The Department of Financial Protection & Innovation (DFPI) of the state of California published a consumer alert yesterday in which it warned the public about companies in the crypto space that offered interest-bearing accounts for failing to adequately disclose the risks to which their customers are exposed when they deposit money into these instruments.

The department stated that it is actively investigating these firms as some of them have limited customers’ ability to withdraw or transfer money between or out of their accounts due to current market conditions.

“Crypto-interest account providers are not governed by the same rules and protections as banks and credit unions, which are required to have deposit insurance”, the DFPI clarified amid rumors that some of these instruments may be covered by the Federal Deposit Insurance Corporation (FDIC).

The press release cited a recent incident involving crypto exchanges BlockFi and the now bankrupted Voyager Digital where the department found that the two companies were offering unregistered securities to the public in the form of interest-bearing accounts.

The warning comes weeks after several companies within the crypto space including Celsius Network, Voyager Digital, and CoinFLEX have unilaterally paused withdrawals for customers.

In most cases, the platforms have failed to adopt proper risk management protocols and have succumbed to the default of one or various counterparties whose loans were under-collateralized.

The lack of industry-specific regulations for this kind of situation has resulted in losses for investors who have not been able to enforce their claims as some of these companies are not even registered or licensed to operate within the United States.

Regulatory agencies in other states such as Alabama, Texas, and Washington have also started investigating the operations of many of these exchanges and crypto lending platforms.

Authorities in California and other states could opt to restrict companies that are incorporated in the United States from offering these interest-bearing accounts in the future although the decentralized nature of blockchain technology may prove elusive for achieving this goal as users could still access the platforms despite these legal roadblocks.

Crypto Winter and 3AC’s Collapse: The Root of the Mayhem

A sharp decline in the value of crypto assets has been partially blamed for these incidents. In addition, the collapse of a large Asian hedge fund called Three Arrows Capital (3AC) has also triggered the crisis among crypto brokers as the investment company defaulted on billions of dollars in loans it took from these crypto firms.

Creditors have forced the liquidation of 3AC in the British Virgin Islands but efforts to recover some of the lost funds may be obstructed by how the company was structured and how its assets were distributed across multiple legal entities.

Industry experts trace back the current issues to the collapse of Terra’s native tokens LUNA and UST – an event that led to over $60 billion in losses from investors across the world.

Three Arrows Capital may have been heavily exposed to the token and suffered heavy losses as a result of its implosion. Even though brokers may have attempted to quickly liquidate 3AC’s positions back then, the unexpectedly fast decline in the value of both tokens left them with losses that exceeded the pledged collateral and a counterparty unwilling to fulfill its obligations.

An SEC Investigation is On Course Against Terra and Its Founder

On 9 June, the US Securities and Exchange Commission (SEC) won an appeal to subpoena documents from Terraform Labs and Do Kwon – the founder of the demised crypto project – as part of an investigation concerning the Mirror Protocol – an exchange that allowed investors to trade synthetic assets that mirrored the price of a certain stock.

The SEC investigation is attempting to determine if this protocol violated federal securities laws such as the marketing and sale of unregistered securities. Do Kwon’s whereabouts are also not known while other investigations are on course including one in South Korea – the location in which Terraform Labs was legally domiciled.

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