US regulators are pushing crypto abroad, and I see their point

By:
on May 11, 2023
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  • US regulators have clamped down aggressively on crypto over the past six months
  • Industry players fear they are being pushed offshore, while critics lament the stifling of innovation
  • Our Head of Research, Dan Ashmore, says crypto brought this upon itself

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The biggest story in crypto over the past six months has been the relentless clampdown by US regulators on the industry at large. 

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To some, this is a totally unjust move to stifle innovation, borne out of allegiance to the Wall Street elite who do not want their place challenged. To others, it is a well overdue cleansing of a sector built upon nothing but greed, serving no purpose beyond gambling, or an avenue to circumvent financial laws. 

In this report, I want to dig into what exactly this great crypto squeeze means. Is the industry being pushed overseas? Is this a bad move for the US long term? And perhaps biggest of all, is it fair?

Is crypto evil?

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Why not get to the crux of it – is crypto a net good for society? 

One person who certainly thinks crypto is harming the world is Congressman Brad Sherman, who this week compared crypto to cocaine and organ harvesting when discussing whether the US’ punitive stance would push innovation into other countries. 

“Peru is way ahead of us (the US) in cocaine production. China is way ahead of us in organ harvesting. We don’t need to keep up on those things and we don’t need to keep up on crypto”. 

A bit hyperbolic perhaps, and the interview has been passed around and ridiculed in crypto circles (predictably). However, like most things in life, there are advantages and disadvantages to crypto. One thing the industry struggles with is a refusal to objectively discuss its shortcomings, instead jumping to the conclusion that “authorities bad and corrupt, crypto perfect”. 

Before we talk about advantages, let us look at some of those flaws. Firstly, there is no doubt that crypto makes crime easier to conduct. The beauty of this technology is also a double edged sword, because being able to zip money around the world in a totally anonymous and instantaneous way obviously has worrisome consequences, as well as the evident upside. 

I was poignantly reminded of this last year when I visited Estonia (the capital city, Tallinn, is a tremendous spot for a city break, if anyone is looking for recommendations). Estonia is today an EU country, winning independence from the USSR in 1991. I took a stroll through the historic centre and came upon the Russian embassy. Estonia shares a border with Russia, which had just invaded Ukraine. The embassy was adorned with horrifying pictures and tragic messages, the building bordered up. The graphic images on the building, the geographical proximity to Russia and the close historical ties between Estonia and the USSR suddenly made the war feel very close and very, very real. 

And I thought of crypto. Specifically, stories about Russia utilising blockchain technology to circumvent sanctions from the West. Blockchain technology is aiding the war effort, and it made me feel a little queasy. I then thought of an interview I did with the head of a cryptocurrency exchange a couple of months previously, when I asked whether there could be a dark side to Bitcoin’s censorship-resistant qualities. He refused to answer.

If you go searching, these issues are everywhere. Another example is that of crypto lender Nexo, which was raided in January by Bulgarian authorities, reports linking the platform with terrorist financing and aiding Russian sanction evasion. 

Whether those allegations are true or not – they have been staunchly denied by Nexo – remains to be seen, and this is just one example. However, the point is that crypto undoubtedly aids criminal activity. Anyone who operates in the space knows this. 

Money can be swiped in seconds before getting sent to a mixer on-chain, the funds coming out the other side with the origin completely obscured. It’s a money launderer’s dream, a scammer’s paradise. Of course, there are benefits too, and some tremendous work by some smart people, but that does not change the fact that there are very real downsides. 

Does crypto’s good outweigh its bad?

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What about innocent Russians? Crypto can aid them access the outside financial world. What about those in other countries around the world under financial oppression? Crypto can provide an escape route. 

These are hints at the power that a decentralised money can have. However, in the US, people are neither sanctioned nor financially oppressed, so it is not relevant when breaking down the stance by US regulators. 

