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In March, Federal Reserve Chairman Jerome Powell said it was “very easy to see the risks” of cryptocurrencies and warned that central banks “don’t know how some digital products will work in times of market stress.”
What they’ve seen recently won’t bring them comfort. The sudden and rapid demise of popular cryptocurrency projects sheds light on the “fragile” nature of many cryptocurrency products and shows the vigilance of regulators who are inherently redundant.
First, in early May, TerraUSD, an algorithmic stablecoin, quickly collapsed, wiping out billions of dollars in value in just a few short days. Celsius then halted the acquisition by customers who had deposited money and were said to be about to lose their insolvency. Celsius’ aggressive moves to liquidate leveraged positions have rocked the cryptocurrency market. Bitcoin briefly hit $20,000 and is down more than 70% since its November 2021 peak.
These bad events and the insecurity they cause will likely instill in regulators and policymakers a new sense of urgency to address the issues that have gnawed at the cryptocurrency industry. But these issues and the fall in cryptocurrency prices can also be a great opportunity to create a clearer path forward. They came amid heightened legal pressure.
What did the legalists say?
In August 2021, federal banking authorities launched cryptocurrency “sprints” and in the fall of 2021, laid out their agenda for 2022. In November 2021, the President’s Working Group on Financial Markets (PWG), released a report detailing stablecoin-related risks, including the risk of panic-like banking activity, and called on Congress to pass new legislation restricting the issuance of stablecoins to insured banks. Then, in March 2022, President Biden issued an executive order on digital assets. The report acknowledges the potential benefits of digital asset innovation but also highlights the downsides: The word “risk” appears up to 47 times.
A host of state and federal regulators weighed in after the Terra boom, and again after Celsius’s troubles and the broader market crash. After Terra’s collapse, U.S. Treasury Secretary Janet Yellen called for a “comprehensive framework” to regulate stablecoins and called on Congress to act. Later, the SEC reportedly was investigating the marketing of TerraUSD by Terraform Labs.
Just days after Celsius halted its acquisition, Securities and Exchange Commission (SEC) Chairman Gary Gensler warned that cryptocurrency platforms that promise high profits may be too good to be true. Meanwhile, state securities regulators in Alabama, Kentucky, New Jersey, Texas and Washington have opened an investigation into Celsius’ activities. After Terra’s failure, Gensler announced the agency would add 20 investigators and litigators to its unit solely for cryptocurrency enforcement and cybersecurity.
In addition, more than 40 states have enacted some kind of cryptocurrency law that is being applied or pending in their legislatures. And California Governor Gavin Newsom recently issued an executive order on cryptocurrencies, outlining a comprehensive regulatory framework for digital assets.
See also: All you need to know about cryptocurrencies and inflation
The spectre of past financial crises
This latest market crash shows how much consumers can lose as up to two trillion dollars in Market Capitalization of crypto assets has been wiped out. And both Terra and Celsius provide clear bad examples of fragile financial engineering combined with the hyper-aggressive push that has led lawmakers to see the spectre of past financial crises.
The collapse of the Terra stablecoin leading to market volatility will make regulators who have warned about the risks associated with cryptocurrencies feel vindicated. Terra experienced the equivalent of an old-fashioned banking operation when investors began to lose confidence that they would always be able to convert their tokens for a dollar. That’s exactly what PWG (and many others, including Sam Bankman-Fried) warn will happen.
Moreover, Terra gained its scale (about $18 billion was in circulation at its peak) because it could be deposited into a profit protocol and earned up to 20% interest. Acting Currency Controller Michael Hsu recently compared productive farming to Ponzi schemes — and he’s not alone. Anchor Protocol promises UST depositors a 20% yield, but there’s no realistic way to keep paying interest if the money stops flooding in. Celsius used its borrowed assets as collateral to Borrow more and made a series of risky bets – including investing in anchor protocol – in search of profits and meeting a promise to pay the “depositor” 8%.
Finally, both Terra and Celsius caused volatility in the cryptocurrency market – a harbinger of the significant spillover effects that could occur if Tether collapsed. This type of financial contagion risk is exactly what regulators try to prevent.
How to prepare
At this point, crypto companies should assume that legal regulation is inevitable. If the industry wants to help itself, it must always be in a ready position. But what’s more, industry leaders must be willing to reform the way the majority of these markets work.
On stablecoins, industry leaders should clearly distinguish between different models and start a dialogue about the ways in which certain models and certain regulatory reforms can achieve the regulatory body’s policy objectives. In the wake of terra’s collapse, the market has clearly viewed certain stablecoins – namely 100% dollar-backed currencies – as more stable than others. However, Tether, which has broken the dollar several times in recent weeks, remains a key factor in a major part of cryptocurrency market activity.
For their part, regulators should also start to realize that not all stablecoins are created equally. Regulators are right to warn of the “risks” inherent in stablecoins but do little to distinguish between stablecoins and “unstable” currencies. The New York Department of Financial Services, the legal body of two stablecoin issuers, has published public guidance requiring stablecoin reserves to be kept in safe and liquid assets and subject to independent endorsements. This guide provides a great foundation for developing a truly stable framework.
Hsu has issued a call for public-private cooperation in the development of stablecoin standards. It’s an invitation that the industry should accept.
More broadly, there needs to be a calculation in the industry. The desire for an open and decentralized cryptocurrency market makes many participants averse to regulatory rules. But already fragile products have served to accelerate and multiply the damage of the cryptocurrency downturn. Industry leaders should take advantage of the cryptocurrency winter to clean up the remnants that could be the cause of the next disaster. It’s time to realize that many products simply don’t fit into fair and orderly markets.
> See also: The easiest MEXC Registration Guide to understand
Conclusion
Attacks against cryptocurrency companies are happening more and more, the amount of damage is immense. As a result, law enforcement agencies are trying to speed up legal codes and bills to protect users’ assets as well as trying to find ways to regulate activities in the crypto space.
