the beginning of destruction.

A strong start, raising hundreds of millions

Unlike the elite backgrounds of the protagonists at FTX and Alameda, the two founders of BlockFi, Zac Prince and Flori Marquez, came from humble beginnings. Both had relevant experience in fintech lending; Zac was inspired to start a business because he couldn't use his crypto holdings as collateral for loans, while Flori, the daughter of an Argentine immigrant and the first in her family to attend college, graduated from the Ivy League school Cornell University and trusted the value of cryptocurrency more due to Argentina's currency devaluation. The two began preparing to establish the crypto lending company BlockFi in 2017. Today, the introduction pages of these founders and company executives have quietly been removed following the FTX collapse.

Lending is a business that has existed for thousands of years, and BlockFi's business model is clear. It can be understood as a crypto version of a P2P lending platform, providing lending services to individual or institutional users and charging interest on loans, while the funding side consists of retail or institutional deposits, offering them interest income. The platform earns the interest spread between loans and deposits.

In February 2018, BlockFi first announced financing news, securing $1.55 million from institutions such as ConsenSys Ventures, SoFi, and Kenetic Capital. SoFi is a well-known P2P lending platform in the U.S., starting with student loans. From 2018 to 2021, BlockFi experienced rapid growth, and just five months after its first financing announcement, in July 2018, BlockFi announced it had raised $52.5 million, led by Galaxy Digital, founded by crypto billionaire Mike Novogratz.

According to PANews statistics, during the new bull market cycle of cryptocurrencies from 2020 to 2021, BlockFi became one of the fastest-growing startups in the industry, completing multiple rounds of financing and raising nearly $800 million from dozens of investment institutions, including Valar Ventures, Bain Capital, Morgan Creek Digital, and Winklevoss Capital. By the summer of 2021, during its Series E financing, BlockFi's valuation had reached $4 billion.

According to a Bloomberg report in March 2021, BlockFi achieved rapid growth, with assets soaring from $1 billion a year earlier to $14 billion by February 2021. Monthly revenue jumped from $1 million to $40 million, and the number of employees increased from 75 to 500.

Internal and external troubles, IPO hopes dashed, SEC investigation leads to decline

In 2020, BlockFi and Coinbase announced plans to go public simultaneously, stating that they would list as early as the second half of 2021. However, subsequent internal and external troubles led to dashed IPO hopes.

As it rapidly developed into mid-2021, issues of internal management began to surface. In May 2021, BlockFi mistakenly issued 701 GUSD as 701 BTC when distributing rewards to users, resulting in a loss of tens of millions of dollars. This incident reflected the lax financial management at BlockFi, and some employees resigned as a result. Additionally, company insiders reported that BlockFi's technical system was poor, using the niche and obscure Elixir programming language, with product iterations and updates lagging behind competitors, necessitating a significant increase in technical staff to compensate for these deficiencies. According to Blockworks, BlockFi fired its Chief Technology Officer, who joined in 2018, and also requested the departure of its Chief Growth Officer.

Amid its rapid growth, BlockFi also caught the attention of the U.S. Securities and Exchange Commission (SEC). During the period when Bitcoin reached new highs in November 2021, it was officially announced that the SEC was investigating BlockFi's interest-bearing crypto accounts, which offered rates as high as 9.5%, deeming them securities. Subsequently, in February 2022, BlockFi reached a settlement with the SEC, agreeing to pay $50 million and halting the opening of new accounts for its high-yield loan products to most Americans, while existing accounts appeared unaffected. BlockFi also agreed to pay an additional $50 million to state regulators. In October of the previous year, BlockFi applied to launch a Bitcoin futures exchange-traded fund (ETF), but it was not approved.

As if that weren't enough, the E round financing for BlockFi in June 2021 was already quite challenging. The originally planned $5 billion fundraising at a $4 billion valuation did not attract much institutional interest. Media reports indicated that the final amount raised was only half of the target. From that point on, traditional asset management companies were no longer optimistic about BlockFi's IPO potential.

The SEC's intervention completely ended BlockFi's glorious era, with its platform funds shrinking directly from tens of billions to $2-3 billion. According to BlockFi's disclosures, as of the end of June 2022, the company had $1.8 billion in outstanding loans from institutional and retail investors, of which $600 million were unsecured loans. Institutional loans accounted for $1.5 billion of the outstanding loans, while retail loans made up the remaining $300 million. In hindsight, the SEC's timely intervention also reduced the losses for retail investors caused by BlockFi.

