Crypto faces critical moment as regulatory walls rise

I have warned investors that a significant downturn in the crypto market could occur if Bitcoin’s value falls below $24,000 amid a bullish trend since mid-December. This prediction has come true as Bitcoin’s price has fallen 10% from its peak in February, with the possibility of a further drop to $20,000. Crypto’s growth in 2022 was primarily driven by monetary policy, but regulations could become a deciding factor this year for to determine which companies will succeed and which will fail.

This situation is due to several factors, including the continued tightening of liquidity and the suspension of wire transfers, notably by Binance in early February. The closure of Silvergate’s central network at the beginning of March has exacerbated the existing difficulty. Furthermore, Signature Bank has recently informed its crypto exchange clients that SWIFT payment transfers of less than $100,000 will no longer be supported, which is related to Coinbase suspending Binance USD trading. This is an urgent concern that needs to be considered.

A growing effort is underway to rethink the relationship between traditional banking systems and the rapidly evolving crypto-economy. The basic principle of Bitcoin was to create a financial system that operates independently of banks, and some experts advocate a completely “bankless” crypto ecosystem. However, the regulatory crackdown this year has given rise to offshore stablecoins like Tether’s, which continue to gain ground despite a decline in trading volume.

The lack of a mechanism to transfer traditional currency into the crypto space appears to be causing stagnation, depriving it of the innovation typically associated with a burgeoning industry. This is where Silvergate has emerged as a critical link between investors, hedge funders and venture capitalists. In addition to facilitating these important connections, Silvergate allows its customers to settle their balances at any time of the day, including weekends and holidays. This 24-hour settlement feature is crucial in the crypto market, allowing investors to take advantage of arbitrage opportunities and ensure seamless exchange of collateral, which is managed through smart contracts.

As regulatory hurdles continue to emerge around crypto, the potential ramifications of these barriers cannot be ignored. A recent report from Coindesk reveals that close to 200 members of Congress accepted campaign donations from FTX executives. This raises concerns that those who have received these donations may be less inclined to support further regulation, fearing a negative association with an exchange that has previously misused user funds.

Adding to growing concerns, the US Federal Reserve, the FDIC and the Treasury Department’s Office of the Comptroller of the Currency issued a joint statement on January 3 warning of the risks that cryptoassets pose to the banking sector. While regulators have previously warned against the instability of cryptocurrenciesthis latest notice highlights the impact that crypto ecosystem could have on the financial resilience of traditional banks. This shift in warning, allegedly initiated by the Biden administration, has had a significant impact and caused a chain reaction.

On January 13, the Securities and Exchange Commission (SEC) filed charges against Gemini crypto exchange and Genesis Trading, alleging that the two firms failed to register a crypto lending scheme as a securities offering. The SEC’s position is that the lending arrangement offered by the two firms required registration with the SEC and compliance with relevant securities laws and regulations. Failure to meet these requirements, according to the SEC, put investors at risk and could have violated securities laws.

Custodia Bank, which was founded three years ago to serve as an intermediary between digital assets and the US dollar payment system, suffered a significant setback in late January. The bank was denied membership in the Federal Reserve System and was also denied a general account. One of the main benefits of being part of the Federal Reserve System is access to a general account, which allows banks to settle transactions with other banks and financial institutions. Custodia Bank’s lack of a main account means it must rely on other banks to handle its transactions, resulting in higher fees and slower processing times. This puts the bank at a significant disadvantage compared to other banks in the digital asset space that have achieved membership in the Federal Reserve System.

Signature Bank has made a bold move in the face of the crypto industry’s growing regulatory challenges. In early February, the bank announced its decision to suspend SWIFT transfers by crypto-related firms of less than $100,000. The move is a clear indication of the financial institution’s cautious approach to cryptocurrencies, which have been plagued by regulatory ambiguities and concerns over financial crime. The decision is expected to affect many smaller crypto firms that rely on such transfers, as they will now have to find alternative methods of moving funds. However, some experts argue that the bank’s move is a necessary step to reduce risk and protect the banking sector from potential threats from the crypto industry.

