The downfall of the crypto unicorn BlockFi: After SEC investigation, it goes downhill, subsequently stepping on landmines with 3AC and FTX

The downfall of BlockFi was directly caused by stepping on the two biggest landmines of the year, Three Arrows Capital and FTX, and fundamentally, its long-term high-interest business model was not viable in the rapidly changing crypto market. The lack of proactive preparation for the arrival of a new bear market cycle and the collapse of the first domino of internal liquidity led to the beginning of its demise.

This article is authorized by PANews and originally published here.

Another crypto unicorn has fallen. After being "acquired" by FTX for less than 5 months, BlockFi collapsed in the ruins of FTX and officially filed for bankruptcy liquidation on November 28.

Starting Strong with Continuous Financing of Hundreds of Millions of Dollars

Unlike the elite backgrounds of executives from FTX and Alameda, BlockFi's two founders, Zac Prince and Flori Marquez, have modest backgrounds. Both have experience in financial technology loans. Zac's entrepreneurial journey began when he couldn't mortgage his own cryptocurrency holdings during a loan process. Flori, as the daughter of Argentine immigrants and the first in her family to attend university, graduated from the prestigious Ivy League school Cornell University in the U.S. Due to the devaluation of Argentina's currency, she had more faith in the value of cryptocurrency. The two started preparing to establish the cryptocurrency lending company BlockFi in 2017. However, the introduction pages of these two founders and company executives were quietly removed after FTX's exposure.

Lending is a business that has existed for thousands of years. BlockFi's business model is clear and can be understood as a cryptocurrency version of a P2P lending platform. They provide lending services to individual and institutional users on the asset side, charging interest on loans, while funding comes from retail or institutional deposits, providing them with interest income. The platform earns the interest difference between borrowing and depositing.

In February 2018, BlockFi first announced financing news, receiving $1.55 million from institutions such as ConsenSys Ventures, SoFi, and Kenetic Capital. SoFi is a well-known U.S. P2P lending platform that started with campus loans. From 2018 to 2021, BlockFi experienced rapid growth. Five months after announcing its first financing, in July 2018, BlockFi announced a $52.5 million financing, led by Galaxy Digital founded by cryptocurrency billionaire Mike Novogratz.

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

According to a March 2021 Bloomberg report, BlockFi experienced rapid growth. As of February 2021, assets surged from $1 billion a year ago to $14 billion. Monthly revenue jumped from $1 million to $40 million, and the number of employees increased from 75 to 500.

Dim Prospects for Going Public After SEC Investigation Leads to Downfall

In 2020, BlockFi and Coinbase announced plans to go public around the same time, with the earliest listing expected in the second half of 2021. However, internal and external issues later made it impossible for BlockFi to go public.

As the company rapidly developed by mid-2021, internal management issues became apparent. In May 2021, BlockFi mistakenly distributed 701 BTC instead of 701 GUSD as rewards to users, resulting in the company losing tens of millions of dollars. This incident reflected BlockFi's loose financial management. At the time, some employees took responsibility and resigned. Additionally, there were reports that BlockFi's technical systems were poor, using the niche and complex Elixir programming language. Product iteration and update speeds were slower than competitors, requiring a large increase in technical staff to compensate for the deficiencies. According to Blockworks, BlockFi dismissed its Chief Technology Officer who joined in 2018 and asked the Chief Growth Officer to resign.

BlockFi was also targeted by the U.S. Securities and Exchange Commission (SEC). In November 2021, during Bitcoin's peak, it was formally announced that the SEC was investigating BlockFi's interest-bearing crypto accounts of up to 9.5% and deemed them as securities. Subsequently, in February 2022, BlockFi reached a settlement with the SEC, paying $50 million to the SEC and halting the opening of new accounts for its high-yield loan products to most Americans, with existing accounts seemingly unaffected. BlockFi also agreed to pay an additional $50 million to state regulatory agencies. BlockFi also applied to launch a Bitcoin exchange-traded fund (ETF) in October 2021 but was not approved.

BlockFi's Series E financing in June 2021 did not go smoothly. Originally planning to raise $5 billion at a $40 billion valuation, the company reportedly only completed half of the financing amount. Since then, traditional asset management companies have not been optimistic about BlockFi's listing potential.

The SEC's intervention marked the end of BlockFi's glorious era. The platform's funds shrank directly from billions to $20-30 billion. According to BlockFi's disclosure, as of the end of June 2022, the company had $1.8 billion in outstanding loans from institutional and retail investors, with $600 million being uncollateralized loans. Institutional loans accounted for $1.5 billion of the total outstanding loans, while retail loans accounted for the remaining $300 million. The timely intervention by the SEC also reduced losses for retail investors using BlockFi.