Secondly, this is a pro for Bitcoin, or perhaps stablecoins, but what about the rest of crypto? For me, until the thousands of altcoins present a clear description of what the actual utility of their product is, I’m finding it hard to shed a tear when I hear of regulators tightening the screw. 

After all, regulators are there to protect people. Last year, we saw the startling collapse of FTX, lives ruined as the exchange, led by the disgraced Sam Bankman-Fried, played fast and loose under a total lack of oversight and regulation. Domiciled in the Bahamas, the nation’s regulators have a lot of questions to answer. But FTX US also declared bankruptcy, its customers burned, too. 

There was also the implosion of the Terra ecosystem this time last year, an event which saw a once-$60 billion ecosystem evaporate into thin air. Suicide hotlines were pinned at the top of Reddit forums, as many viewing UST as a dollar-equivalent saving medium were burned. It was horrific. 

Clearly, crypto has run wild over the past couple of years and, clearly, it has hurt people. At the end of the day, regulators are there to protect consumers, and hence it is not surprising to see them move in so aggressively. The scandals in crypto were simply too egregious, the bankruptcies too large – beyond FTX and Terra, there has been Celsius, BlockFi, Voyager Digital, Genesis, Babel Finance and many, many more. In this context, is it really unexpected to see regulators move in?

Stifling innovation

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The biggest criticism of all this seems to be from those decrying the US’ stance for stifling innovation, and pushing an industry overseas. It’s a valid concern; indeed, it is already happening. Coinbase CEO Brian Armstrong touted the UAE as a potential international hub this week, as the embattled exchange continues to struggle in the US amid the worsening environment.

For Coinbase, I feel sympathy. The exchange offers genuine utility – a way to buy and sell Bitcoin and other crypto – and is a legitimate business. It trades publicly on the Nasdaq, its financials available for all to see. It hasn’t done a lot wrong. 

And yet, it was recently served with a Wells notice, apparently for a violation of securities laws, most likely in relation to its staking products. 

While Coinbase is a solid business, it is unlucky because, well, a lot of the crypto industry is not. There is no reason for the bulk of these altcoins to exist, and many companies or founders hold vast control over the distribution of tokens, as well as sizable stashes themselves. Not all those they are marketing and selling to know the risks, however, nor the full story behind the distribution of these tokens. 

Additionally, most of these tokens appear to be securities, which is where a lot of the discussion comes in. While there is a real grey area with stablecoins, which I do agree present as a grey area and have been harshly treated by regulators, the bulk of products offered feel closer to securities than not. And with that, comes responsibilities and disclosure requirements. 

As an aside, a quick intervention to say that I am not referring to Bitcoin here. Even SEC chairman Gary Gensler has acknowledged Bitcoin is not a security. As is frequently the case, Bitcoin exists in its own category here, away from most of the market. 

Binance show why regulators have come in

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As I said, it is the Coinbases of the world that get hit unfairly, and where most sympathy should lie. But unfortunately, they have their peers to blame, as Coinbase’s transparency is a glaring outlier in an industry built upon the most murky and clandestine foundations imaginable. 

Take the world’s biggest stablecoin, Tether, long chastised for its murky reserve situation. While it has improved markedly recently, it was fined in 2021 for misstating its reserves. At a market cap of $82 billion, it is a vitally important cog to the entire industry, and therefore an enormous source of risk. 

But the most prudent example is Binance. Much like Binance, this is a legitimate company and serves a real purpose. Not only that, it is the biggest exchange on the planet, responsible for a mammoth two-thirds of all trading volume as of the end of 2022. And yet, it is impossible to know what is going on underneath the hood. 

I penned a deep dive on this problem last December. There was no way to make any sort of reasonable financial assessment of the company. Binance still operates without a headquarters. Its liabilities are mystery. There is almost nothing to assess. 

