Regulation can help pull crypto out of the bear market

The cryptocurrency industry is under pressure in the midst of a strong bear market sentiment that has ravaged the value of most tokens. With the price of assets like Bitcoin, Ethereum, Avalanche, Solana and others far below their all-time highs, investors are getting nervous.

In addition, there are the challenges in the DeFi industry. The unrest began in May with the collapse of the Terra blockchain and its stablecoin UST, which until then was growing rapidly in popularity. Unlike other stackable coins such as USDT and USDC, which are backed by real values, UST was an algorithmic stackcoin that relied on some clever number crunching to maintain its 1: 1 link to the US dollar.

Unfortunately, these algorithms failed to do their job when UST came under constant selling pressure, and in just two days the value fell well below $ 1, completely wiping out the value of Terra’s original LUNA token as well.

This was followed by even more shocks involving a number of big names in the DeFi area. The most notable was Celsius, a crypto-lending and lending platform that promised high interest from depositors. In June, Celsius suddenly announced that it was temporarily suspending withdrawals until further notice, which means that investors could no longer access the cash they had locked into the minutes.

At the same time, prominent crypto companies including Three Arrows Capital and Voyager are said to be facing bankruptcy, while crypto lender BlockFi barely escaped the same fate thanks to a bail of $ 680 million from the cryptocurrency exchange FTX.

Such a development has led to a new chorus of calls for greater regulation of the cryptocurrency industry. Regulators say there is an urgent need to know who runs these crypto companies and understand how their operating policies and procedures work.

During the beef market that began in early 2021, the demand for regulation was drowned out. Warren Buffet has previously called this the “limb effect”, or a crowd mentality – when things are going well, no one cares about regulation because they are too busy trying to make money in the good times and make money fast. So no one cares about the risk and the consequences. But when things go wrong and the price of cryptocurrencies starts to fall, investors suddenly turn around and demand protection from their authorities.

Previous bear markets have led to similar demands for regulation with little result, but it seems that things may be different this time. In a recent blog post, the institutional cryptocurrency exchange AAX noted that some influential individuals and bodies appear to be seriously aware of the crypto space in the wake of the Terra debacle, which wiped out millions of dollars in investor cash.

For example, US Treasury Secretary Janet Yellen has called on Congress to introduce a “comprehensive framework” for managing stable coins. Securities and Exchange Commission Chairman Gary Gensler, who warned investors that high-yield cryptocurrencies should be treated with caution.

“Meanwhile, U.S. politicians introduced major legislation in June 2022 that would create the first comprehensive federal framework for digital currency regulation,” AAX said. “And the EU is reportedly working on its own proposal for crypto-regulation.”

Platforms like Celsius advertise how crypto holders can earn big returns on tokens like Bitcoin, Ethereum and other cryptocurrencies by depositing them on their platforms. For example, it claimed that users could earn interest rates of up to 6.2% on their BTC deposits, and 5.35% on ETH. The platform was able to do so during the bull market as the price of both tokens was quickly appreciated. But as conditions changed and the value of these tokens fell, Celsius quickly found himself in trouble.

According to AAX, Celsius was unprepared for the sudden market crash, and in a desperate attempt to stop itself from being liquidated, it resorted to using the customer’s funds to protect its own positions. This left it in a situation where it no longer had the funds available to return the investor’s deposit.

“It would not fly in a regulated traditional financial system,” AAX said, explaining why the demand for regulation is growing.

It is assumed that regulators are attentive, and will most likely look at how DeFi platforms such as Celsius are able to pay such high interest rates on the customer’s deposits. They will look closely behind the scenes at how these protocols work, in terms of the influence and controls on lending they provide.

It is likely that regulators will try to crack down on anything they perceive as too risky. An example of this happened recently when the SEC rejected Grayscale’s application to launch a Bitcoin spot ETF. The SEC explained its decision and said it was concerned that Greyscale had failed to answer questions about concerns about market manipulation.

Forbes senior contributor Rufas Kamau later wrote that SEC Chairman Gensler has previously said he sees Bitcoin as a “commodity”, which means that legally, several regulators must work together to put in place a proper structure to regulate such a product.

AAX said it believes crypto companies expect more regulatory clarity in the near future, and that it will be welcome when it comes. If the crypto industry, especially the DeFi sector, can implement more security measures such as federal deposit insurance, this will provide greater protection for investors and ensure that there is enough liquidity even when the markets are stressed. That would be a good thing, AAX said, as it would build trust and stability in the overall DeFi system by assuring investors that their funds will be available when they need to withdraw them.

With all the alarm created by the current bull run, it seems inevitable that greater regulation will be on the way. This is likely to help the industry weed out the higher-risk platforms that do not provide enough protection and security measures for users. If that happens, it could lead to a new wave of optimism and confidence in the crypto space.

“Perhaps a clearer regulatory gamebook, coupled with a maturing Web3 economy, will be enough to kick-start the next bull run, as even more companies and more consumers will be all the more interested in joining the crypto movement,” AAX said. “A more structured and clearer regulatory framework for cryptocurrencies will enable users to feel more secure as they navigate the digital assets industry.”

The question is only when the increased regulation will take place. The supervisory authorities have been notoriously slow to implement measures. An example of this is the scandal involving QuadrigaCX, a cryptocurrency exchange whose CEO allegedly gambled away client funds and stole passwords to offline cold wallets.

The QuadrigaCX scandal happened all the way back in 2017, but it was not until 2021 – four years later – that the first regulated cryptocurrency exchange appeared. Believers in regulation and what it can do for the crypto industry, will hope that regulators move much faster this time.