Why the crypto crash is fueling calls for cryptocurrency regulation

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Why the crypto crash is fueling calls for regulation

Cryptocurrencies have thrived by positioning themselves as alternatives to the traditional financial system. But the ongoing crypto crash — which has seen markets plunge, investors madly selling assets and even a bank run — is reigniting calls to regulate the freewheeling industry.

In other words: The crypto crackdown is coming. And what emerges could look much more like the traditional banks, stock markets and investments that the industry has long disparaged.

Treasury Secretary Janet Yellen in May urged Congress to enact comprehensive regulations on stablecoins — cryptocurrencies pegged to the U.S. dollar — after one of the most prominent, Terra, collapsed; the Securities and Exchange Commission is investigating the crash. Meanwhile, Sens. Kirsten Gillibrand (D-N.Y.) and Cynthia Lummis (R-Wyo.) introduced major legislation earlier this month that would create the first comprehensive federal framework for regulating digital currencies. And the European Union is reportedly working on its own proposal for crypto regulation.

Those calls for stronger oversight will be hard to fend off for an industry that has lost more than $2 trillion in value since its peak in November 2021, experts said. Some estimates place the toll of the Terra collapse alone at roughly $60 billion.

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“It’s going to lead to more regulation, especially because you have this awful mix of whatever is going to happen with this very uncertain economy, coupled with all of the marketing of crypto that’s happening right now to vulnerable and minority communities, all the celebrity endorsements,” said Bill Maurer, director of the Institute for Money, Technology and Financial Inclusion at the University of California, Irvine. “The thing is, if regulation is going to happen, it better happen fast.”

The prices of market-leading cryptocurrencies such as Bitcoin and Ethereum have plummeted in recent weeks. Meanwhile, liquidity problems prompted crypto lender Celsius Network to freeze transfers and withdrawals earlier this month, citing “extreme market conditions.” And cryptocurrency exchange Coinbase said last week that it plans to lay off approximately 1,100 employees, or 18 percent of its workforce.

An end to crypto shadow banking?

Much of the recent concern around crypto centers on the idea that the industry is a hive of “shadow banking” — banking activities undertaken by under- or unregulated entities, rather than an insured and tightly regulated financial institution.

The bottom line is that companies operating in this way forego safeguards like federal deposit insurance, which can protect investors and ensure a baseline level of liquidity even when markets are stressed.

Those safeguards have the added benefit of building confidence in the overall financial system: reassuring the public that the value of money is stable and their funds will be available when they need to withdraw them. But confidence in crypto has so far rested largely on sheer enthusiasm, rather than the knowledge that the system has built-in protections.

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“One of the foundational mythologies of crypto is that you’re going to have this private money and finance that is unregulated and yet still secure, because of the technological workaround,” Mehrsa Baradaran, a professor at the University of California, Irvine, School of Law and author of “The Color of Money” and “How the Other Half Banks.”

Yet Celsius’ decision to freeze withdrawals was a response to a classic bank run, as people rushed to pull their funds — and because Celsius is a crypto lender, there was no federal deposit insurance. The company’s collapse may be a harbinger of things to come.

As prices for digital currencies have plummeted, the overall ecosystem is showing signs of stress. A Hong Kong-based crypto lender, Babel, froze withdrawals as it sought review its liquidity situation. It was recently valued at over $2 billion and had over $3 billion in loans on its balance sheet. Meanwhile, crypto lender BlockFi, a Celsius competitor, was bailed out by crypto exchange FTX to the tune of a $250 million revolving line of credit. FTX did something similar with crypto brokerage Voyager Digital last week.

Baradaran compared it to the 1907 bank panic, when J.P. Morgan stepped up to save the traditional financial system, effectively picking winners and losers.

“FTX bailed them out because they’ve got the money, like J.P. Morgan,” said Baradaran. “But as we saw from 1907, then what happens with the Great Depression, around 15 years later, is that there’s just isn’t enough money to bail out the firms this time.”

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Writing on the wall

The Gillibrand-Lummis bill would classify cryptocurrencies and other digital assets as commodities overseen by the Commodity Futures Trading Commission (CFTC) rather than securities regulated by the Securities and Exchange Commission. That’s notable in part because the SEC has so far taken the lead on monitoring and investigating the crypto industry — announcing in May that it would be adding 20 positions to its team dedicated to its Crypto Assets and Cyber Unit. The agency’s leader, Gary Gensler, has also spoken bluntly about the need to regulate the crypto industry.

It’s not clear whether the Senate bill will make it into law, and if so, how much it will have changed by then.

But Baradaran is skeptical that legislation with real teeth will arrive quickly, because — to put it mildly — partisan gridlock means that Congress has become bad at passing anything in recent years. That doesn’t rule out action by the SEC, CFTC or other federal agencies on various aspects of crypto, but it does raise questions about when, or if, the U.S. will see a unified framework for crypto.

“I think getting any sort of regulation on this is kind of a mess,” said Baradaran. “You look at who is interested in this and who does it benefit. It benefits everybody generally to have some sort of regulatory system, but the regulated industries are going to oppose it. Those things have a harder time getting passed, which is why they tend to go toward the Federal Reserve or the Treasury or the [Federal Deposit Insurance Corp.] or the [Office of the Comptroller of the Currency]. All of those agencies already have the authority to do it.”

Lars Seier Christensen, chairman of the Switzerland-based Concordium Foundation, which oversees a major blockchain project, said he’s concerned that there will be further catastrophic decentralized finance events in the next 12 months. DeFi is the crypto industry term for peer-to-peer financial transactions made using blockchain technology.


“The worst conceivable scenarios could have systemic risks ingrained,” said Christensen, who is also a founder of Denmark-based Saxo Bank, which offers online trading and investments. “Even without systemic risks, the involuntary liquidation of crypto assets placed as collateral can have a big impact on prices, as the demand side is generally quite weak.”

Some crypto companies also see the writing on the wall.

“Regulation is coming — there’s no stopping that,” Mark Basa, director of Hokk Finance, a decentralized finance product builder. “Regulators want to ensure that the [backers of a cryptocurrency are] not promoting the asset as a speculative one, but also want to ensure that the investor is not dumping their life savings with zero chance of getting it all back.”

Thanks to Lillian Barkley for copy editing this article.

  • Benjamin Powers
    Benjamin Powers

    Technology Reporter

    Benjamin Powers is a technology reporter for Grid where he explores the interconnection of technology and privacy within major stories.