If you were to ask the average person on the street, or anyone from the traditional financial system, they would most likely say ban crypto. Some politicians have also expressed that they believe crypto should be banned.
Many of these people know little about cryptocurrencies. They make their decisions based on pre-existing bias or ignorance. Many people also form opinions about crypto based on what they hear from the mainstream media. Instead of taking the time to educate themselves, they turn to the media for a quick fix.
What you’re hearing from mainstream media lately, especially in 2022, is stories of crypto failure after crypto failure. You hear the usual talking points about crypto being used for money laundering, supporting terrorism, and as a means for rogue states to evade sanctions.
You also hear stories about crypto scams or exchange clients losing huge sums of money when exchanges go under. To be fair, these cases happen in the crypto sector, which has endured crisis after crisis in 2022. However, there is more to crypto than these scenarios.
The macro cryptocurrency environment
To say that 2022 was not a good year for the cryptocurrency sector would be an understatement. But the crypto sector is not alone; Many markets are suffering from macroeconomic events including the Russia-Ukraine war and rampant price inflation.
In the summer, the inflation rate reached its highest level in over 40 years. To combat this problem, central banks around the world have raised interest rates. These actions have caused the US dollar to hit its highest level in 20 years. Rate hikes have also pushed bond yields higher, leading to the biggest fall in stock markets since the COVID-19 crash of 2020.
The crypto sector has also been hit hard, with Bitcoin down over 75% since the November 2021 peak. Overall, the crypto sector has lost $2.2 trillion in value. Crypto bear markets are nothing new, but this year’s high-profile failures have added to the already negative sentiment.
The crypto sector in crisis: Prelude to a US crypto ban?
Looking back on 2022’s string of failures and renewed scrutiny by regulators and Congress, this year could be the crypto equivalent of the 2008 financial crisis. In the past seven months, one high-profile failure has occurred after another.
This crisis has also shown how interconnected the crypto sector has become. With such relationships, it only took a domino to fall to trigger what is arguably the worst crisis the crypto sector has faced. It is not yet known whether the worst has already happened or is yet to come.
The first high-profile failure was the collapse of Terra Luna in May 2022, when its UST stablecoin and LUNA token fell to near zero. The chart above shows the magnitude and speed at which the LUNA token collapsed.
The Terra blockchain and its UST stablecoin have been two of crypto’s top 10 assets, adding to the enormity of this failure. What led to this failure is complicated and would take too long in this article. If you want to know more, you can click on this link.
The shockwaves of this debacle were felt throughout the crypto sector. With many companies in the crypto sector already spiraling, it wasn’t long before the Terra contagion killed its first victim. In early June, Celsius froze its users’ funds and eventually filed for Chapter 11 bankruptcy. But that was just the beginning as the Terra Contagion was just beginning.
The collapse of multi-billion dollar crypto fund Three Arrows Capital (3AC) was the next domino to fall. What ultimately killed Three Arrow Capital were heavy losses incurred by the collapse of the Terra blockchain.
Next came the collapse of crypto exchange Voyager Digital, which froze customer accounts in July 2022. As it turned out, Three Arrows Capital had defaulted on a hundreds of millions of dollars in loan from Voyager Digital.
Fast forward to early November when a balance sheet from Alameda Research was leaked and Coindesk reported that much of its reserves were based on the FTT token. The FTT token is the native token of the FTX exchange. The report also highlighted potential solvency and leverage concerns related to Alameda Research. Alameda Research was led by the trading firm of FTX CEO Sam Bankman-Fried.
To make a long story short, the collapse of FTX happened over 10 days starting on November 2nd. FTX filed for Chapter 11 bankruptcy protection on November 11, 2022. The failure also brought down Alameda Research and FTX.US, which were believed to be fully isolated from FTX.
FTX CEO Sam Bankman-Fried was arrested on December 12, 2022 on federal charges of wire fraud, conspiracy and other charges. Click this link for more information on the FTX debacle.
It is not yet known if there will be more casualties as a result of these outages. One thing is clear, untold numbers of customers have lost enormous sums of money that they may never see again. If they can salvage anything from the bankruptcy proceedings, it will most likely be pennies on the dollar.