Bankruptcy filing after stepping on the landmines of 3AC and FTX

At the peak of the bull market, even after the SEC investigation, BlockFi was still able to meet user withdrawal demands. However, as the market entered a bear phase, asset prices plummeted, liquidity dried up, and industry-wide risks led to customer defaults. Coupled with the product's own maturity mismatch, which could not respond to investors' withdrawal demands in real time, BlockFi fell into a deep abyss.

The most direct trigger was the collapse of Three Arrows Capital. BlockFi had provided approximately $1 billion in loans to Three Arrows Capital, with collateral consisting of two-thirds Bitcoin and one-third GBTC, resulting in a 30% over-collateralization rate. From a risk control perspective, providing such a high loan amount to a single borrower posed obvious potential risks. BlockFi suffered a loss of about $80 million due to Three Arrows Capital.

"Bleeding too much," BlockFi sought institutional rescue in June and officially announced on July 2 via Twitter that it had received funding support from FTX, which would provide BlockFi with a $400 million revolving credit facility, with FTX having the right to acquire BlockFi at a variable price of up to $240 million. The agreement stipulated certain conditions, such as obtaining SEC regulatory approval for BlockFi Yield by the end of the year and increasing the acquisition price if customer assets reached $10 billion by the formal acquisition in the fall of 2023.

In reality, BlockFi chose FTX US among several institutions, stating that other options were not attractive because user funds might be reduced, which would not be in the clients' best interests. They believed that the FTX US platform and products were highly complementary to BlockFi and expected to enhance services through strengthened cooperation.

BlockFi did not realize that FTX had other plans in mind.

Notably, PANews observed that BlockFi updated an article on its official website on July 20, sharing the management framework of its risk control team, stating that the risk control team was independent of the business team and consisted of seasoned risk management professionals who had experienced the 2008 financial crisis and the 2011 European debt crisis. However, this page was updated after BlockFi filed for bankruptcy on November 28.

Good times did not last long. Just four months after receiving FTX's lifeline, this white knight revealed its "demonic" true nature. On November 11, BlockFi announced it would suspend withdrawal services, advising customers not to deposit into BlockFi Wallet and Interest Accounts, stating, "Given the unclear status of FTX.com, FTX US, and Alameda, we cannot operate as usual."

Shortly thereafter, on November 28, BlockFi filed for Chapter 11 reorganization in a New Jersey court. Documents indicated that BlockFi had over 100,000 creditors, with estimated assets and liabilities both in the range of $1 billion to $10 billion. BlockFi currently still holds $256.9 million in cash to support certain operations during the restructuring process.

After the FTX collapse, a BlockFi employee revealed that the only condition for FTX to rescue BlockFi was to place its user funds on their platform, but this was denied by BlockFi officials, who claimed that most BlockFi assets being on FTX was a rumor. However, there were indeed significant risk exposures to FTX and related entities, including debts owed to us by Alameda, assets held by FTX.com, and amounts not withdrawn from our credit line at FTX.US. In bankruptcy court, BlockFi's lawyer stated that approximately $355 million in cryptocurrency was currently frozen at FTX. Additionally, BlockFi had also provided a $671 million loan to Alameda Research.

SEC becomes a creditor, Valar Ventures is the largest institutional shareholder

According to the bankruptcy filing documents, Ankura Trust Company, LLC, which specializes in handling bankruptcy cases, is its largest creditor, holding approximately $729 million in unsecured claims, followed by $275 million in unsecured claims from FTX US and $30 million from the U.S. Securities and Exchange Commission.

According to the settlement agreement from February 2022, BlockFi is to pay the SEC a $50 million fine in five installments and pay the full amount within two years. The company has already paid the first two installments, totaling $20 million, leaving an outstanding debt of $30 million to the SEC.

Bankruptcy documents show that Valar Ventures, a venture capital firm spun off from Thiel Capital, founded by PayPal co-founder Peter Thiel, holds 19% of the shares, making Valar one of BlockFi's largest shareholders.

In a statement, BlockFi believes it is in a more favorable position than FTX. No defects in company control or system integrity have been found, and BlockFi's financial information is trustworthy. Just hours after applying for Chapter 11 bankruptcy protection, BlockFi sued former FTX CEO Sam Bankman-Fried (SBF) in a New Jersey court, seeking to seize his $575 million stake in the stock and trading app Robinhood. It is alleged that SBF used Robinhood stock as collateral for the payment obligations of an unnamed borrower under his company Emergent Fidelity Technologies earlier this month.

At this point, it is uncertain whether BlockFi's founders regret accepting FTX's invitation, as choosing other institutions might have led to a different outcome. If the first misstep with Three Arrows Capital stemmed from macro and risk control deficiencies, the second misstep can only be attributed to their poor choice, resulting in a painful price to pay.