Decline Continues After FTX and 3AC Missteps Lead to Bankruptcy Application

During the peak of the bull market, even after the SEC investigation, BlockFi was able to meet user withdrawal demands. However, when the market entered a bearish phase, asset prices plummeted, liquidity was insufficient, and industry risks led to customer defaults. Additionally, the product's mismatched settings couldn't meet investors' withdrawal demands promptly, plunging BlockFi into a crisis.

The direct trigger was the collapse of Three Arrows Capital. BlockFi had provided approximately $1 billion in loans to Three Arrows Asset, with collateral being two-thirds Bitcoin and one-third GBTC, with an excess collateral rate of 30%. From a risk management perspective, providing such a high loan amount to a single borrower posed obvious risks. BlockFi suffered a loss of approximately $80 million due to Three Arrows Capital's losses.

In June, with BlockFi bleeding heavily, the company sought institutional assistance and officially announced on July 2nd that it had received funding support from FTX, which would provide BlockFi with a $400 million revolving credit line. FTX also had the right to acquire BlockFi for up to $240 million at a variable price. The agreement included conditions such as BlockFi obtaining SEC's important regulatory approval for BlockFi Yield's S-1 by the end of this year, and the acquisition price would increase accordingly when customer assets reached $10 billion by the fall of 2023.

In reality, BlockFi chose FTX US among several institutions, stating that other options were not attractive as user funds might be reduced, not aligning with customer interests. They believed that FTX US's platform and products were highly complementary to BlockFi's and expected to enhance services through strengthened cooperation.

BlockFi failed to realize that FTX had other intentions.

It is worth noting that PANews observed that on July 20th, BlockFi updated an article on its website specifically sharing the risk management team's management framework, indicating that the risk management team operates independently from the business team and consists of experienced risk management teams who have experienced the 2008 financial crisis and the 2011 European debt crisis. However, this page was updated after BlockFi filed for bankruptcy on November 28th.

After receiving blood transfusions from FTX, just four months later, this white-clad angel revealed its "demonic" side. On November 11th, BlockFi announced a suspension of withdrawal services, advising customers not to deposit funds in BlockFi Wallet and Interest Accounts, stating, "Due to the uncertain status of FTX.com, FTX US, and Alameda, we cannot operate as usual."

Subsequently, on November 28th, BlockFi submitted a Chapter 11 reorganization application to the New Jersey court where its headquarters are located. The filing showed that BlockFi had over 100,000 creditors, with estimated assets and liabilities ranging from $1 billion to $10 billion. BlockFi currently holds $256.9 million in cash to support some business during the reorganization process.

After FTX's collapse, a BlockFi employee revealed that FTX's only condition for helping BlockFi was to move its user funds to their platform. However, this information was denied by BlockFi's official statement, claiming that most of BlockFi's assets were not with FTX. Nevertheless, there were significant risks exposed to FTX and its affiliated entities, including Alameda's debts owed to us, assets held by FTX.com, and the amount untapped in our credit line at FTX.US. In bankruptcy court, BlockFi's lawyers stated that BlockFi currently had approximately $355 million in cryptocurrency frozen at FTX. Additionally, BlockFi had provided a $671 million loan to Alameda Research.

SEC Becomes Creditor, Valar Ventures Largest Institutional Shareholder

According to bankruptcy filing documents, Ankura Trust Company, LLC, a specialized institution handling bankruptcy cases, is its largest creditor, holding unsecured claims worth approximately $729 million. This is followed by FTX US's unsecured claim of $275 million and the U.S. Securities and Exchange Commission's $30 million.

According to the February 2022 settlement agreement, BlockFi is required to pay the SEC $50 million in five installments, with the full amount to be paid within two years. The company has paid the first two installments totaling $20 million, leaving a remaining debt of $30 million to the SEC.

Bankruptcy data shows that Valar Ventures, a venture capital firm spun off from investment company Thiel Capital founded by PayPal co-founder Peter Thiel, holds a 19% stake, making Valar one of BlockFi's largest shareholders.

In a statement, BlockFi believes it is in a better position than FTX. No control or system integrity flaws were 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 for seizing his $575 million worth of shares in stocks and trading app Robinhood. Allegedly, SBF pledged Robinhood stocks as collateral in the name of his company Emergent Fidelity Technologies earlier this month to secure payment obligations for an unnamed borrower.

At this point, the founders of BlockFi may be regretting not rejecting FTX's invitation in the first place. If they had chosen another institution, perhaps they wouldn't have ended up in this situation. If the first misstep with Three Arrows Capital stemmed from macro and risk control deficiencies, the second misstep was simply a result of their own wrong choices, leading to a painful price to pay.