It claimed a Mazars-sponsored proof-of-reserves report was an “audit”, but such was the comically untransparent nature, Mazars pulled all work with crypto companies, citing a “misunderstanding” of how the reserve reports work. Binance’s edition didn’t even have liabilities. Only within crypto could a company try to claim an audit without even revealing its liabilities.

CEO Zhao even had the gall to instruct people to “ask around” to prove that Binance did not owe anyone money. For the biggest exchange on the planet, responsible for billions of customer funds, that is simply not good enough. 

Since then, Binance has been levelled with many allegations and lawsuits. The CFTC filed a civil enforcement action against the exchange. 

“Binance did not require its customers to provide any identity-verifying information before trading on the platform…and failed to implement basic compliance procedures designed to prevent and detect terrorist financing and money laundering”, the complaint reads. 

“The complaint further alleges that even after Binance purported to restrict U.S. customers from trading on its platform, Binance instructed its customers – in particular its commercially valuable U.S.-based VIP customers – on the best methods for evading Binance’s compliance controls”.

Binance also admitted to mixing up customer funds with collateral, citing it as a “mistake”, and proving yet again why regulators are so intent to clean the space up. 

This is wild west stuff. And again, is anyone actually surprised that regulators are moving in to stop it?

I wrote an open letter earlier this year lamenting how hypocritical a lot of crypto had become. While the industry was founded on the principles of “trust, don’t verify” and a distrust for the legacy financial system, it has got to the point where we are meant to blindly believe the words of CEOs on Twitter, because verification is literally impossible. 

Given what happened last year (I could pull up a Sam Bankman-Fried tweet here, but I have had enough of that guy, to be honest), it would be downright bizarre if regulators didn’t move in at this point. 

The downsides to punitive regulation

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On the flip side, innovation and entrepreneurship is a boon for any country, and an overly punitive stance will push companies abroad. Europe’s MiCa regulation is often cited as a glaring contrast to the US’ new aggressive stance, and I think much of that argument is reasonable. 

To clamp down on the entire industry does feel a bit heavy-handed. There are tax dollars and jobs here. While the future stance of crypto is up for debate, pushing it away now also means that if crypto does grow in the future, it is countries outside the US that will benefit. 

But I really think that crypto has drawn this upon itself. The behaviour of most companies in the space is nowhere near the standards that are required of financial companies in the US, and those standards are for the benefit of consumers. Transacting in the manner that Binance does should not be tolerated (I keep using Binance as an example, but this holds for most companies in the crypto space. Here is a similar piece on Nexo last year, lamenting how its opaque nature makes it impossible to make an assessment of its business).

It feels like regulators are just doing their jobs. Most tokens exist for no other reason beyond wild speculation, a capitalist hellscape built around nothing but the desire for money at all costs. Some of the action may be heavy handed, but the space needs cleaning up, and cleaning up quick.

In closing, there is good and bad to crypto. But anyone who dismisses the events of the last year, and the opaque nature in which most companies operate, misses the point. You can love the technology behind crypto, you can love the innovation,  you can love Bitcoin. Fine. But that does not excuse the unacceptable nature of many crypto companies, nor the outright flaunting of financial laws that has transpired. 

Most cryptocurrencies serve zero purpose, and there is no reason for them to trade. Rug pulls are aplenty, scams are ubiquitous, founders and marketers frequently take advantage of gullible retail investors. I understand the line of argument that we should allow people to invest in what they want, but there has to come a point where regulators need to step in. That point was 2022, when it became clear the sums of money, and the scale of the transgressions, were too large to ignore. 

It is a shame that legitimate companies will get caught up in the crossfire. There may well be a loss of resources and capital to other countries. These are undoubtedly drawbacks. But the US is the financial centre of the world, and its standards should be high. 

Crypto shot itself in the foot; it brought this upon itself. It played fast and loose with the rules, and people got hurt. The sad thing is, it wasn’t those that deserved it. Regulators are far from perfect, but crypto could not be allowed to continue the way it was. 

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