Bitcoin’s bounce could be volatile as the regulatory outlook darkens

“This is a coordinated crackdown,” says Nic Carter, a partner at crypto venture capital firm Castle Island Ventures. An analogy, he says, is Operation Choke Point, a 2013 federal initiative that targeted banks that did business with payday lenders, firearms dealers and others. “Now, every major regulator is acting to discourage banks from touching crypto,” he says.

The initiatives come after crypto fell apart last year in bankruptcies, fraud and $2 trillion in token losses, highlighted by the $32 billion collapse of FTX. While the market has rebounded — with Bitcoin up 50% so far this year — regulators are under pressure to prevent more damage to investors, including the millions of Americans who lost money in the collapse.

One way to do that, it seems, is to keep crypto out of the banking system. Top federal regulators issued a joint statement in January saying they are “carefully reviewing any proposals by banking organizations to engage in activities involving cryptoassets.” Banks like Signature Bank (ticker:SBNY) have paired ties to crypto. The warning may make the banks less likely to seek regulatory approval.

The Federal Reserve also shot down hopes for more crypto banking. The Fed rejected an application by digital-asset-focused Custodia Bank for a so-called Master Account, which would have allowed Custodia to directly access the Fed’s payment systems without going through an intermediary bank. Custodia has sued the Fed for handling the application.

“Regulators have a choice,” says Custodia CEO Caitlin Long. “Should they create a regulated path forward to deal with this, or should they relegate it to the shadows?”

The Fed may have been spooked by a run on Silvergate Capital ( SI ), a small California-based bank that had become a crypto giant, handling $11.9 billion in deposits from clients including FTX. Silvergate’s deposit base collapsed by $8.1 billion, and the bank tapped the Federal Home Loan Bank system for billions in liquidity while selling bonds it owned at a huge loss. The contagion from, among other things, FTX crashed Silvergate’s share by 83%.

Some crypto startups say they are having trouble getting bank accounts. JW Verret, a law professor trying to start a nonprofit called Crypto Freedom Lab, says he has been unable to open checking accounts at six banks. “I have big donors and have to cash the checks,” he says. “I sit down with the banks and it’s basically the same story. “Sorry, we don’t do crypto.” “

The Securities and Exchange Commission is also stepping up. The agency reached a $30 million settlement with trading platform Kraken, which offered a “staking” service that the SEC said constituted an unregistered security. Kraken agreed to stop offering the product in the US, without admitting or denying wrongdoing.

The SEC also wants to make it more difficult for companies to serve as a “qualified custodian” under new guidelines. Companies must separate crypto assets and they must be remote from bankruptcy so that investors do not have to fight for their assets in a bankruptcy proceeding. “Based on how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians,” SEC Chairman Gary Gensler said in a statement.

Perhaps the biggest concern in crypto right now: Regulators appear to be building a case that stablecoins are unregistered securities — a potential prelude to lawsuits. Stablecoins, usually pegged to the dollar, are critical to crypto markets, acting as cash proxies and accruing to the standard dollar. The largest, Tether and USDC, are worth a combined $111 billion.

Crypto firm Paxos was last week ordered to stop issuing Binance USD, or BUSD, stablecoins by the New York Department of Financial Services. BUSD has a market cap of $14.5 billion and was one of the main stablecoins on the Binance exchange. Paxos said it had also received a Wells Notice from the SEC – a warning of an enforcement action, alleging that BUSD should have been registered as a security. Paxos says it is “prepared to take vigorous legal action if necessary.”

A stablecoin crash can put huge profits at risk. Companies that issue them, such as Circle and Tether, hold billions of dollars in reserves in bank deposits or cash equivalents such as government bonds and money market funds. With some government interest rates now at 5%, coin issuers can earn significant interest. Tether says it has $70.7 billion, mostly in cash equivalents, and earned $700 million in net income in the fourth quarter. Circle’s $41 billion issue could be worth $1.6 billion a year in interest at recent rates.

Circle’s chief strategy officer, Dante Disparte, says the firm does not expect problems with BUSD to affect USDC. He says Congress should establish rules. “The regulation through enforcement cases is not helpful,” he adds.

Coinbase Global

(COIN) has a lot to lose. The trading platform is being investigated by the SEC in several areas, including its asset listing process and its return-generating products. Stablecoins bring in money through an agreement with Circle. Coinbase is also building a staking business through the Ethereum blockchain, acting as an intermediary for investors to stake tokens to the network in exchange for a return. This business may also face legal challenges.

“Coinbase embraces regulation and has since day one,” a spokesperson said in a statement. “But a lot of what we’re seeing right now is regulation by enforcement.” Clear rules are needed, the company added.

For now, with regulatory pressure mounting, Coinbase and other firms may be fighting for their existence. If the crashes continue, “there will literally be no crypto ecosystem,” says Mizuho analyst Dan Dolev. “The whole thing is falling apart like a house of cards.”

Write to Joe Light at [email protected]