Why Washington cooled on crypto — it wasn’t just FTX

What a difference a year makes. On March 9, 2022, US President Joe Biden’s office issued his executive order on digital assets, marking the first official sign of a comprehensive approach to the regulation of the crypto ecosystem. At the time, I and many others saw this as a very big deal, not least because of the strong signal that crypto had “arrived.” It was now significant enough to warrant attention from the head of the world’s largest economy, and the surprisingly supportive tone of the document surely meant that a constructive regulatory approach was on the rise. How wrong I was.

A year later, the supportive tone has largely disappeared. The holistic approach we hoped for turned out to be more of a threat than we expected, and the focus is now on building barriers rather than building a guiding framework. What happened in the meantime?

Noelle Acheson is the former head of research at CoinDesk and Genesis Trading. This article is an excerpt from her Crypto is macro now newsletter, which focuses on the overlap between the changing crypto and macro landscape. These opinions are hers and nothing she writes should be taken as investment advice.

Part of that answer is unfortunately obvious. The ball of fraud-fueled fire that was the collapse of the FTX crypto exchange in November was a spectacular embarrassment for not only crypto companies that had confided in then-CEO Sam Bankman-Fried and his team. It was also an embarrassment to the politicians who had sat down with him, who had lined up for the photo op and entertained his ideas about crypto regulation. With a few brave exceptions, politicians understandably closed ranks and tried to distance themselves from anything to do with crypto risk.

But the shift is more complex than it might seem. Even before the FTX revelations, the tone of the Biden administration was more antagonistic. Absent from the executive order were calls for a clampdown; it was more about asking for investigations and reports, more about gathering information and ideas.

In September, the White House published an update, which mentioned the implosion of the Terra ecosystem in the first paragraph. Further down, the update highlighted the loss of value in the market, how sellers “commonly” mislead consumers and how non-compliance with existing laws remains “widespread”. Already this sounded very different.

The update also provided some recommendations from the White House, the first of which was that the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) “aggressively pursue investigations and enforcement actions against illegal practices in the digital asset space.”

The second recommendation was that the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) “redouble their efforts to monitor consumer complaints and enforce against unfair, deceptive or abusive practices.”

The third was for agencies to “issue guidance and rules to address current and emerging risks in the digital asset ecosystem.” You get the drift.

The rest of the report emphasizes support for FedNow, the Federal Reserve’s instant payments network due to launch in mid-2023, as a solution to financial exclusion – in other words, the US doesn’t need crypto payment efficiency, the Fed does.

And then we have the official document released in January of this year, titled “The Administration’s Roadmap for Mitigating Cryptocurrency Risk.” You hardly need to read it to know what it contains—the last sentence of the very first paragraph spelled it out: “As an administration, our focus is to continue to ensure that cryptocurrencies cannot undermine financial stability, to protect investors, and to hold bad actors accountable.” The tone had moved from supportive to antagonistic to somewhat panicked.

But to blame the shift in the US regulatory tone on crypto scammers is simplistic. Another significant change in the regulatory backdrop between the announcement and the two updates is the economic mood, and this is more significant than many suspect.

When the order was published, the Federal Reserve had not yet begun its interest rate hike campaign; it would start this with the first hike of 25 basis points at the Federal Open Market Committee (FOMC) meeting the following week. The market knew interest rate hikes were coming. US headline consumer price index (CPI) data showed inflation rising rapidly, reaching 7.9% for February (this will be reported the following day) – but it seriously underestimated how high it would go. The implied interest rate 12 months out, according to the Fed Funds futures market, was now a ridiculous 2.87%.

At the time of the ruling, dark clouds were already building for stocks. The S&P 500 was around 4,270, down 10% year to date. By the September update, it had fallen almost another 10%, and tech company layoffs began to fill the headlines. Understandably, with investors hurt, the government had to act tough on risky, largely unregulated assets that had caused heavy losses. In other words, the markets needed a “bad guy” to distract from what looked to be a bleak scenario across all asset groups.

November delivered the ultimate “bad guy” when the FTX scam shocked the crypto ecosystem and mainstream observers alike. For a while, it was an unwanted distraction from a core inflation rate that had hit its highest level in four decades, a dollar that was at its highest against a basket of other currencies in two decades, and volatility in the US financial market not seen since The great financial crisis of 2008-2009. Things looked bad on macroeconomic screens, but the crypto fallout gave Washington, DC, a problem it could show the world they were doing something about.

However, the current hostility is about more than the political satisfaction of prosecuting criminals. It is a natural reaction to wider concerns. When times get bad, we seek comfort, and new, complicated and disruptive technologies are never comfortable. When times get bad, we instinctively magnify external threats because it makes us feel more connected to our tribe. When times get bad, we focus more on surviving today and less on building a productive tomorrow. When times get bad, leadership manuals tell us to act stronger than we feel to inspire confidence.

On a more practical level, if the economy is about to enter a downturn, the Biden administration would likely prefer that businesses and individuals invest in more traditional, high-employment endeavors than in this newfangled notion that seeks to disintermediate national authority.

I am not suggesting that the administration’s hostility to cryptoassets is just for show. I think it’s not just because of the brutal hits to investors in the last 10 months. It is also because of the darker clouds over the US economy.

This one has a silver lining. Just as administrations change, so do economic cycles. The opposition is far from uniform – Thursday’s House Financial Services Committee hearing with a provocative title “Coincidence or Coordinated? The administration’s attack on the digital asset ecosystem’ is an example. There was some skepticism and outright distrust among some lawmakers and one of the witnesses. But most of the witnesses and many of the elected representatives present were eloquent advocates for clearer rules and usable frameworks. Everyone agreed that regulation was good, and most seemed to support the idea of ​​market reform and the need to keep crypto business in the US

Hearings rarely achieve anything in the short term, but they are an opportunity to drive political efforts into the ground. The initial approach of the new House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion is encouraging in its seemingly critical view of current policies and policy processes. Its leader, Rep. French Hill (R-Ark.), made a sharp point in his written statement after articulating the need to support innovation for the sake of leadership and competitiveness while ensuring appropriate controls and accountability:

“These are the administration’s own principles articulated in its executive order, even though their recent actions seem to be in conflict with these principles.” (my emphasis)

They actually do. The White House may argue that recent industry events have shown that cracking down on US crypto activity is in the best interest of Americans. But this regrettable shift is about much more than protecting investors from fraud – it’s a reflexive response to the wider economic threats gathering on the fast-approaching horizon. Because of that, we know this will pass, as all cycles do.