A lesson from this experience is not to store crypto on a centralized exchange. When you engage in lending, staking, or yield farming, you must take the risk of losing everything.
Will the US Ban Crypto?
What’s the argument for US banning crypto? The main argument for making crypto illegal seems to be to protect investors from losing money.
The collapse of FTX, FTX.US and Alameda Research, the most high profile bankruptcies of 2022, has caught the attention of the US Congress as it has caused financial damage to over 1 million clients. This loss has led to several congressional hearings, and more hearings will follow.
Some members of Congress have expressed the belief that crypto should be banned for several reasons, including protecting investors. If the goal is to protect US citizens from losing money, which at first sounds very noble, why are people allowed to lose vast sums of money in so many other ways?
Here are a few examples:
- Legalized Gambling: A report by the National Council on Problem Gaming shows that 2 million US citizens suffer from serious gambling addictions. Another 4 to 6 million have mild or moderate problems.
- Lotteries: US citizens spent nearly $29 billion on lotteries in 2019.
- day trading: A US Securities and Exchange Commission (SEC) study of forex traders found that 70% lose money every quarter and typically lose 100% of their money within 12 months.
A total crypto ban is unlikely. One reason this is dubious is due to the massive amount of institutional investment that has poured into the crypto sector in recent years. Also, a US ban on crypto would cause tech innovations to flee to friendlier jurisdictions. Such a ruling would be costly for the US, as the brightest minds wanting to work on this technology would relocate to other countries.
Also, a U.S. crypto ban would ultimately do more harm than good to investors, as it would remove an opportunity to further diversify investor portfolios. Due to the volatility, most investors should avoid holding a large portion of their investment portfolio in cryptocurrencies. But having an age-appropriate proportion of crypto in a portfolio isn’t irresponsible.
Is more regulation the answer?
Yes, rather than a ban, the focus should be on developing sensible regulations for centralized exchanges. They should be required to be audited by an external firm to prove their solvency. They should also be required to provide evidence that client funds are segregated from company funds.
How cryptocurrencies are defined and categorized needs to be clarified. Whether a cryptocurrency is classified as a security or a commodity determines whether it is regulated by the SEC or the Commodity Futures Trading Commission (CFTC). Regulations vary for each classification, and regulatory confusion will continue until clear guidelines are issued.
Educating the public should also be a priority. Educating investors about the dangers of storing their crypto on exchanges could have eliminated some losses.
The current state of the crypto market
It has been said that you know when a crypto bear market is nearing its end when investor sentiment is as low as it can be. One could argue that the crypto market is nearing that point. With all the failures and turbulence this year, investor sentiment for this bear market is likely at a low ebb.
The news is filled with the same old stories that surround every bear market. Here are common expressions of doubt:
- Is Crypto Dead?
- Can Crypto Survive?
- Crypto is a scam!
- Crypto is a Ponzi Scheme!
- All crypto is used for is drugs and money laundering!
- Crypto has no value!
No one knows at what price or when Bitcoin will bottom, but if historical patterns continue, the bottom could be near. With the exception of the 2011 bull market top, all other tops and bottoms occurred in November, December and January.
This chart illustrates how much value has fallen since the November peak. Over $2.2 trillion has evaporated from the crypto sector, but the percentage loss is still lower than during the 2018 bear market.
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Is Crypto Coming Back in 2023?
Hopefully, everything the crypto sector has endured will result in a more resilient asset class. It will take time to restore investor confidence over the next year or so, but 2023 could be a year of recovery.
frequently asked Questions
Q
Can the US government shut down crypto?
A
Due to Bitcoin’s decentralized nature, a government cannot shut down the network. However, governments have attempted to ban or restrict its use by their citizens.
Q
What would happen if the US government banned bitcoin?
A
If bitcoin were banned, the price of bitcoin would drop significantly. How low it would fall would depend on how bitcoin buyers around the world react. A significant drop in the US stock market could also occur if Bitcoin-related publicly traded companies collapse.
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