Jonathan Raa/NurPhoto via AP
Keeping crypto out of the broader financial system was the most important regulatory action of the past decade.
To those who have said that cryptocurrency will never become a medium of exchange, I’m here to tell you that it already has—for collapsing cryptocurrency firms. The crypto exchange named Huobi laid off 20 percent of its staff late last week, and remaining employees will be required to take their salaries in stablecoins, which are supposed to mirror the dollar on a 1-to-1 basis. In a functioning crypto market, it should be extremely simple to convert stablecoins to dollars and pay staff with them. The fact that it’s not happening suggests that the stablecoins are worth dramatically less in reality, to say nothing of the supreme lack of confidence such a move inspires.
Huobi is just one of several faltering companies in cryptoworld. The implosion of what’s been unmasked as a criminal enterprise at FTX has created a chain reaction, where lost faith, pullbacks on trading volume, and potentially similar schemes at FTX competitors are devastating the nascent asset class. It should reinforce the fact that the government’s success in keeping crypto out of the broader financial system was the most important regulatory action of the past decade. We rarely give enough credit to agencies that prevent something from happening; it’s hard to prove a negative, as they say. But if we manage to get out of this cycle without a recession, we will have the banking regulators, primarily Gary Gensler at the Securities and Exchange Commission, to thank.
Here’s a brief rundown. FTX is already out of the picture and in bankruptcy. Genesis, a large lender, just laid off 30 percent of its staff, after laying off 20 percent last August. The firm is considering a bankruptcy filing. Genesis helped stake Alameda Research and Three Arrows Capital, both of which have themselves filed for bankruptcy, so this was probably inevitable. Digital Currency Group, which owns Genesis, had Larry Summers on its payroll for six years as an adviser; he quietly stepped aside recently.
Meanwhile, the former CEO of crypto lender Celsius, Alex Mashinsky, has been sued by New York Attorney General Tish James for—stop me if you’ve heard this before—defrauding investors by lying about the company’s financial condition. Mashinsky described Celsius as “safer than a bank,” but he funneled customer deposits into high-risk bets that went bust. His deceptions led to losses of around $440 million.
The direct reverberations from FTX continue as well. Silvergate, the unassuming bank that was used by crypto firms as a conduit, has seen its stock fall 84 percent in the last three months, with crypto-related deposits falling off a cliff and assets being sold quickly to whoever wants them. Law enforcement is engaged in seizing Silvergate accounts as part of the effort to return funds to FTX customers.
The price of Bitcoin has actually inched up since bottoming out at the end of the year, but I think it’s clear that the havoc in digital asset markets is nowhere near over. Even Binance, the largest and allegedly sturdiest of the crypto exchanges, has been less than forthcoming about its finances and has lost $12 billion in assets in the past two months.
If we manage to get out of this cycle without a recession, we will have the banking regulators, primarily Gary Gensler at the Securities and Exchange Commission, to thank.
Hedge funds that have done business with Binance are receiving subpoenas related to federal investigations around compliance with anti–money laundering laws. Meanwhile, the SEC, along with securities regulators in Texas, has filed objections to Binance’s acquisition of assets from a bankrupt lender named Voyager Digital.
Perhaps the most important move by the banking regulators did not involve a specific crypto firm or token. The Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency last week issued a joint statement that essentially told large banks to rethink any inkling of holding crypto assets in their portfolios. After detailing the numerous risks from crypto—including fraud and scams, misrepresentations and poor risk management from crypto companies, high volatility, legal uncertainties, and the potential for digital versions of old-time bank runs—the regulators stated: “It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system.”
While the joint statement went on to say that banks aren’t legally prohibited or discouraged from providing any permitted services to customers, you didn’t have to read between the lines to get the regulators’ point. They don’t want to see major banks investing in a bunch of crypto at this point, and they will be watching closely any transactions of that type. “Issuing or holding as principal crypto-assets … is highly likely to be inconsistent with safe and sound banking practices,” the regulators wrote.
The statement was as remarkable for who said it as what was said. OCC and the Fed at various times have played footsie with the crypto industry, with OCC granting special charters to crypto banks. But now they have followed the lead of Gensler, who took the same hard line against owning crypto assets last April, through a bulletin saying that banks would have to mark digital assets as liabilities on their balance sheets for accounting purposes. Gensler’s bulletin has been mostly successful in keeping banks out of crypto.
Gensler also prevented the creation of an exchange-traded fund made up of Bitcoin funds, which would have made it easier for banks and individuals to get exposure to crypto, in much the same way as derivatives broadened the damage from the housing bubble collapse outward from just those who physically owned mortgages or mortgage-backed securities to a far larger group of investors.
The SEC’s plea deals with FTX officials Caroline Ellison and Gary Wang also show how Gensler has been pushing to protect the public. The deals explicitly state that FTX’s crypto token FTT is a security, which is something Gensler has been screaming about for close to two years now. Securities must be registered with the SEC, with proper documentation. None of this is done in the crypto world, which is why firms have resisted the SEC’s demands. If the plea arrangement goes through, the SEC can use that precedent to show that the industry as a whole is out of compliance. That would probably end the practice of these tokens, sometimes lovingly referred to as “shitcoins,” which are ripe for abuse.
One fundamental cause of the 2008 financial crisis was the failure of the regulators to recognize the risks in the ever-inflating housing bubble and to hive it off from the broader system. That lesson was one that Gensler learned in the crypto fiasco. Despite the regrettable vaporizing of customer funds, people uninvolved with digital assets have been largely unharmed. The system worked to keep the crypto mess contained. That was a direct result of Gensler’s smart maneuvers, which the rest of the regulatory apparatus is now backing up.
I’m sure that Congress will attempt to step in and “do something” on crypto, with the claim that this unregulated space must be tamed. But it’s important to recognize that the most important regulation has already been done. The banking and securities regulators protected the economy from a crypto-fueled downturn. This shows the importance of having the right personnel in place making the decisions. As the digital asset industry continues to wobble, at least people with nothing to do with crypto aren’t paying the price. Keeping that barrier in place should be the goal going forward.
