Bank panic is burned in the American collective imagination for good reason. When the Great Depression hit, the economies of million americans were wiped out when their banks collapsed. That’s why the Federal Deposit Insurance Corp. (FDIC) has been introduced in 1933. Since then, not a penny of FDIC-insured funds has been lost when banks fail.
It’s a different story when your “bank” is a cryptocurrency business. As crypto prices crash, customer deposits either disappear with them or get hacked by the people behind the company. Unregulated markets today look much like they did in the 1920s.
Bitcoin advocates have largely stopped claiming that the cryptocurrency can function as real money, mainly because it is still largely unachievable pay anything in it. Now the claim is that bitcoin is a “store of value”—meaning an asset that will not lose its value over time. This turned out to be dramatically wrong. More than that, traders were shoveling valuables into their own US dollar-denominated safes.
In May, Terraform Labs’ stablecoin terraUSD (UST) – a token pegged to the value of the US dollar but allowing faster transactions with little legal oversight – crashed and in turn sent the price of bitcoin crashing. Things seemed stable for a few more weeks, but below the surface the cryptocurrency market was in crisis.
On June 12, crypto investment firm Celsius stopped all withdrawals, claiming “extreme market conditions”. The market panicked. Bitcoin price fell from $28,000 to $20,000. On June 14, reports emerged that Celsius was “restructuring.” Within a week, bitcoin fell again.
Celsius said it could replace bank accounts and claimed one million customers. The company was offering eye-popping interest rates of around 18% per annum. But Celsius’ interest rates were downright implausible. You can’t get more than a few percent back anywhere in today’s economy. If someone offers 18%, your first thought should be, “What’s wrong here?” »
Celsius had already been expelled from Alabama, Texas, Kentuckyand New Jersey because his interest-bearing accounts were, functionally, unregistered securities offerings. The United States Securities and Exchange Commission had looked into Celsius since January 2022– but had not yet acted against her.
The other problem was that Celsius was closely tied to many other crypto companies, including lending companies offering similarly implausible interest rates. He was not a dishonest operator; it was part of a systemic risk, comparable to Lehman Brothers during the 2008 financial crisis.
Behind it all was a toxic dumping ground of unregulated investments of dubious origin. The price of Bitcoin started rising in 2020 and launched into a new asset bubble in early 2021, peaking at $64,000 in April 2021 and again at $69,000 in November 2021. Both pumps of prices coincided with the injection of billions of tethers, a dodgy dollar-equivalent stablecoin, via unregulated offshore exchanges. The real interest, and the real dollars, came from ordinary investors when Elon Musk started talking about crypto in January 2021 and bought bitcoin for Tesla in February. When Tesla reportedly sold bitcoin in May, many of these investors left the market. (Musk later claims that he had only sold 10% of the holdings.) Without their actual dollars, the price of bitcoin fell back to $31,000 in June 2021.
The headlines about exorbitant crypto valuations all in the billions. But those numbers are thinly calculated virtual amounts, not real dollars you could use or cash out. Crypto trading is zero-sum: every dollar earned by a winner is lost by a loser. When this influx of real dollars slows, crypto markets have a problem.
There were not enough outside dollars to pay for the paper wealth of crypto holders. The industry had to come up with more elaborate plans to attract new money from outside. Venture capitalists have frantically promoted NFTs and Web3, even though the meaning of “Web3” has never been clear. Crypto companies even ran ads during the Super Bowl in February, marking the time when an industry has reached nearly every US consumer, and there are no new customers left.
It’s good if your customers regularly need your product and you earn money from it, like light bulbs, insurance or toilet paper. But it was a sign of the end for many losing start-ups that reached Super Bowl level, and it’s even more deadly for investment plans that depend on bringing in new customers to pay the bills. old – like Charles Ponzi discovered in 1920.
Until 2021, crypto credit companies have taken advantage of the bubble, offering implausible interest rates. Celsius and crypto hedge fund Three Arrows Capital (3AC) had prominent positions in each other and Terraform’s Anchor protocol. Celsius has repeatedly remortgaged loans – using borrowed assets as collateral for another loan – allowing for greater leverage for even better returns in good times.
Crypto investment firms have been playing the hottest crypto markets: DeFi protocols. DeFi is short for “decentralized finance” – a way to automatically exchange almost any cryptocurrency for any other. You can deposit assets and borrow against them. You can build complicated lever chains. You can even remortgage your loans without a human stopping you.
