Federal regulators took notice.
The sudden and rapid collapse of popular cryptocurrencies and crypto-related companies revealed the unwieldy nature of the crypto industry and provided some validation to already-skeptical regulators.
And it all happened against a backdrop of already-accelerating regulatory pressure, because unlike the traditional stock market, there aren’t robust federally mandated protections in place for crypto investors. As a result, experts anticipate crypto regulation to ramp up even more in the coming months.
“After the catastrophic events that have unfolded in the crypto market over the past few weeks, it is clear that stringent regulation could arrive soon,” says Marcus Sotiriou, market analyst at digital asset broker GlobalBlock. “The collapse of decentralized finance (DeFi) lenders could be the reason that regulators have been looking for to implement draconian controls over cryptocurrency.”
Bitcoin and ethereum are more than 50% down from their all-time highs late last year. The largest crypto has been hovering around the $20,000 mark for weeks now, while the second-largest has largely been holding near $1,000 up until it recently rallied more than 40% in a matter of days and climbed above $1,500. As of Monday, bitcoin was holding above $21,000 — three times lower than its all-time high of $68,000.
This week’s Federal Reserve meeting could introduce new volatility to the crypto market. The Fed is expected to bump its benchmark interest rate by 75 to 100 basis points, and it could send stock and crypto prices down in the near term as investors remain weary of the economy’s health. “In the near term, we’ve seen bitcoin and other cryptocurrencies generally sell-off with risk assets as the speculative frenzy that defined investing over 2020 and 2021 grinds to a halt,” says Stéphane Ouellette, CFA and founder of FRNT Financial, an institutional capital markets and advisory platform focused on digital assets.
No one actually knows how the average investor will be affected by growing regulations, at least not until the federal government decides on specific rules. But all in all, many experts generally agree crypto regulation would actually be a good thing for investors.
“Regulations will come up and they have to come up at some point, which would stabilize the market even further,” said Tally Greenberg, head of business development at Allnodes, a platform that provides hosting, monitoring, and staking services. “That protects investors, so it’s a good thing. It’s not a bad thing.”
What’s Happening to the Crypto Industry, and Why Does It Matter?
Ever since bitcoin and ethereum hit all-time highs at the end of 2021, the market has been on a ruthless downtrend with little sign of relief. Bitcoin has been tracking with the stock markets very closely this year, and has been impacted by the challenging macroeconomic environment as a result.
Conditions in the crypto market took a turn for the worse in May when bitcoin fell below $26,000 for the first time in 16 months. The rest of the cryptocurrency market fell with it. Because investors withdrew their liquidity from the crypto market at an extraordinary rate, a popular stablecoin known as TerraUSD (UST) depegged from the dollar, which caused its linked cryptocurrency luna to crash as well.
The luna and UST crash led to a contagion among other crypto firms. Three Arrows Capital, a crypto hedge fund based out of Singapore, collapsed a few weeks after the Terra Luna crash, which then triggered the downfall of many other companies across the crypto market, particularly lenders which the hedge fund borrowed from in enormous sums, including BlockFi, Celsius, Voyager, and Genesis. Crypto brokerage Voyager Digital and crypto lender Celsius both filed for Chapter 12 bankruptcy recently. Vauld and Zipmex, crypto trading and lending platforms, became the latest crypto firms to halt customer withdrawals.
The collapse of the crypto market puts U.S. regulators in a “tricky spot,” Ouellette says. That’s because the vast majority of both crypto investors and platforms that power it are not based in the U.S. “This is a new spot where clearly, if such regulators view their roles as investor protection they will need to respond somehow to these disasters,” he says.
Oulette says an obvious regulatory response is mandating U.S.-based platforms be fully regulated and “implement a framework where unlicensed platforms can be quickly shut down shortly after launch.” While that doesn’t address the issue of Americans accessing platforms in other parts of the world that don’t abide by U.S. regulatory standards, it would be a step in the right direction, he says.
“Whatever the regulatory response, it is one of the more complicated dynamics U.S. regulators have ever faced,” he says.
What Investors Should Know About New Crypto Regulation
New crypto regulation is coming fast, experts say. The exponential growth of cryptocurrencies, DeFi, and the broader Web3 space means time is short for finding regulatory solutions.
“Whatever crypto regulation takes hold, it will likely be bold and global,” says Edward Moya, senior market analyst at foreign brokerage firm Oanda.
The U.S. Securities and Exchange Commission recently reiterated its concern about the lack of regulation surrounding cryptocurrencies, and what its doing to tackle it. SEC Chairman Gary Gensler said in a Yahoo Finance interview on July 14 that crypto investors “would benefit from investor protection around these various service providers … the exchanges, the lending platforms, and the broker-dealers. He added that the agency is “working in each of those three fields — exchanges, lending, and the broker-dealers — and talking to industry participants about how to come into compliance, or modify some of that compliance.”
So, what does this mean for crypto investors? The latest crypto market crash is a reminder for investors that crypto assets come with extra risk and volatility, especially in times of economic and political uncertainty. Until there are set rules in place, take extra caution in what cryptocurrencies and DeFi platforms you invest in, as well as where you store your assets. The safest place to store your crypto assets is in a hot or cold wallet; these crypto wallets are experts’ favorites. Experts recommend investing no more than 5% of your investment portfolio in crypto.
“People should be cautious with lending firms offering lucrative yields of double-digits on assets like bitcoin and ethereum,” says Sotiriou. “People should consider the risks involved like smart contract exploits, lender becoming insolvent and whether the protocol has been stress tested.”
Once crypto receives regulatory clarity, the risk of crypto market contagion like we’ve seen in recent weeks will reduce significantly in the future and the industry will begin to see even more institutional adoption, according to Sotiriou.
“Waves of institutional capital will be sidelined from the crypto industry until countries like the U.S. provide regulatory clarity,” he says. “But I am still long term bullish despite the negative short-term impacts.”