Who to Blame for Crypto's Collapse?
Was it the regulators, scammers, the macro or ideologues?
Since the all-time-high in late 2021, crypto has erased $2.1 trillion dollars in market value and is down by a staggering 71%. Large stablecoins like USDC and USDT (Tether) have maintained their pegs to the US dollar, but everything else has been smoked. As Alex Kruger points out, 98.8% of all 12,922 crypto tokens have fallen by at least 90% from their all time high.
It all started in April, when crypto prices fell about 30% on macro weakness, particularly high inflation, recession fears, and interest rate hikes. Shortly after, in early May, algorithmic stablecoin Terra (UST) and sister token Luna violently imploded, crushing market sentiment. This week, a crypto bank with $12B in assets under management called Celcius halted customer withdrawals and is likely insolvent. The same day, Three Arrows Capital, a prominent crypto hedge fund, apparently went bust after having many of its leveraged positions liquidated.
With crashing token valuations, the proverbial dominoes have begun to fall. Except this time, unlike 2017, there’s a lot more leverage in crypto and a lot more retail and institutional money in the space. At some point, people will start throwing blame around and pointing fingers for the meltdown. Here’s where I point mine —>
In the US, the Securities Exchange Commission (SEC) and Commodities Futures Trading Commission (CFTC) have simply done an abysmal job of regulating the crypto industry. As we have discussed several times in this newsletter, most crypto tokens and crypto products are straightforwardly securities in the US, and should be regulated as such. But they aren’t.
Instead, crypto exists in a regulatory gray zone where things that are usually crimes are de facto legal for crypto because existing laws and regulations are inadequate or aren’t enforced nearly aggressively enough. In practice, everyone in crypto gets away with every crime in the book and has been for years, basically.
As a result, people have bought into thousands and thousands of crypto ‘tokens’ marketed as equity, except without any of the protections afforded to shareholders of public companies. The result is widespread insider trading, wash trading, ponzi schemes, and outright fraud. The result is dangerously unregulated and uninsured stablecoins, quasi-banks, and bank accounts. The result are single institutions mired by conflicts of interest that are brokerages, exchanges, market makers, hedge funds, banks and public companies all at the same time.
It’s a disaster.
I don’t know enough about US regulators to put my finger on the causes of this ongoing oversight failure. Are the SEC and CFTC understaffed or underfunded? Is their leadership weak? Is the SEC’s mandate too narrow? Are there issues with inter-agency coordination? Are there issues with international regulatory coordination? Is domestic regulation hard because all crypto is digital, global and borderless? Is crypto just too low on the priority list? Did US lawmakers fail to update outdated legislation?
Again, I don’t know. But whatever the reasons, they don’t excuse regulators. This outcome — hundreds of thousands of retail investors FOMOing into garbage crypto investments and losing their shirt — is mostly their fault. For reasons that escape me, they’ve been asleep at the wheel for years and deserve most of the blame.
Individual Scammers and Fraudsters
As a general principle, it’s important to bring criminals to justice, especially the flagrant scammers that lose retail investors the most money. But as a policy person, I can’t help but see crypto scams and frauds as a basic consequence of the bigger problem of under-regulation; as a predictable symptom of the Wild West regulators let crypto become.
When the rules of a financial system are essentially ‘anything goes,’ frauds thrive. When so few scams are investigated and prosecuted, pyramid schemes flourish. When all any ‘rugpull’ gets is a penalty and no jail time, extremely risky investments are sold as stable and risk-free and on and on. We’ve had financial deregulation before and … this is always the result, more or less.
In some sense, individual scammers obviously deserve blame, a jury of their peers and time behind bars if they’re found guilty. But that’s also beside the point. It was a policy and regulatory failure that facilitated all the frauds in the first place and it’s that broken system that needs to change.
Public Intellectuals and Technologists
Public intellectuals haven’t done enough to debunk the technobabble about blockchains and cryptocurrencies that duped so many retail investors. Blockchains have been sold as revolutionary technological innovations by their proponents for years, but ask any software engineer what they are and they’ll say they’re just databases, like an excel spreadsheet, but with slightly different properties.
A simple description of them reveals the absurdity of the claim that they’re revolutionary. In blockchain databases, new data are grouped and added to the end of the database together as ‘blocks,’ not line by line. Then the blocks are secured with cryptography and ‘chained’ to one another. Hence the name blockchain.
Blockchains are on the internet, not a particular hard drive or server, and don’t require special authorization to be used, so they are ‘open’ and ‘permissionless.’ Also, unlike spreadsheets on your USB, lots of unrelated people across the world maintain the database and keep copies of it, so the database is ‘decentralized.’
Database maintainers or ‘miners’ spend a lot of electricity and computing power to agree and decide on which transactions to group into blocks to add to the chain. For their trouble, they get paid in money that is invented by the database. This is the blockchain’s native token, a cryptocurrency like Bitcoin or Ethereum. And that’s it. That’s the blockchain revolution!
Public intellectuals have done too little to downplay the technological significance of this particular database design. With better education, fewer retail investors would have been duped by the ‘get-rich-quick’ mystique of the blockchain technobabble.
Public, permissionless databases and money can be useful, particularly in the context of authoritarian regimes and financial repression. But is slow, append-only database technology that is resistant to censorship a revolution worth betting 100% of your net worth on? No.
As I said before, part of the reason that crypto, equities and bonds are tanking is that the US Federal Reserve is raising interest rates to combat record-high 8.6% consumer price inflation. Still, any attempt to blame this macro backdrop for sagging crypto valuations is absurd.
Crypto is advertised as a hedge against discretionary monetary policy and inflation. It’s supposed to insure holders against traditional finance and the ‘fiat system.’ If any of this was true, crypto valuations would be rising, not sagging. But they aren’t. Because crypto is not a hedge against any of these things.
Blaming the macro for this collapse is laughable. Macro downswings were the one thing crypto was supposed to protect holders against!
Incredibly, there are people in crypto that (still) believe that more regulation and government oversight in crypto would be bad, not good. These people are probably in the minority, but are very loud and play an outsized role in shaping the industry narrative. Their rhetoric seeps into the crypto ethos and into lobbying efforts.
Libertarian ideologues also deserve part of the blame for being so spectacularly resistant to the one thing the industry needs to start adding net positive value to society, serious oversight and guardrails.
Regulators: Time to Act
Crypto has been around for a decade. Serious oversight is long overdue. Toxic projects and products need to be squashed to make way for the subset of potentially useful innovations in financial services, cross-border capital flows and crypto-dollarization.
How many boom-and-bust cycles where retail investors are duped and crushed do we need for regulators to get serious about doing their jobs?