You can also create an asset from scratch, make a few trades, and give it a dollar price tag based on those trades, even though your token’s price is really in another token, priced in a third token, and than being priced in dollars. This allows you to assert a “market capitalization” of millions or billions. Terraform’s UST token and its twin luna token were created and valued in this way. UST was touted as a “stablecoin”, reliably worth $1, and backed by luna. But UST and Luna were only backed by wishful thinking — and by Anchor, another investment vehicle that offered 20% interest on UST deposits. UST, Luna and Anchor collapsed in May. An alleged $18 billion in UST fell to zero. Bitcoin crashed from $36,000 to $26,000.
Ordinary mom and pop investors were badly burned by the May crash. The influx of retail dollars has been cut almost entirely. Crypto exchanges such as Coinbase, Gemini, and Crypto.com are where outside dollars move in and out of crypto; all three announced massive layoffs. When 60 Minutes Australia led a segment on the crypto downturn, journalist Tom Steinfort confessed that he himself had invested in the rise of crypto on the advice of friends.
UST/luna was the Bear Stearns moment of crypto. Big lenders reassured customers that everything was fine and they hadn’t been exposed to UST or luna – even when they had been – but withdrawing often became difficult. Observers noted DeFi transactions from lenders, visible on the public blockchain, and detailed how the numbers claimed by the companies often simply did not match the evidence.
Finally, Celsius halted customer withdrawals on Monday, June 13. 3AC started dumping of assets on Tuesday and announced the Wednesday that he was “communicating with the parties concerned”. Finblox, which offered up to 90% annual interest, reduced withdrawals to $1,500 per month on Thursday. Babel Finance froze withdrawals Fridayciting “unusual liquidity pressures”.
The bitcoin price had fallen to $20,000 on June 13 and remained just above that price all week. This level was not just psychological; there were several DeFi loans that would have automatically been called and liquidated if the price fell below this number. This meant that holders of these loans had to keep the price a little higher. Other cryptocurrencies, such as ether, had equally critical price points.
Funds to pump prices eventually ran out. At 6:51 UTC on June 18, bitcoin surged from $20,300 to $19,100 in five minutes as several loans automatically liquidated simultaneously. It hit a low of $17,600 later in the day. Much like the financial crisis of 2008, the crypto-economy was wrecked by rampant, overleveraged financial engineering and deliberately concealed risks. But this time, there was no Federal Reserve to bail out companies.
So who will save crypto? Since 2017, tether has steadily bailed out crypto markets. A study showed that tether injections supported most of the 2017 bubble, including times when tether was insolvent. But Tether Holdings was fined by New York and the Commodity Futures Trading Commission (CFTC) in 2021 for repeated misrepresentations as to its claimed warranty reserve and placed under a strict reporting regime. Tether Holdings unwound its reserve position, reducing issuance by 15 billion tether, and last week specifically denied that he was exposed companies that have recently gone bankrupt – even if the company was a investor in Celsius.
Regulating the cryptocurrency trading market is difficult. US-regulated crypto exchanges are just the cashier’s desk for precious dollars. The vast majority of trading and price discovery takes place on totally unregulated offshore exchanges that ostensibly avoid US clients. These stock exchanges allow and perpetuate all the market and customer abuses that regulated the stock markets in 1933.
Crypto exchanges are notorious for abusing customers, but they can get away with it, and offshore markets make that much easier. Yet even Coinbase, an American exchange operating under New York regulations, ran a heavily rigged market in the cryptocurrency litecoin from 2015 to 2018. 99% of exchanges some days a Coinbase employee would go into trading, buying and selling himself. The exchange was a $6.5 million fine by the CFTC.
Celsius, however, was a blatant failure of existing regulation at the expense of ordinary investors. The company operated in the US jurisdiction for three years, offering implausible interest rates without good explanations of where the money came from and taking investments from retail clients. Celsius and similar companies that sold to US investors should have been shut down a year ago at the latest.
Now that the party is over and the horse has run away, Regulators can feel safe to move in and close the stable door. If they don’t, another bubble could recur in a few years. Regulators failed to rein in crypto after the bitcoin bubble burst in 2017. They must not miss their chance this time.