In early February, Kraken, a popular crypto exchange, agreed to pay $30 million to settle charges filed by the SEC that it provided unregistered securities through its staking program. The program offered a fixed return to users, regardless of the actual performance of the staked assets, which the SEC determined was a violation of securities laws. Kraken’s failure to register with the SEC put investors at risk and created an unfair advantage for the platform. The settlement serves as a reminder that the cryptocurrency industry is subject to the same rules and regulations as traditional financial markets.

On February 13, Paxos was ordered to stop production of the Binance-branded BUSD stablecoin due to concerns that Paxos may have been negligent in monitoring the use of the stablecoin. As a result, the market value of BUSD dropped from $16 billion to its current value of $8 billion. The decision by the New York Department of Financial Services (NYDFS) to halt production of BUSD caught many in the industry off guard. Paxos had been considered one of the most trusted stablecoin issuers in the market, having received regulatory approval from the NYDFS to operate as a trust company. However, the NYDFS’s move underscores that even well-established firms are subject to regulatory scrutiny.

On March 4, Silvergate Bank took the unexpected step of suspending its exchange network, resulting in the bank’s relationships with Circle, Crypto.com, and Coinbase ending. The closure of the exchange network also had potential implications for Bybit, as the exchange had to stop dollar transfers. Silvergate Bank’s decision comes under increasing scrutiny because of its links to FTX.

On March 8, four days later, Silvergate Bank announced that it was shutting down and liquidating its operations, citing that the majority of deposits were leaving its balance sheet, which had weakened its financial stability. The closure of Silvergate Bank highlights the potential fragility of financial institutions in the crypto space and the impact of regulatory changes on their operations.

In a major development for the crypto industry, on March 10, the New York Attorney General’s office filed a lawsuit against KuCoin for alleged violations of securities and commodities laws. The lawsuit accuses KuCoin of misrepresenting itself as an exchange while acting as a securities and commodities broker and seeks to block the exchange’s access in New York. However, what is particularly notable about the complaint is the claim that Ethereum, the second largest cryptocurrency by market capitalization, is also a security. The lawsuit alleges that ETH, along with other cryptocurrencies such as LUNA and UST, is a speculative asset that relies on third-party developers to provide profits to holders of the cryptocurrency. This lawsuit could have significant implications for the entire industry, as it could open the door to increased regulatory scrutiny and potentially even more legal challenges in the future.

I am very sure that crypto investors are not giving up without a fight. Although Kraken faced defeat, Coinbase CEO Brian Armstrong has defended the firm’s staking service and is willing to defend the product in court if necessary. Well-funded firms like Coinbase and Ripple may have the financial means to take on the SEC. Ripple CEO Brad Garlinghouse has warned that SEC regulations could make the US a less attractive place for crypto firms.

Although the SEC had initially opposed Binance’s acquisition of Voyager Digital, which filed for bankruptcy after Three Arrows Capital defaulted on a $670 million loan provided by the broker, a bankruptcy judge has approved the deal. While there are still regulatory hurdles to overcome, the judge appears to be leaning toward approval. Following the announcement, Voyager VGX tokens saw a 16% increase in 24 hours, potentially resulting in Voyager creditors getting 73% of their money back.

In a separate case, the justices question why Bitcoin spot markets can be manipulated while Bitcoin futures markets, which are approved for trading on US soil and through ETFs, cannot. The SEC has argued that a 99% correlation does not equal causation, citing the fragmentation of Bitcoin spot markets compared to centralized trading of Bitcoin futures on the CME in Chicago. As a result, the discount on Grayscale GBTC has fallen from an all-time low of -48% to -36%, as speculation about the possibility of converting the trust into an ETF has increased. The spread has likely reached a floor with a potential downside of -10% and upside of +33%, which I predicted in our 2023 Outlook report published in December 2022. While a Bitcoin ETF would have been significant two years ago, many interested investors have since created alternative accounts to buy Bitcoin.

All hope is not lost, however, and these developments indicate potential opportunities in the cryptocurrency market for investors.