Crypto reckoning looms in Washington as investors lose billions

“Crypto haters, anti-crypto regulatory enthusiasts will use this as a marching signal,” said Anthony Scaramucci, a pro-crypto financier best known for his 10 days as communications director for former President Donald Trump in 2017. “Gary Gensler and Elizabeth Warren have started using it as totems to block, contain, slow down the industry – no doubt they will.”

Crypto lobbyists, executives and prominent investors are warning that this week’s turmoil – which has coincided with steep losses in traditional financial markets – will serve as a wake-up call to Congress about the dangers of a largely unregulated digital asset ecosystem. Wiping out small investors could also force a rigorous investigation of venture capitalists and other financiers behind crypto projects that are now failing.

Much of the initial research will focus on Terraform Labs, the company behind the collapsed algorithmic stablecoin TerraUSD. Terraform, led by CEO Do Kwon, had enticed consumers to buy both its stablecoin and an associated crypto token called Luna by promising skyrocketing returns in exchange for depositing the assets on its crypto lending platform. Stablecoins are a type of crypto token whose value is tied to traditional assets such as the US dollar. With algorithmic tokens like TerraUSD, that link is maintained by a combination of computer code and market incentives.

A week ago, the combined market cap for the two tokens was north of $45 billion. As of Thursday morning they were basically worthless.

“TerraUSD instability is yet another reason why we need to closely regulate stablecoins and other cryptocurrencies,” Senate Banking Chair Sherrod Brown (D-Ohio), a longtime digital asset skeptic, said in a statement. “These products, which are far more complex than they show to consumers, jeopardize Americans’ hard-earned money and have the power to affect the rest of the economy.”

Terraform Labs did not respond to requests for comment.

For now, there’s little chance that the events that overtook Terra and wiped out his investors will pose an immediate threat to the wider financial system, Treasury Secretary Janet Yellen told the House Financial Services Committee on Thursday.

That said, Terraform’s failure has spread to crypto markets where traditional financial institutions have started investing heavily.

Kwon, through an affiliated entity, tried to fend off the run on TerraUSD and Luna by releasing approximately $1.5 billion in Bitcoin and other crypto reserves to buy up Terraform’s flags. tokens and realign the price of its stablecoin. Those efforts have not worked, but the shopping spree has likely depressed Bitcoin prices at a time when prices of the popular digital asset were already under pressure. Bitcoin traded about $28,000 on Thursday night, nearly 60 percent lower than its all-time high in November.

“What we need to worry about right now is the fallout,” said Mike Boroughs, co-founder and head of portfolio management for blockchain investment firm Fortis Digital. Boroughs added that when positions in Terraform’s lending platform are liquidated, it will likely put pressure on other decentralized finance products that private investors and hedge funds have relied on for their returns.

While those losses may be more visible with hedge funds, “I think young investors, whose first investment experience has been in crypto, are really scared of what’s happening next,” said Teunis Brosen, chief economist for digital finance and regulation for Dutch lender ING. . “They react more in panic than a more experienced investor would.”

The harm to private investors could have significant consequences as legislators and regulators assess the harm.

Other stablecoin companies are concerned that policymakers in Washington don’t see the difference between their products and those that led to Terra’s collapse, said Dante Disparte, chief strategy officer and head of global policy for stablecoin startup Circle.

“I don’t think it’s emblematic of the overall market any more than it’s emblematic of all stablecoins,” he said.

The prices of most popular stablecoins are pegged to fiat currencies, often one-to-one with the dollar, and are backed by financial reserves to ensure the markets’ stability. TerraUSD used a different method, relying on an algorithm to keep its price in line with $1 worth of Luna – a strategy that ultimately exposed both products to market disruption.

“This was always exactly the risk scenario for them,” Sam Bankman-Fried, the billionaire founder of global crypto exchange FTX, said in an interview.

Certain legislators, including key Sen. Pat Toomey (R-Pa.) and Rep. Patrick McHenry (RN.C.), have emphasized that Terra’s death spiral has little to do with the business models of reserve-backed tokens like Circle’s USD Coin.

Still, the crash will likely put even more pressure on Congress to pass a law related to those products, which support transactions with other digital currencies like Bitcoin or Ether. Federal officials have warned that so-called traditional stablecoins could pose a systemic risk to financial markets if they continue to grow outside a standardized regulatory framework.

Tether, the most widely used stablecoin by market cap, was knocked short of its $1 peg early Thursday. The company released a statement shortly afterwards saying it was back to “business as usual”.

Tether has been investigated for the adequacy of its reserves and was previously fined by both the Commodity Futures Trading Commission and the New York Attorney General for misrepresenting the way it backed its stablecoin.

Recent events could “stiffen even further the spines of those who act to contain this risk to the financial system,” said Bill Nelson, chief economist at the Bank Policy Institute, a former Federal Reserve official who has repeatedly warned about the risks. that form stablecoins for the markets. The Bank Policy Institute is a trade group representing major traditional banks.

Despite a litany of introductions and proposals for stablecoin accounts, nothing proposed by members of either side would address specifically what happened to Terra. Lawmakers are also widely divided on crypto policy. While Warren has emerged as one of the industry’s biggest critics, in recent months a growing number of Democrats have begun embracing digital currency startups amid massive lobbying.

With Congress a long way from passing crypto legislation — on stablecoins or otherwise — crypto lobbyists and investors who spoke with POLITICO said they expect the industry and its financiers to receive more scrutiny from regulators. Terraform Labs was already under investigation by the SEC over an investment product that reflected the prices of mainstream securities.

As SEC chairman, Gensler has become a top enemy of the crypto industry due to his repeated warnings that the unregulated market is a major risk to investors.

“If I’m Gary Gensler, I’ll attack this. It’s a ‘I told you so’ moment,” said a former regulator who asked for anonymity because of their employment with a crypto venture fund.

The SEC declined to comment.

There is also likely to be a renewed focus on the types of projects supported by blue-chip investment firms.

Terraform’s backers have included major institutional investors and crypto heavyweights such as Mike Novogratz, CEO of Galaxy Digital, a former director of Fortress Investment Group who has a tattoo referring to Terraform’s Luna token. Another Terraform investor is the venture capital arm of Coinbase, the third largest digital asset exchange in the world.

“It’s a black eye,” said Ryan Selkis, a crypto investor and founder and CEO of Messari, an industry data provider. “It’s a storm to weather and, you know, it’s certainly cause for introspection, among the major crypto market participants who were caught with their pants down. Now is a good time to think about the next phase and how we can leverage the gains of the past few years and redeploy them to even lay a foundation for the next cycle.”

Victoria Guida and Bjarke Smith-Meyer contributed to this report.

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