Cryptocurrency Rally: What Could Go Wrong?

Last year, crypto almost ended itself. Today, the government tries to hinder it or even suffocate it.

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To control what they perceive to be a lawless sector, regulators have enacted a flurry of directives, enforcement actions, and other measures. A legal challenge to stablecoins—a crucial component of cryptocurrency exchanges and a link to conventional banking—as well as warnings to banks and fines for the practice of "staking" are among the measures.

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Nic Carter, a partner at cryptocurrency venture capital firm Castle Island Ventures, claims that "this is a concerted crackdown." He uses Operation Choke Point, a 2013 federal campaign that targeted financial institutions doing business with payday lenders, gun traffickers, and other parties, as an example. Every major regulator is currently taking steps to prevent banks from dealing with cryptocurrency, he claims.

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The activities follow the collapse of crypto last year, which included frauds, bankruptcies, and a $2 trillion loss of tokens, highlighted by the $32 billion collapse of FTX. Regulators are under pressure to prevent further harm to investors, especially the millions of Americans who lost money in the collapse even if the market has recovered, with BitcoinBTCUSD -2.27% up 50% year to date.

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It appears that keeping cryptocurrency out of the financial system is one way to do this. Banks like Signature Bank (ticker:SBNY) have cut links to crypto after top federal regulators said in a joint statement in January that they are "carefully considering any proposals from banking entities to engage in activities that include cryptoassets." The warning might discourage banks from requesting regulatory approval.

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Meanwhile, the Federal Reserve dashed prospects for expanded crypto banking. The Fed turned down Custodia Bank's request for a "Master Account," which would have given Custodia direct access to the Fed's payment systems without going through a middle bank. Custodia Bank focuses on digital assets. Due to the Fed's handling of the application, Custodia has filed a lawsuit.

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Caitlin Long, CEO of Custodia, says that regulators have a choice. "Will they develop a controlled course of action to tackle this, or will they push it into the background? ”

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A run on Silvergate Capital (SI), a small bank in California that had grown to be a crypto powerhouse and received $11.9 billion in deposits from clients like FTX, may have alarmed the Fed. As a result of the $8.1 billion decline in Silvergate's deposit base, the bank sold bonds it owned at a significant loss and turned to the Federal Home Loan Bank system for billions in liquidity. Among other things, the FTX epidemic caused Silvergate's shares to drop by 83%.

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Some cryptocurrency start-ups claim that opening bank accounts is difficult. J.W. Verret, a law professor attempting to form a nonprofit organization called the Crypto Freedom Lab, claims he has been unable in opening checking accounts at six different banks. I need to cash the checks from some significant donors, he claims. "I meet with the banks, and the narrative is essentially the same. Sorry, but we don't trade in cryptocurrency.

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Also, the Securities and Exchange Commission is doing more. With trading platform Kraken, which provided a "staking" service that the SEC said amounted to an unregistered security, the agency struck a $30 million settlement. Without disputing or admitting any wrongdoing, Kraken decided to stop selling the goods in the United States.

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Also, the SEC intends to make it more difficult for businesses to fulfill the role of "qualified custodian" under the new rules. To prevent investors from having to fight for their assets during a bankruptcy case, companies would have to separate crypto assets and be bankruptcy remote. Investment advisors "cannot rely on them as competent custodians based upon how crypto platforms normally function," SEC Commissioner Gary Gensler said in a statement.

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Authorities appear to be constructing a case that stablecoins are unregistered securities—possibly setting the stage for lawsuits—which is perhaps the biggest concern in cryptocurrency right now. As cash substitutes and on-ramps to traditional dollars, stablecoins, which are often tied to the dollar, are essential to the cryptocurrency markets. Tether and USDC are the largest, with a combined value of $111 billion.

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The New York Department of Financial Services ordered the cryptocurrency company Paxos to stop creating Binance USD, or BUSD, stablecoins last week. BUSD was a popular stablecoin on the Binance exchange with a market cap of $14.5 billion. BUSD allegedly should have been registered as a security, according to a Wells Notice the SEC sent to Paxos, which warned of potential enforcement action. According to Paxos, it is "prepared to sue tenaciously if required."

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A stablecoin crackdown might put significant profits in danger. Businesses that issue them, like Circle and Tether, maintain reserves in the billions of dollars in bank deposits or cash alternatives like Treasury bonds and money market funds. As some Treasury yields are currently at 5%, coin makers can make a sizable profit. Tether claims to own $70.7 billion, the majority of which is in cash equivalents, and that its fourth-quarter net profit was $700 million. At current rates, the $41 billion that Circle issued might earn it $1.6 billion in interest per year.

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Dante Disparte, chief strategy officer at Circle, states that the company does not anticipate that problems with BUSD will harm USDC. He asserts that Congress should enact regulations. He continues, "The regulating by enforcement thing isn't good."

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Much is on the line for Coinbase Global (COIN). The SEC is looking at the trading platform in a number of areas, including its asset listing procedure and its yield-generating products. Stablecoins generate revenue thanks to a partnership with Circle. With the Ethereum blockchain, Coinbase is also developing a staking business, serving as a middleman for investors to stake tokens to the network in exchange for a payout. Legal issues could also affect that company.

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According to a statement from a spokesman, Coinbase "embraces regulation and has done so since day one." The company noted that there should be clear guidelines instead of the regulation by enforcement that is prevalent at the moment.

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As a result of increasing regulatory pressure, Coinbase and other companies may currently be in a survival battle. According to Mizuho analyst Dan Dolev, if the crackdowns continue, "there is practically no crypto ecosystem." "Everything just crumbles like a house of cards."