‘We’ve grown too fast’: Crypto faces reckoning as the market fluctuated

That can 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 ramps up its campaign to curb inflation, investors are dumping risky assets in anticipation of rising interest rates. Startups that boomed during the two stimulus-fueled pandemic years have begun to crash.

The market plunge is likely to dampen expectations surrounding 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 a bid from top exchanges and developers to push for new laws and light regulations that they claim would help blockchain-based businesses thrive. And it could hurt any trust the industry has built in Washington, especially amid growing scandals on popular lending platforms where customer accounts have been frozen or wiped out.

“When everything goes up, it hides a lot,” Commodity Futures Trading Commissioner Caroline Pham said in an interview. “From a regulator’s perspective, it just underscores that we just need to do something.”

Top scholarships 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 the watchdog group Public Citizen. That drive accelerated into early 2022 and was bolstered by tens of millions in campaign contributions from power brokers like FTX founder Sam Bankman-Fried.

But the battle to shape legislation and influence agency decisions to tighten industry oversight has only just begun, and Caitlin Long, the founder and CEO of a Wyoming-based crypto bank, said some digital asset companies blame themselves for the increasing heat from regulators. The statements the companies make to Washington policymakers often amount to “regulatory theatre,” she said.

“They know they are in a regulatory gray area,” said Long, who is suing the Fed for opening a master account that would put its bank under the direct supervision of the central bank. For some crypto companies, “the strategy is to get as big as possible as soon as possible; become too large to have to comply with the regulations.”

That strategy may be too big to work. Market regulators and law enforcement have already targeted areas such as insider trading, disclosure errors and investor protection issues. And regulators, including top executives from both the Securities and Exchange Commission and the CFTC, have indicated more investigations are likely.

“I hope we use the turmoil of the past few weeks to see where we stand from a regulatory standpoint,” said Robert Baldwin, a former Treasury official and chief of policy at the Association for Digital Asset Markets. While the industry has built credibility with policymakers, he said, “recent events are forcing people to take a step and think about what’s going on. It’s probably also forcing companies to be a little more cautious.”

Meanwhile, with Congressional attention divided by Ukraine’s crises to inflation, the urgency to pass new crypto laws is likely to wane as investors shy away from risky digital assets. Even with the headlines snagging crypto corporate celebrities, a recent Fed survey found that only 12 percent of US adults had or use 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 seek liquidity to bail out their projects.

The latest explosion started last weekend after Celsius Network — a bank-like cryptocurrency lender that promised annual returns of as much as 18 percent on customer deposits — announced it was pausing withdrawals and crypto-for-crypto trading services for about 2 million customers.”due to extreme market conditions† The company, which has not responded to several requests for comment, is reportedly investigating a restructuring.

Celsius’s woes echoed that of TerraForm Labs — the startup behind an algorithmic stablecoin that collapsed last month — which had also attracted billions of dollars from retail traders and institutional investors by linking its token to a high-yield decentralized lending program.

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

Both companies have had to deal with securities regulatory authorities. Celsius was ordered by four government agencies to stop offering unregistered securities in the form of interest-bearing accounts for fear the company would be unable to meet its obligations to depositors.

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

While some decentralized financial (DeFi) lenders — or more centralized firms that provide access to DeFi-like yields — may offer cheaper alternatives to tightly regulated banks, a lack of institutional underwriting standards puts even more risk in crypto markets.

“If you offer a higher return by taking out worse loans, that just creates a 2008 subprime crisis in another sector,” Boroughs said.

Crypto proponents have resisted these kinds of comparisons, arguing that autonomous or community-run systems that mimic the functions of traditional lenders and exchanges could become safer and cheaper alternatives. And for now, no existing platform has scaled to the extent that it could pose a systemic risk to the economy.

Lawmakers and crypto advocates say the market volatility could provide certain companies with an opportunity to showcase their practices as a potential model for future legislation or regulation. Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (DN.Y.) say their recent crypto account — celebrated as a landmark by the industry — was shaped by some of the issues that arose after the TerraUSD collapse.

“We’re kind of at this ugly duckling stage,” said Linda Jeng, a former Fed official who leads regulatory and policy efforts at the crypto-industry-backed standards organization Center. Jeng said she looked forward to working with regulators to “develop appropriate proportional rational rules and regulations.”

Nevertheless, the advent of more scandals could create obstacles for the industry trying to defend that Washington case — especially with new venture-backed platforms offering similar services rolling off the assembly line.

“If you want to launch a successful platform in this space, the current framework is just extremely ambiguous about how you would do that,” said Tomicah Tillemann, the global chief policy officer of Haun Ventures, a venture firm that recently started funding. to a new DeFi lending platform† “We and others have been calling on the SEC to provide clarification for a long time, and they have totally failed to do so.”

SEC chairman Gary Gensler says the rules around crypto lending are clear.

BlockFi, another platform that has endured recent layoffs, paid $100 million to settle claims that its revenue-generating accounts were unregistered securities. Coinbase scrapped plans for a product that would allow customers to earn interest on their digital assets after a very public row with the regulator last year. The agency was reportedly investigating Celsius — as well as several other crypto lending platforms — in the months before it froze its clients’ assets.

An SEC spokesperson declined to comment on whether there are any ongoing investigations.

“Loan platforms, they operate a bit like banks,” Gensler said at an event Tuesday, adding that trading platforms and exchanges that offer skyrocketing returns have largely not disclosed enough information about their products to investors.

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

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