How Does The Current Bear Market Impact Crypto Regulations?

Crypto market's impact on crypto regulation

Over the past decade, the crypto industry has thrived and expanded to become a viable alternative to the traditional financial system. Whereas the Old World is opaque, riddled with middlemen and hidden fees, the New World is transparent and equally accessible to everyone. It hasn’t all been smooth sailing though. The market has gone through severe cycles reaching, exorbitant new highs and depressing lows. It’s considered a natural phenomenon in a new industry and it is not necessarily easier to experience for those that are actively involved in the space.

All this time, what has likely contributed to the intense volatility of cryptocurrency is the lack of regulations. The limitations that come with comprehensive investor protections might slow the industry down, but that intended upside is less risk for everyone. However, financial regulators have never been able to put proper frameworks in place at the same pace at which the crypto industry evolves. 

At the height of the ICO frenzy of 2017, all regulators had to offer as guidance was effectively saying, “Many projects look like securities, and they might be regulated as such.” In 2021, there was more talk about regulating stablecoins, but to this day, there is still no clear-cut framework.

The current crypto crash has reignited calls to regulate the crypto industry. Those calls for stronger oversight are hard to fend off for an industry that has lost more than $2 trillion in value since its peak in November 2021. 

Shaky foundations of top-tier projects

First, in May 2022, the sudden implosion of Terra’s algo stablecoin UST wiped billions of dollars off the market. It was a fast-rising stablecoin ranking in the top 3 in terms of market cap, until everything suddenly went to zero during a death spiral that played out over just a few days. It took the native network token LUNA down with it, causing even more damage. The South Korean organization behind the project is currently under investigation by the country’s authorities. The Terra collapse is of particular interest to financial regulators, as the project attracted investments from a retail audience by marketing the product as a safe and ‘stable’ solution that offered a high yield (19.5%) against a low risk.

Then, just weeks after, lending platform Celsius announced that they were suspending withdrawals for all customers who had deposited funds on the platform. It turned out that the company had sizeable positions in stETH – a synthetic token pegged to Ethereum which began to de-peg at this time. To make matters worse, Celsius apparently used customer funds to protect their own positions from being liquidated. That wouldn’t fly in the regulated traditional financial system. The drastic moves by Celsius – and forced liquidations of leveraged positions – hindered crypto markets even more as BTC touched $20K.

One of the industry’s largest trading and investment firms liquidated its position. Three Arrows Capital, or 3AC, was one of the biggest investors in the Terra blockchain, and it withdrew nearly $400 million of stETH and ETH from the Curve protocol in May 2022. After weeks of rumors on crypto Twitter, 3AC finally confirmed it was facing financial difficulties following the collapse of Terra and the depegging of stETH. That’s when BTC dipped below $19K for the first time in 2 years.

These events have shed light on the “House of Cards” nature of many crypto products, and the industry expects regulators to take more decisive actions this time around. 

Regulators, mount up

A wide range of state and federal regulators have weighed in following the implosion of Terra, and again following Celsius’ troubles and the broader market collapse. After the Terra collapse, U.S. Treasury Secretary Janet Yellen called for a “comprehensive framework” governing stablecoins and urged US Congress to act.

Just days after Celsius halted redemptions, Securities and Exchange Commission (SEC) Chairman Gary Gensler cautioned that crypto platforms promising high returns may be too good to be true. Meanwhile, state securities regulators in Alabama, Kentucky, New Jersey, Texas, and Washington have opened an investigation on Celsius.

Meanwhile, US politicians introduced major legislation in June 2022 that would create the first comprehensive federal framework for regulating digital currencies. And the European Union is reportedly working on its own proposal for crypto regulation.

At this point, crypto companies are anticipating regulatory clarity. The bottom line is that companies need to increase safeguards like federal deposit insurance, which can protect investors and ensure a baseline level of liquidity even when markets are stressed. Those safeguards have the added benefit of building confidence in the overall financial system: reassuring the public that the value of money is stable and their funds will be available when they need to withdraw them.

Lastly, increased regulations might also help to attract the many institutions and corporations eager to join the crypto industry but still waiting on the sidelines. Perhaps a clearer regulatory playbook, together with a maturing Web3 economy, will be enough to kickstart the next bull run as even more companies and more consumers will then be all the more interested to join the crypto movement. A more structured and clearer regulatory framework for cryptocurrencies will enable users to feel more safe as they navigate within the digital assets industry.

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