Crypto investors brace for more crackdowns from regulators

The Securities and Exchange Commission has been the crypto market’s principal cop since the Trump administration. (Photo: Reuters)
The Securities and Exchange Commission has been the crypto market’s principal cop since the Trump administration. (Photo: Reuters)

Summary

Officials cut off access to products and services vital to digital-currency business

The walls are closing in around crypto. Regulators hadn’t taken action against many of the industry’s biggest players, but are now cutting off access to products and services central to the digital-currency business.

On Monday, New York regulators shut down new issuance of the world’s third-largest stablecoin, BUSD, prompting investors to flee the coin and raising worries about the future of crypto exchange giant Binance, which gives the coin the “B" in its name.

Binance’s partner in issuing the coin, Paxos Trust Co., is facing a potential Securities and Exchange Commission lawsuit. A few days earlier, the SEC fined the parent of another big crypto exchange, Kraken, and forced it to stop offering a popular type of crypto-yield product to U.S. investors. Banking regulators are quietly pushing banks to cut ties with crypto customers, limiting their ability to plug into the real-world financial system.

The flurry of actions came after years of slow-moving investigations and debate in Washington over how to best handle the fast-growing industry. Some observers detected a shift in officials’ tone after the collapse of the FTX crypto exchange, which strengthened the hand of politicians and regulators calling for tougher enforcement. Now crypto executives are bracing for more regulatory lawsuits and investigations, and investors have started to flee suspected targets.

“It certainly feels, from an industry perspective, like there’s a crypto carpet bombing going on right now," said Kristin Smith, CEO of Blockchain Association, a crypto industry group.

Over a 24-hour period from Sunday to Monday, there were $2.7 billion worth of outflows from Binance, according to blockchain data provider Nansen. On Monday morning, some $144 million worth of BUSD were redeemed for dollars, according to Nansen. Paxos said Monday it “categorically disagrees" with the SEC’s assertion that BUSD must comply with federal securities laws.

Binance’s in-house token, BNB, tumbled 8% on Monday, according to CoinMarketCap.com. The coin is often seen as a gauge of investors’ perceptions of Binance.

The scope of such actions suggests that the SEC and other regulators want to rein in pillars of the crypto market such as stablecoins—digital coins that maintain a price of $1—and staking, a common way for investors to earn interest on their crypto.

Worries of a crackdown appear to have taken the wind out of the sails of an early-2023 rally in the digital currencies market. Bitcoin was trading at about $21,621 at 5 p.m. ET Monday, down 9% from its price Feb. 1.

Banking regulators, meanwhile, have signaled a pessimism about whether lending institutions can be safely involved with the industry. Some banks have pared back their involvement with crypto.

Last week, Binance said it would suspend U.S. dollar bank transfers. The move came after the exchange said its banking partner, Signature Bank, would no longer support crypto transactions below $100,000. Signature, one of the largest banks to serve crypto firms, started pulling back from the crypto business last year.

The SEC has been the crypto market’s principal cop since the beginning of the Trump administration, when regulators expressed interest in the novel technology underpinning cryptocurrencies. Many of the SEC’s earlier enforcement actions targeted smaller players, giving the market the impression that the industry’s best known brands were safer to deal with and faced less regulatory risk.

Then FTX, one of the world’s best-known trading platforms, failed in November after a report revealed its affiliated hedge fund, Alameda Research, was heavily exposed to an illiquid digital asset issued by FTX. The disclosure triggered a run on customer deposits that caused the firm and its affiliates to enter bankruptcy.

The FTX blowup emboldened the SEC, said Coy Garrison, a former regulator and now a partner at Steptoe & Johnson LLP who advises clients on crypto legal issues. “There is a political incentive to bring bigger cases post-FTX to be viewed as the responsible cop on the beat," he said.

The SEC in January sued crypto lender Genesis Global Capital LLC and its partner Gemini Trust Company LLC, alleging that their program allowing users to earn interest on their crypto tokens violated securities laws. Gemini, which operates one of the largest U.S. crypto exchanges, has said it plans to fight the lawsuit.

Crypto executives have been spooked by last week’s settlement between the SEC and the parent company of the Kraken crypto exchange, in which the company paid a $30 million penalty and agreed to stop offering so-called staking services to U.S. investors. The company didn’t admit wrongdoing.

The case suggests that the SEC might force other companies to stop offering access to staking, a practice in which investors lock up their digital assets such as ether or solana in return for an interest rate-like yield. The loaned assets allow the borrowers to facilitate transactions on the assets’ underlying blockchain network.

“This really should put everyone on notice in this marketplace," SEC Chair Gary Gensler said on CNBC last week.

Services such as lending and staking have been available for years, but the SEC only recently took formal action against them. That has furthered the industry’s grievance that Mr. Gensler is uninterested in negotiating a bespoke regulatory regime for crypto. Instead, the SEC wants to impose its full Wall Street rulebook on the industry, industry officials say.

“You are starting to see opportunistic and uneven actions that are designed to try to bring major industry players and platforms within the SEC’s jurisdiction," Mr. Garrison said. “They have a tenuous connection to investor protection. These products have been offered for a long time."

Binance.US, the American affiliate of Binance which also offers staking services, has said it is monitoring the situation. Meanwhile Coinbase CEO Brian Armstrong has pledged to fight the SEC if the agency attacked how it offers staking. “We will happily defend this in court if needed," he tweeted on Sunday.

Mr. Gensler has warned since FTX’s fall that crypto companies, including the exchanges that are the hubs of the market, are running out of time to voluntarily comply with investor-protection rules. Mr. Gensler has dismissed crypto-industry claims that their market is too unique to coexist with SEC rules as a “talking point."

Bank regulators appear to have cooled on crypto after a period during the Trump administration when they seemed more open to banks serving digital-currency companies. In early January, a trio of bank regulators issued a statement expressing skepticism that digital assets could be safely held by financial institutions. Within a week, Metropolitan Commercial Bank, a small New York bank that had dipped its toes into crypto, announced it was closing its crypto business.

Meanwhile, two companies trying to win banking licenses have been left in limbo after winning preliminary approval in early 2021 from the Office of the Comptroller of the Currency. Paxos National Trust and Protego Trust Co. applied to start banks that would custody crypto assets and facilitate trading.

Protego’s conditional charter expired recently. The company believes the agency’s increasingly anti-crypto stance played a role in it not yet getting full approval, according to people familiar with the matter.

Paxos said it remains in discussions with the regulator. “Paxos has not been asked to withdraw its application for a national trust bank charter from the OCC, nor has it been denied the charter," Paxos said in a statement on Twitter.

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