Crypto investors are bracing for more regulatory crackdowns

by Arthur · February 14, 2023

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

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

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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 major crypto exchange, Kraken, forcing it to stop offering a popular type of crypto yield product to US investors. Banking regulators are quietly pushing banks to cut ties with crypto customers, limiting their ability to connect to the real financial system.

The flurry of actions came after years of slow-moving investigations and debate in Washington about how best to handle the fast-growing industry. Some observers detected a shift in the tone of officials following the collapse of the FTX cryptocurrency exchange, strengthening the hand of politicians and regulators calling for stricter enforcement. Now, crypto executives are bracing for more regulatory lawsuits and investigations, and investors have begun fleeing 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 the Blockchain Association, a crypto industry group.

Over a 24-hour period from Sunday to Monday, there were outflows from Binance worth $2.7 billion, according to blockchain data provider Nansen. On Monday morning, BUSD to the value of around 144 million dollars was 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 internal token, BNB, fell 8% on Monday, according to CoinMarketCap.com. The coin is often seen as a benchmark for investors’ perception of Binance.

The scale 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 crypto.

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

Bank regulators, meanwhile, have signaled pessimism about whether lending institutions can safely be involved in the industry. Some banks have reduced their involvement with crypto.

Last week, Binance said it would suspend wire transfers in US dollars. 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 serving crypto firms, began pulling back from crypto operations last year.

The SEC has been the crypto market’s main policeman since the beginning of the Trump administration, when regulators expressed interest in the new technology that underpins cryptocurrencies. Many of the SEC’s previous 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 that its associated hedge fund, Alameda Research, was heavily exposed to an illiquid digital asset issued by FTX. The revelation triggered a run on customer deposits that led to the bankruptcy of the firm and its affiliates.

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 after the FTX to be seen as the responsible cop on the beat,” he said.

In January, the SEC sued crypto lender Genesis Global Capital LLC and its partner Gemini Trust Company LLC, alleging that their program that allows users to earn interest on their crypto tokens violated securities laws. Gemini, which operates one of the largest US 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 crypto exchange Kraken, in which the company paid a $30 million penalty and agreed to stop offering so-called staking services to US investors. The company did not admit wrongdoing.

The case suggests the SEC could force other companies to stop offering access to staking, a practice where investors lock up their digital assets like ether or solana in return for an interest-like return. The lent assets allow borrowers to facilitate transactions on the assets’ underlying blockchain network.

“This should really take notice of everyone in this marketplace,” SEC Chairman Gary Gensler said on CNBC last week.

Services such as lending and betting have been available for years, but the SEC only recently took formal action against them. That has fueled industry complaints that Gensler is uninterested in negotiating a tailor-made regulatory regime for crypto. Instead, the SEC wants to impose its full Wall Street rulebook on the industry, industry officials say.

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

Binance.US, the American subsidiary of Binance that also offers staking services, has said it is monitoring the situation. Meanwhile, Coinbase CEO Brian Armstrong has vowed to fight the SEC if the agency attacked how it offers bets. “We would be happy to defend this in court if necessary,” he tweeted on Sunday.

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

Banking regulators appear to have cooled on crypto after a period under the Trump administration when they appeared more open to banks serving digital currency companies. In early January, a trio of banking 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 that it would be shutting down its crypto operations.

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 deposit cryptoassets 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 receiving full approval, according to people familiar with the matter.

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