Development of Bitcoin and thousands of other cryptocurrencies in a little over a decade has changed the definition of money — and spawned a parallel universe of alternative financial services, allowing crypto businesses to move into traditional banking territory. Investors can earn interest on their holdings of digital currencies — often a lot more than they could on cash deposits in a bank — or borrow with crypto as collateral to back a loan. Crypto loans generally involve no credit checks as transactions are backed by digital assets. The market is quickly being flooded with businesses from the vaguely familiar to science-fiction-like entities. They run the gamut from BlockFi, which offers interest-bearing accounts like a bank and has state lender licenses, and Kraken Bank, which was granted a Wyoming bank charter and hopes to soon take retail deposits, to markets controlled by computer code and devised to be governed by users through a token distribution structure. Compound, a decentralized, automated lending and borrowing system began in 2018 and now has more than $18 billion in assets earning interest.
Deposits are not guaranteed by the Federal Deposit Insurance Corporation. “Cyberattacks, extreme market conditions, or other operational or technical difficulties” could lead to a temporary or permanent halt on withdrawals or transfers, the company cautions in fine print. Some regulators and lawmakers worry that those warnings are not prominent enough and that consumers need stronger protections. Traditional banks lend out their customers’ deposits and pay clients a slice of the earnings as interest. Crypto outfits take a similar approach: They pool deposits to offer loans and give interest to depositors. But by law, banks are required to have reserves to ensure that even if some loans go bad, customers can still withdraw funds, whereas cryptobanks do not have the same reserve requirements and the institutions they lend to can take risky bets. Crypto is very volatile, making it less practical for transactions like payments or loans. That’s where stablecoins come in. They are cryptocurrencies pegged to stable assets, commonly the dollar. They are meant to provide the steady value of government-issued money in digital form for blockchain transactions, but they are issued by private entities. Popular dollar-tied tokens include Tether and U.S.D. Coin. The number of stablecoins in circulation globally has jumped from $29 billion in January to $117 billion as of early September, according to The Block, a publication dedicated to cryptocurrency. Decentralized finance, or DeFi, loosely describes an alternative finance ecosystem where consumers transfer, trade, borrow and lend cryptocurrency, theoretically independently of traditional financial institutions and the regulatory structures that have been built around Wall Street and banking. Some regulators and innovators argue that new technology demands a new approach, saying novel risks can be addressed without necessarily crimping innovation.