Everything you need to know about the US crackdown on crypto

The time of crypto regulations is upon us. It may come as no surprise that regulators are putting their foot down after the disastrous year of 2022. Regulations for the industry were already in the works, but the fact that millions of retail investors lost money due to activity that could’ve been prevented has put these efforts into full gear.

Over the past 2 months, we’ve seen various important enforcement actions by the US regulators. It has become clear that the US is going to crackdown hard on the industry this year and in this article, we’re giving you a full rundown of everything that has happened until now.

The US is on the offense against crypto

2022 was arguably the worst year in crypto history. When the US central banks (FED) started to raise interests rates, the tide starting turning for risk assets and as they say “when the tide goes out, you’ll see who’s swimming naked”.

For the crypto industry, the tide went out like an inverse Tsunami and it became clear many, many parties were swimming naked. Terra Luna and their algorithmic stablecoin UST, Three Arrows Capital, Celsius, BlockFi, FTX and Alameda and now Silvergate all collapsed in a series of unfortunate (and oftentimes fraudulent) events.

A lot of this could’ve been prevented with adequate regulations in place. Hence, it may come as no surprise that following 2022, these are being rolled out at a high pace. What is a surprise is the speed, aggression and sometimes even questionable focus of US regulator’s actions. Where they let the biggest frauds happen right under their noses, they are now coming after law-abiding crypto companies.

Enforcement has begun

At the start of January, it became clear that US regulators were going to clampdown hard on the crypto industry. On January third, the US Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Controller of the Currency (OCC) issued a joint statement on crypto-asset risks to banking organizations. In it, they claim crypto is a serious threat to the traditional financial system and gave a strong indication of what’s to come.

An important name in the story of the US crackdown is Gary Gensler. Gensler is the head of the US’ Securities and Exchange Commission (SEC). In a recent interview, he reiterated his long term stance that “all crypto tokens except Bitcoin are securities” and has also recently expressed his impatience with the industry for not following the SEC’s regulations. The SEC has also significantly grown the headcount at its crypto unit over the past months.

What’s important to note is that on the other hand, legitimate players in the industry have been begging for regulatory guidelines for years but so far, the SEC has refused to help. Now, it’s becoming clear that they will not provide guidelines but instead will regulate via enforcement.

Kraken’s settlement

On Thursday February 9th, news came out that the US-based exchange Kraken settled with the SEC for a $30 million fine and would discontinue its staking services for US residents. The argument here was that the staking services were in fact the offer of unregistered securities, which fall under the jurisdiction of the SEC.

As staking your crypto does offer a passive income, the SEC’s enforcement was not that surprising. By paying the fine, Kraken neither admitted nor denied the allegations, but it’s late CEO did not seem happy with how the regulators handled the situation and how little guidance they have provided.

Paxos and BUSD

On February 13th, it was reported that stablecoin issuer Paxos received a Well Notice 10 days earlier indicating that the SEC was planning to sue Paxos over the issuance of Binance’s BUSD stablecoin. The SEC claims that BUSD was in fact an unregistered security, which is odd given that a stablecoin is pegged to the dollar and hence does not provide passive returns nor a potential for future return on investment. What did came to light was BUSD might not have been backed 1:1 by real US Dollars at all times, which is definitely a problem as investors trust it is.

In response the to Wells Notice, Paxos announced to stop issuing BUSD and gave BUSD holders 12 months to redeem the stablecoin for bank-based Dollars. In an official statement, the company did say that it “categorically disagrees” with BUSD being a security. Jesse Austin Campbell, a former Paxos executive, stated that “probably, the greatest mistake you could have made is to be an onshore, regulated company in the crypto space. You are the ones constantly getting punished, fined and harassed even though you’re not the ones who lost user money,”

This action might set a dangerous precedent for stablecoins in general if the intention is to label them all as securities. The SEC has explicitly stated that everything but Bitcoin is a security, which might be a hint at stablecoins too. In the wake of the BUSD charges, the stablecoin lost about 50% of its total market capitalization.

New custodian regulations

On February 15th, the SEC proposed a new rule that would require crypto exchanges to either become an officially licensed custodian or hold customer’s assets with a party that is licensed. Reason for this was the SEC’s concern about crypto firm’s custody practices.

In light of recent events, it has become clear that several crypto firms did not segregate their own funds from customers’ funds, leading to a loss of assets in case of bankruptcy or other insolvency. This new rule would enhance the protection of client’s funds. While this seems like a positive development for crypto investors, a much more ominous theory spells that this might be a death sentence for the industry as we know it…

Chocking the industry: No more banks for crypto

In a recent essay, Nick Carter lays out his theory of what he calls “operation chokepoint 2.0”. It spells that the US government is trying to crackdown on crypto through the banking sector, by applying pressure to banks to avoid providing financial services to crypto companies. This is very much in line with the January 3rd joint statement by financial regulators discussed earlier.

As the title of the essay indicates, this has happened before with other industries. In 2013, during the Obama administration, the original operation Chokepoint sought to cut off legal but unwanted industries such as online poker, firearms and adults entertainment from the banking sector. This has been incredibly effective at marginalizing these industries. Another example of the effectiveness of such an operation is how Russia got cut off from the global financial system in 2022.

Operation Chokepoint 2.0 posits that US regulators are now trying to do the same to the crypto industry by making crypto so unattractive to do business with for banks that they stop providing services. The risks and costs for most banks are simply not worth it. For crypto firms, obtaining access to the onshore banking system has always been a challenge, but there were some positive developments until recently.

If Chokepoint 2.0 is actually true, the crypto industry would be cut off from dealing with fiat, making it impossible to send fiat to and from crypto service providers and hence onboard new customers or even paying employees. While a terrifying idea, veteran crypto lawyer Jake Chervinsky puts some nuance to the discussion.

More headwinds to come, but no complete ban

The biggest fear of regulators is that the crypto market’s turmoil and volatility starts spilling over to the traditional industry and want to make sure this can never happen. Given crypto’s infancy and risky nature, this is a sensible fear. However, even though the industry lost about $2 trillion is value in 2022, no traditional financial institutions were affected and both crypto supporters and skeptics agree that last year’s market turmoil didn’t affect the traditional financial system. The recent panic at crypto bank Silvergate could be the confirmation the regulators have been looking for that in fact, this can actually happen.

Rumours are running amok that the SEC is far from done. Many US-based crypto organizations may have gotten a Well Notice that they’re in violation of securities regulations. Crypto executives are concerned that the industry might become completely unbanked as banks do not want to deal with industry anymore.

While a complete ban does seem unlikely according to industry insiders, SEC actions are now everyone’s worry. The SEC’s recent actions could’ve been much worse if they had come out and outrightly enforced that everything but Bitcoin is a security, but the year has just gotten started. For now, it does seem as if the SEC is focusing on specific companies. The US still is a democracy and there are regulations in place for the SEC itself. With roughly 20% of Americans owning crypto and an increasing number of politicians (especially Republicans) supporting the industry, an outright ban or too severe could face a backlash.

The coming month and years will be a regulatory battle between the crypto industry and the US financial regulators. While this introduces massive uncertainty for US-based projects and investors, it will also help clean up and legitimize the industry.

One notable observation here is that Bitcoin seems to be out of the crosshairs and might actually benefit from all this. On the flipside, US-based projects might be at massive risk for the moment. Luckily, crypto is a truly worldwide phenomenon and there are many jurisdictions that are not following suit but are instead started to embrace this young and promising industry.

Over the coming period, we’ll be keeping you up to date on the latest developments in the US’s crackdown on crypto and all its implications! If you want to stay in the loop in the easiest way, subscribe to our mailing list here.