“We grew too fast”: Cryptocurrencies face a reckoning as the market faltered

“We grew too fast”: Cryptocurrencies face a reckoning as the market faltered

That could be said for the entire digital asset market, which has seen more than two-thirds of its value evaporate since peaking at $3 trillion last fall. As the Federal Reserve steps up its campaign to rein in inflation, investors are dumping risky assets in anticipation of rising interest rates. Startups that soared during the two years of stimulus-fueled pandemic have begun to fall to the ground.

The market downturn is likely to temper expectations around a two-year lobbying campaign that has made digital assets one of the most visible industries on Capitol Hill. Crypto’s shrinking footprint could weaken the bid for major exchanges and developers to push through new laws and light regulations that they say would allow blockchain-based businesses to flourish. And it could damage any trust the industry has built up in Washington, particularly amid mounting scandals at popular lending platforms where customer accounts have been frozen or deleted.

“When everything goes up, a lot of things hide,” Caroline Pham, commodity futures trading commissioner, said in an interview. “From a regulator’s perspective, it really just underscores that we just have to be doing something.”

Major exchanges and industry associations pumped $9 million into Washington’s lobbying efforts in 2021, more than tripling their spending from the previous year, according to a report by watchdog group Public Citizen. That momentum accelerated through early 2022 and was amplified by tens of millions in campaign contributions from influential operatives like FTX founder Sam Bankman-Fried.

But the battle to shape legislation and influence agency decisions to beef up industry oversight is just beginning, and Caitlin Long, founder and CEO of a Wyoming-based crypto bank, said some digital asset firms they are to blame for the mounting pressure from regulators. . Representations companies make to Washington lawmakers often amount to “regulatory theater,” she said.

“They know they exist in a regulatory gray area,” said Long, who is suing the Fed to open a master account that would put his bank under direct central bank supervision. For some crypto companies, “the strategy is to grow as fast as possible; become too large to be required to comply with regulations.”

That strategy might be too big to work. Market regulators and law enforcement have already focused on areas such as insider trading, disclosure failures, and investor protection issues. And regulators, including top brass at both the Securities and Exchange Commission and the CFTC, have signaled that further investigations are likely.

“I hope we use the turmoil of the last few weeks to see where we are from a regulatory standpoint,” said Robert Baldwin, a former Treasury official and chief policy officer of the Digital Asset Markets Association. While the industry has gained credibility with policymakers, he said, recent events “force people to step up and think about what’s going on. It will also probably force companies to be a bit more cautious.”

Meanwhile, with Congress’s attention divided by crises from Ukraine to inflation, the urgency to pass new crypto laws will likely lessen as investors move away from high-risk digital assets. Even with celebrity endorsements of cryptocurrency businesses grabbing headlines, a recent Fed survey found that only 12 percent of American adults had owned or used digital currencies in the past year.

The decline in digital asset markets, coinciding with losses in more traditional financial markets, is accelerating as hedge funds, cryptocurrency-based lending platforms and stablecoin issuers scramble for liquidity to save your projects.

The latest outburst began last weekend after Celsius Network, a bank-like crypto lender that promised annual returns of up to 18 percent on customer deposits, announced it would pause withdrawals and crypto exchange services. for crypto for roughly 2 million customers “due to extreme market conditions.” The company, which has not responded to multiple requests for comment, is reportedly exploring restructuring.

Celsius’s troubles echoed those of TerraForm Labs, the startup behind an algorithmic stablecoin that crashed last month, which also attracted billions of dollars from retail traders and institutional investors by linking its token to a lending program. high performance decentralized

The market downturn is also starting to bring down major cryptocurrency investment firms. Three Arrows Capital, a Dubai-based hedge fund, is reeling after posting hundreds of millions of losses from its investments in TerraForm tokens and other declining digital assets.

Both businesses have had run-ins with securities regulators. Celsius was ordered by four state agencies to stop offering unregistered securities in the form of interest-bearing accounts amid fears the company could not meet its obligations to depositors.

“Lawmakers care less about common stockholders and preferred stockholders; first and foremost, they care about those depositors,” said Mike Boroughs, co-founder and head of portfolio management at blockchain investment firm Fortis Digital.

While some decentralized finance (DeFi) lenders, or more centralized companies offering access to DeFi-like returns, might offer cheaper alternatives to tightly regulated banks, the lack of institutional underwriting standards injects even more risk into crypto markets.

“If you’re offering a higher yield by taking on worse loans, that just creates a 2008 subprime crisis in a different industry,” Boroughs said.

Cryptocurrency advocates have resisted such comparisons, arguing that community-governed or autonomous systems that mimic the functions of traditional lenders and exchanges could become safer and cheaper alternatives. And, for now, no existing platform has been scaled up to the point where it could pose a systemic risk to the economy.

Legislators and cryptocurrency advocates say market volatility could provide an opportunity for certain companies to highlight their practices as a potential model for future legislation or regulation. sens. cynthia lummis (R-Wyoming) y kirsten gillibrand (DN.Y.) say their recent crypto bill, celebrated by the industry as a milestone, was shaped by some of the issues that arose following the TerraUSD collapse.

“We’re kind of in an ugly duckling phase,” said Linda Jeng, a former Fed official who leads policy and regulatory efforts at the Center, a crypto industry-backed standards organization. Jeng said she hoped to work with regulators to “develop appropriate proportionate rational rules and regulations.”

However, the arrival of more scandals could create roadblocks for the industry as it tries to make that case in Washington, particularly with new venture capital-backed platforms offering similar services coming off the conveyor belt.

“If you want to start a successful platform in this space, the current framework is extraordinarily ambiguous as to how you would do it,” said Tomicah Tillemann, global policy director at Haun Ventures, a venture firm that recently provided seed funding to a new platform. of DeFi loans. “We and others have been asking the SEC to provide clarification for a long time, and they have failed to do so completely.”

SEC Chairman Gary Gensler says the rules on crypto lending are clear.

Gary Gensler, Chairman of the US Securities and Exchange Commission, testifies before a Senate Committee on Banking, Housing and Urban Affairs oversight hearing on the SEC on September 14, 2021 in Washington, DC. | Evelyn Hockstein/Getty Images
BlockFi, another platform that recently endured layoffs, paid $100 million to settle claims that its yield-generating accounts were unregistered securities. Coinbase scrapped plans for a product that would have allowed customers to earn interest on their digital assets after a highly public dispute with the regulator last year. The agency was reportedly investigating Celsius, as well as several other crypto-lending platforms, in the months before freezing their clients’ assets.

An SEC spokesman declined to comment on whether any investigations are pending.

“Lending platforms are operating a bit like banks,” Gensler said at an event on Tuesday, adding that trading platforms and exchanges offering sky-high returns have largely not disclosed enough information about their products to investors.

“If it seems too good to be true, it may be too good to be true,” he said.

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