Crypto: Regulators are cracking down as FTX fallout casts a shadow over digital assets

When FTX collapsed in November, it was a seismic event for the crypto industry. Many called it the “Lehman moment.” The comparison holds true in broad strokes: An industry giant came tumbling down, contagion spread, and regulators who’d been reluctant to act suddenly had a clearer target and a wave of public outrage to bolster their cause. And now, we may be officially entering the Dodd-Frank era of crypto. (Dodd-Frank, of course, being the 2010 legislation Congress passed in response to lax oversight in parts of the banking industry that plunged the world into one of the worst financial crises in history.) As the crypto market has exploded into a trillion-dollar industry, proponents are grappling with a regulatory infrastructure ill-equipped to handle it and broadly suspicious of its fundamental pitch as a the future of finance. In the three months since FTX filed for bankruptcy, state and federal regulators have escalated both their rhetoric and their actions to keep the fast-growing digital asset industry in check — a shift that is, unsurprisingly, not going over great with crypto companies. On Tuesday, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing pointedly titled “Crypto Crash: Why Financial Safeguards are Needed for Digital Assets.” “While crypto contagion didn’t infect the broader financial system, we saw glimpses of the damage it could have done if crypto migrated into the banking system,” the committee’s chairman, Sen. Sherrod Brown, said in his opening remarks. “These crypto catastrophes have exposed what many of us already knew: Digital assets — cryptocurrencies, stablecoins, and investment tokens — are speculative products run by reckless companies that put Americans’ hard-earned money at risk.” Stablecoins in the spotlight The hearing came a day after a regulatory crackdown on one of the world’s most popular stablecoins. On Monday, New York regulators ordered blockchain firm Paxos to stop issuing BUSD, aka Binance USD, citing “several unresolved issues” related to Paxos’ oversight of its relationship with crypto exchange Binance. So-called stablecoins are digital tokens that maintain a one-to-one backing with US dollars or other fiat currency. Investors typically buy them to store money and facilitate deals within the cryptocurrency infrastructure, making them a bedrock of the crypto ecosystem. The New York Department of Financial Services didn’t immediately respond to CNN’s request to comment. Paxos told customers they would be able to redeem their BUSD through February 2024, with options to redeem funds in US dollars or to convert their tokens to Pax Dollar, another stablecoin issued by the company. At the same time, the Securities and Exchange Commission plans to sue Paxos, alleging that BUSD should have been registered under federal securities laws. Paxos “categorically disagrees” with the SEC, it said in a statement Monday, “because BUSD is not a security under the federal securities laws.” The firm said it would “engage” with the SEC on the issue and is prepared to “vigorously litigate if necessary.” The firm declined to comment beyond its statement. The BUSD news has clearly unsettled investors. Binance, which partnered with Paxos to launch the stablecoin in 2019, on Monday suffered one of its worst-ever days in terms of withdrawals with $873 million in net outflows, according to data provider Nansen. Enforcement ramps up The crackdown on BUSD and Paxos is just the latest instance of regulatory muscle-flexing in recent months — actions that are sowing confusion and frustration among crypto’s proponents, many of whom have sought regulatory clarity for years. “Regulation by enforcement is puzzling for crypto enthusiasts,” said Marcus Sotiriou, market analyst at digital asset broker GlobalBlock, in a note. “People are desperately trying to figure out how to offer a product legally whilst getting zero guidance.” In recent weeks, the SEC has leaned on a whack-a-mole enforcement strategy that critics say is unfairly targeting the nascent industry. Last week, the SEC reached a $30 million settlement with crypto platform Kraken that will force the firm to unwind its “staking” practice, which allows investors to make passive yield on their crypto holdings. The settlement immediately raised questions about other exchanges that offer staking, which crypto advocates say is vital to supporting the healthy function of some virtual currencies. In January, regulators warned US banks and other market participants about the risks of fraud, volatility, and shoddy risk management in the crypto world. “It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” they said in a statement — the first-ever joint statement on crypto from the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. -— CNN’s Michelle Toh and Brian Fung contributed reporting.

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Crypto is joining the grown-up table, and no one is happy about it