The crypto market meltdown sent prices through the floor. It also sent regulators into action

The crypto market went into a full meltdown in May and June, losing $1 trillion in value in a matter of weeks.

Federal regulators took notice.

The sudden and rapid collapse of popular cryptocurrencies and crypto-related companies revealed the unwieldy nature of the crypto industry and provided some validation to already skeptical regulators.

And it all happened against a backdrop of already accelerating regulatory pressure, because unlike the traditional stock market, there are no robust federally mandated protections in place for crypto investors. As a result, experts expect crypto regulation to increase even more in the coming months.

“After the catastrophic events that have unfolded in the crypto market in recent weeks, it is clear that strict regulations may be coming soon,” said Marcus Sotiriou, market analyst at digital asset broker GlobalBlock. “The collapse of decentralized finance lenders (DeFi) may be why regulators have been looking to implement draconian controls over cryptocurrency.”

Bitcoin and Ethereum are down more than 50% from their all-time highs late last year. The largest crypto has been hovering around the $20,000 mark for several weeks now, while the second largest has largely held close to $1,000 until recently surging more than 40% in a matter of days to climb above $1,500. As of Monday, bitcoin was holding above $21,000 — three times lower than its all-time high of $68,000.

This week’s Federal Reserve meeting could introduce new volatility to the crypto market. The Fed is expected to raise its benchmark interest rate by 75 to 100 basis points, and that could send stock and cryptocurrency prices lower in the near term as investors remain weary of the economy’s health. “In the short term, we’ve seen bitcoin and other cryptocurrencies generally sell off risk assets as the speculative frenzy that defined investments over 2020 and 2021 comes to a halt,” said Stéphane Ouellette, CFA and founder of FRNT Financial, an institutional capital markets and advisory platform focused on digital assets.

No one really knows how the average investor will be affected by growing regulations, at least not until the federal government decides on specific rules. But overall, many experts generally agree that crypto regulation will actually be a good thing for investors.

“Regulations will come up and they have to come up at some point, which will further stabilize the market,” said Tally Greenberg, head of business development at Allnodes, a platform that offers hosting, monitoring and staking services. “It protects investors, so that’s a good thing. It’s not a bad thing.”

What is happening to the crypto industry and why does it matter?

Ever since bitcoin and ethereum hit all-time highs in late 2021, the market has been in a ruthless downtrend with little sign of relief. Bitcoin has tracked the stock markets very closely this year, and has been affected by the challenging macroeconomic environment as a result.

Conditions in the crypto market took a turn for the worse in May when bitcoin fell below $26,000 for the first time in 16 months. The rest of the cryptocurrency market fell with it. As investors pulled their liquidity from the crypto market at an extraordinary rate, a popular stablecoin known as TerraUSD (UST) became decoupled from the dollar, causing the associated cryptocurrency luna to crash as well.

The Luna and UST crash led to contagion among other crypto firms. Three Arrows Capital, a crypto hedge fund based in Singapore, collapsed a few weeks after the Terra Luna crash, which then triggered the fall of many other companies across the crypto market, particularly lenders that the hedge fund borrowed huge sums from, including BlockFi, Celsius, Voyager and Genesis. Crypto brokerage firm Voyager Digital and crypto lender Celsius both filed for Chapter 12 bankruptcy recently. Vauld and Zipmex, crypto trading and lending platforms, became the latest crypto firms to halt customer withdrawals.

The collapse of the crypto market puts US regulators in a “difficult spot,” says Ouellette. That’s because the vast majority of both crypto investors and the platforms that operate it are not based in the U.S. “This is a new place where it’s clear that if such regulators see their roles as investor protection, they will have to somehow respond to these disasters,” he says.

Oulette says an obvious regulatory response requires US-based platforms to be fully regulated and “implement a framework where unlicensed platforms can be quickly shut down shortly after launch.” While it doesn’t address the problem of Americans accessing platforms in other parts of the world that don’t comply with US regulatory standards, it would be a step in the right direction, he says.

“Whatever the regulatory response, it’s one of the more complicated dynamics that US regulators have ever faced,” he says.

What investors should know about new crypto regulation

New crypto regulation is coming fast, experts say. The exponential growth of cryptocurrencies, DeFi and the wider Web3 space means that time is running out to find regulatory solutions.

“Whatever crypto regulation takes hold is likely to be bold and global,” said Edward Moya, senior market analyst at foreign brokerage Oanda.

The US Securities and Exchange Commission recently reiterated its concern about the lack of regulation surrounding cryptocurrencies, and what it is doing to address it. SEC Chairman Gary Gensler said in a July 14 Yahoo Finance interview that crypto investors “would benefit from investor protections around these different service providers … the exchanges, the lending platforms and the broker-dealers. He added that the agency is “working on each of these three fields — exchanges, lending and broker-dealers – and talking to industry participants about how to come into compliance, or change some of that compliance.”

So, what does this mean for crypto investors? The latest crypto market crash is a reminder to investors that crypto assets come with added risk and volatility, especially in times of economic and political uncertainty. Until there are set rules in place, be extra careful about which cryptocurrencies and DeFi platforms you invest in, as well as where you store your assets. The safest place to store crypto assets is in a hot or cold wallet; these crypto wallets are experts’ favorites. Experts recommend that you invest no more than 5% of your investment portfolio in crypto.

“People should be wary of lending firms that offer lucrative double-digit returns on assets like bitcoin and ethereum,” says Sotiriou. “People should consider the risks involved such as smart contract exploits, lender becoming insolvent and whether the protocol has been stress tested.”

As crypto gains regulatory clarity, the risk of crypto market contagion, which we have seen in recent weeks, will be significantly reduced in the future, and the industry will begin to see even more institutional adoption, according to Sotiriou.

“Waves of institutional capital will be sidelined from the crypto industry until countries like the US provide regulatory clarity,” he says. “But I remain positive in the long term despite the negative short-term consequences.”