Crypto almost killed itself last year. Now the government wants to make its life harder, if not choke it off.
Regulators have issued a flurry of directives, enforcement actions, and other measures to rein in what they see as a rogue industry. The initiatives include warnings to banks, fines over a practice called “staking,” guidelines for companies taking custody of crypto, and a legal challenge to stablecoins—a critical part of crypto markets and bridge to traditional banking.
“This is a coordinated crackdown,” says Nic Carter, a partner at crypto venture-capital firm Castle Island Ventures. An analogy, he says, is Operation Choke Point, a 2013 federal initiative that targeted banks doing business with payday lenders, firearms dealers, and others. “Now it’s every big regulator acting to discourage banks from touching crypto,” he says.
The initiatives come after crypto fell apart last year in bankruptcies, frauds, and $2 trillion in token losses, punctuated by the $32 billion collapse of FTX. While the market has rebounded—with Bitcoin up 50% year to date—regulators are under pressure to prevent more damage to investors, including millions of Americans who lost money in the collapse.
One way to do that, it seems, is to keep crypto out of the banking system. Top federal regulators issued a joint statement in January saying they are “carefully reviewing any proposals from banking organizations to engage in activities that involve cryptoassets.” Banks such as
Signature Bank
(ticker:SBNY) have pared ties to crypto. The warning could make banks less likely to seek regulatory approval.
The Federal Reserve also knocked down hopes for more crypto banking. The Fed rejected an application from digital-assets-focused Custodia Bank for a so-called Master Account, which would have enabled Custodia to get direct access to the Fed’s payment systems without going through an intermediary bank. Custodia has sued the Fed over its handling of the application.
“Regulators have a choice,” says Custodia CEO Caitlin Long. “Are they going to create a regulated path forward to handle this, or are they going to relegate it to the shadows?”
The Fed may have been spooked by a run on
Silvergate Capital
(SI), a small California-based bank that had become a crypto giant, handling $11.9 billion in deposits from customers including FTX. Silvergate’s deposit base collapsed by $8.1 billion, and the bank tapped the Federal Home Loan Bank system for billions in liquidity while also selling bonds it owned at a huge loss. The contagion from FTX, among other things, crashed Silvergate’s stock by 83%.
Some crypto start-ups say they’re having trouble getting bank accounts. J.W. Verret, a law professor trying to launch a nonprofit called the Crypto Freedom Lab, says he has failed to open checking accounts at six banks. “I have large donors and need to cash the checks,” he says. “I sit down with the banks, and it’s basically the same story. ‘Sorry, we don’t deal in crypto.’ ”
The Securities and Exchange Commission is stepping up, too. The agency reached a $30 million settlement with trading platform Kraken, which offered a “staking” service that the SEC said amounted to an unregistered security. Kraken agreed to stop offering the product in the U.S., without admitting or denying wrongdoing.
The SEC also wants to make it harder for companies to serve as a “qualified custodian” under new guidelines. Companies would have to segregate crypto assets, and they would have to be bankruptcy remote, so investors wouldn’t need to fight for their assets in a bankruptcy proceeding. “Based upon how crypto platforms generally operate, investment advisors cannot rely on them as qualified custodians,” SEC Chair Gary Gensler said in a statement.
Perhaps the biggest worry in crypto now: Regulators appear to be building a case that stablecoins are unregistered securities—a potential prelude to lawsuits. Stablecoins, typically pegged to the dollar, are critical to crypto markets, acting as cash proxies and on-ramps to standard dollars. The biggest ones, Tether and USDC, are worth $111 billion combined.
Crypto firm Paxos was ordered this past week to stop issuing Binance USD, or BUSD, stablecoins, by the New York Department of Financial Services. BUSD has a market value of $14.5 billion and was one of the primary stablecoins on the Binance exchange. Paxos said that it had also received a Wells Notice from the SEC—a warning of an enforcement action, alleging that BUSD should have been registered as a security. Paxos says it is “prepared to vigorously litigate if necessary.”
A stablecoin crackdown could jeopardize big profits. Companies that issue them, such as Circle and Tether, keep billions of dollars in reserves in bank deposits or cash equivalents like Treasuries and money-market funds. With some Treasury yields now at 5%, coin issuers can earn considerable interest. Tether says it holds $70.7 billion, mostly in cash equivalents, and made $700 million in net profit in the fourth quarter. Circle’s issuance of $41 billion could be worth $1.6 billion a year in interest at recent rates.
Circle’s chief strategy officer, Dante Disparte, says the firm doesn’t expect issues with BUSD to affect USDC. He says that Congress should establish rules. “The regulation through enforcement stuff isn’t helpful,” he adds.
Coinbase Global
(COIN) has much to lose. The trading platform is being investigated by the SEC in several areas, including its process for listing assets and its yield-generating products. Stablecoins bring in money through a deal with Circle. Coinbase is also building a staking business through the Ethereum blockchain, acting as a middleman for investors to stake tokens to the network in exchange for a yield. That business may also face legal challenges.
“Coinbase embraces regulation and has since day one,” a spokesperson said in a statement. “But a lot of what we’re seeing right now is regulation by enforcement.” Clear rules are needed, the company added.
For now, with regulatory pressure rising, Coinbase and other firms could be fighting for their existence. If the crackdowns continue, “there’s literally no crypto ecosystem,” says Mizuho analyst Dan Dolev. “The whole thing falls apart like a house of cards.”
Write to Joe Light at joe.light@barrons.com
Credit: marketwatch.com