Is It Time to Put Crypto Out of Its Misery?

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In Foreign Policy, David Gerard encourages regulators to clamp down on crypto before another bubble/bust cycle takes place, ruining the savings of many more speculators in the process. He concludes:

Ordinary mom-and-pop investors were badly burned by the May crash. The influx of retail dollars was almost entirely cut off. Crypto exchanges such as Coinbase, Gemini, and Crypto.com are where the outside dollars flow in and out of crypto; all three announced massive layoffs. When 60 Minutes Australia ran a segment on the crypto downturn, reporter Tom Steinfort confessed that he himself had invested in the crypto upswing on a tip from friends.

UST/luna was crypto’s Bear Stearns moment. The large lenders reassured customers that all was well and they had not been exposed to UST or luna—even when they had—but withdrawing often became difficult. Observers noted the lenders’ DeFi trades, visible on the public blockchain, and detailed how the companies’ claimed numbers often just didn’t match the evidence.

Finally, Celsius cut off customer withdrawals on Monday, June 13. 3AC started dumping holdings on Tuesday and announced on Wednesday that it was “in the process of communicating with relevant parties.” Finblox, which offered up to 90 percent annual interest, cut withdrawals to $1,500 a month on Thursday. Babel Finance froze withdrawals on Friday, citing “unusual liquidity pressures.”

The price of bitcoin had dropped to $20,000 on June 13 and stayed just above that price all week. This level was not merely psychological; there were multiple DeFi loans that would have automatically been margin-called and liquidated had the price gone below that number. This meant that the holders of those loans had to keep the price pumped just a little higher. Other cryptocurrencies, such as ether, had similarly critical price levels.

Funds to pump the prices finally ran out. At 6:51 a.m. UTC on June 18, bitcoin dropped from $20,300 to $19,100 in five minutes as multiple loans autoliquidated simultaneously. It bottomed at $17,600 later that day. Just as in the 2008 financial crisis, the crypto economy had been destroyed by unrestrained and overleveraged financial engineering and deliberately concealed risks. But this time, there was no Federal Reserve to bail firms out.

So, who will save crypto? Since 2017, tether has regularly bailed out the crypto markets. One study showed that injections of tethers had propped up most of the 2017 bubble, including times when tether was insolvent. But Tether Holdings was fined by New York and the Commodity Futures Trading Commission (CFTC) in 2021 for repeated misrepresentations as to its claimed backing reserve and placed on a tight reporting regime. Tether Holdings has been unwinding its reserve position, reducing its issuance by 15 billion tethers, and last week specifically denied it was exposed to the recently failed firms—even as the company was an investor in Celsius.

Regulating the cryptocurrency trading market is difficult. U.S.-regulated crypto exchanges are just the cashier’s desk to the precious dollars. The vast majority of the trading, and the price discovery, happens in utterly unregulated offshore exchanges that ostensibly avoid U.S. customers. These exchanges allow and perpetrate all the market and customer abuses that caused stock markets to be regulated in 1933.

Crypto exchanges are notorious for abusing customers however they can get away with, and offshore markets make that a lot easier. Yet even Coinbase, a U.S. exchange operating under New York regulation, ran a largely faked market in the cryptocurrency litecoin from 2015 to 2018. 99 percent of the trades on some days were one Coinbase employee wash trading—buying and selling from himself. The exchange was fined $6.5 million by the CFTC.

Celsius, however, was a glaring failure of existing regulation at the expense of ordinary investors. The company operated in U.S. jurisdiction for three years, offering implausible interest rates with no good explanations of where the money came from and taking investments from retail customers. Celsius and similar companies that marketed to U.S. investors should have been shut down a year ago at the latest.

Now that the party is over and the horse has bolted, regulators may feel safe to move in and shut the stable door. If they don’t, then another bubble may happen again in a few years. The regulators failed to rein in crypto after the 2017 bitcoin bubble burst. They must not miss their chance this time.