New York (CNN) When FTX collapsed in November, it was a seismic event for the crypto industry. Many called it the “Lehman moment”.
The comparison is broadly accurate: an industry giant collapsed, the contagion spread, and regulators who had previously acted hesitantly suddenly had a clearer purpose and a wave of public outrage to bolster their cause.
And now we could officially enter the Dodd Frank era of cryptography. (Dodd-Frank, of course, is the 2010 legislation that 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 struggle with a regulatory infrastructure ill-equipped to deal with it and are largely wary of its fundamental direction as the future of finance.
In the three months since FTX filed for bankruptcy, State and federal regulators have escalated both their rhetoric and actions to keep the fast-growing digital asset industry in check — a shift that, unsurprisingly, hasn’t gone down well with crypto companies.
On Tuesday, the Senate Committee on Banking, Housing and Urban Development held a hearing poignantly titled “Crypto Crash: Why Financial Safeguards are Needed for Digital Assets.”
“While the crypto contagion did not infect the broader financial system, we saw glimpses of the damage it could have done had crypto migrated into the banking system,” said committee chair Sen. Sherrod Brown in his opening statement. “These crypto disasters have exposed what many of us already knew: digital assets — cryptocurrencies, stablecoins, and investment tokens — are speculative products run by ruthless corporations that are putting 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 halt issuance of BUSD, also known as 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 hedge with US dollars or another fiat currency. Investors typically buy them to store money and facilitate trades within the cryptocurrency infrastructure, making them a bedrock of the crypto ecosystem.
The New York Treasury Department did not immediately respond to CNN’s request for comment. Paxos informed customers that they can redeem their BUSD until February 2024, with the option to redeem funds in US dollars or convert their tokens into 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 federal securities laws.” The company said it will “commute” with the SEC on the matter and is prepared to “proceed vigorously if necessary.” The company declined to comment beyond what it said.
The BUSD News clearly has worried investors. Binance, which has partnered with Paxos to launch the stablecoin in 2019, on Monday had one of its worst days in terms of withdrawals, with net outflows of $873 million, according to data provider Nansen.
Enforcement will be strengthened
The crackdown on BUSD and Paxos is just the latest example of regulatory muscle flexing in recent months – actions that do are sowing confusion and frustration among crypto advocates, many of whom have been seeking regulatory clarity for years.
“Regulation through enforcement is confusing 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 legally offer a product while not getting guidance.”
In recent weeks, the SEC has relied 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 company to end its “staking” practice, which allows investors to earn passive income from their crypto holdings .
The settlement immediately raised questions about other exchanges offering staking, which crypto advocates say is vital to supporting the healthy functioning 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 associated with the crypto-asset sector that cannot be mitigated or controlled do not migrate into the banking system,” they said in a statement — the first-ever joint statement on crypto by 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 coverage.