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Top One Magazine

Crypto reckoning looms in Washington as investors lose billions

Crypto markets crashed again. This time, it’s different.

A major downturn in Bitcoin and Ether prices and the flailing death spiral of a popular stablecoin have erased hundreds of billions of dollars from investor portfolios in less than a week.

As crypto executives and retail investors pick through the wreckage, industry leaders fear that the latest blow-up will provide ample fodder for powerful skeptics like Sen. Elizabeth Warren (D-Mass.) and Securities and Exchange Commission Chair Gary Gensler to crack down on an industry that has presented itself as the future of financial services.

“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 former President Donald Trump’s communications director in 2017. “Gary Gensler and Elizabeth Warren are going to use it as totems to block, curtail, slow down the industry – no question that they’re going to do that.”

Crypto lobbyists, executives and prominent investors are warning that this week’s turmoil — which 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. As small investors are wiped out, it could also force a harsh examination of venture capitalists and other financiers behind crypto projects that are now failing.

Much of the initial scrutiny will be directed at Terraform Labs, the company behind the collapsed algorithmic stablecoin TerraUSD. Terraform, led by CEO Do Kwon, had enticed consumers to purchase both its stablecoin and an accompanying crypto token, called Luna, by promising sky-high yields in exchange for depositing the assets in its crypto lending platform. Stablecoins are a type of crypto token whose value is pegged to traditional assets like the U.S. dollar. With algorithmic tokens like TerraUSD, that peg is maintained through a combination of computer code and market incentives.

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

“TerraUSD’s instability is yet another reason we must closely regulate stablecoins and other cryptocurrencies,” Senate Banking Chair Sherrod Brown (D-Ohio), a longtime skeptic of digital assets, said in a statement. “These products, which are far more complex than they let on to consumers, put Americans’ hard-earned money at risk and have the power to impact 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 its investors will pose any immediate danger to the broader financial system, Treasury Secretary Janet Yellen told the House Financial Services Committee on Thursday.

With that said, Terraform’s failure has rippled through crypto markets where traditional financial institutions have started to invest heavily.

Kwon, through an affiliated entity, sought to fend off the run on TerraUSD and Luna by releasing roughly $1.5 billion of Bitcoin and other crypto reserves to buy up Terraform’s flagging tokens and bring the price of its stablecoin back into alignment. Those efforts didn’t work, but the buying spree likely depressed Bitcoin prices at a time when prices of the popular digital asset were already under pressure. Bitcoin traded around $28,000 Thursday evening, down nearly 60 percent from the all-time high it hit in November.

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

While those losses might be more visible at hedge funds, “I think young investors, whose first investing experience has been in crypto, are really scared about what’s happening now,” said Teunis Brosen, head economist for digital finance and regulation for the Dutch lender ING. “They are reacting more in a panic than a more experienced investor might do.”

The damage to retail investors could have a significant bearing as lawmakers and regulators assess the damage.

There’s concern among other stablecoin companies that Washington policymakers might not 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 the stablecoin startup Circle.

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

Prices of most popular stablecoins are pegged to fiat currencies, often on a one-to-one basis with the dollar, and backed by financial reserves that are supposed to assure markets of their stability. TerraUSD used a different method, relying on an algorithm that was supposed to keep its price in lockstep with $1 worth of Luna — a strategy that ultimately left both products exposed to market disruption.

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

Certain lawmakers, chief among them Sen. Pat Toomey (R-Pa.) and Rep. Patrick McHenry (R-N.C.), have stressed that Terra’s death spiral has little to do with the business models of reserve-backed tokens like Circle’s USD Coin.

Even so, the crash will likely put even more pressure on Congress to pass a law addressing those products, which underpin transactions involving 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 briefly knocked off its $1 peg early Thursday. The company put out a statement shortly thereafter saying it was back to “business as usual.”

Tether has been scrutinized for the adequacy of its reserves and was previously fined by both the Commodity Futures Trading Commission and New York’s attorney general for misstating how it supported its stablecoin.

Recent events might “further stiffen the spine of those who are acting to contain this risk to the financial system,” said Bank Policy Institute chief economist Bill Nelson, a former Federal Reserve official who has repeatedly warned of the risks stablecoins pose to markets. The Bank Policy Institute is a trade group that represents large traditional banks.

Despite a litany of stablecoin bill introductions and proposals, nothing proposed by members of either party would specifically address what occurred with Terra. Lawmakers are also split on crypto policy broadly. While Warren has emerged as one of the industry’s biggest critics, a growing number of Democrats in recent months have started to embrace digital currency startups amid a major lobbying push.

With Congress nowhere close to passing crypto legislation — on stablecoins or otherwise — crypto lobbyists and investors who spoke to POLITICO said they expect the industry and its backers to face greater scrutiny from regulators. Terraform Labs was already under investigation from the SEC over an investment product that mirrored the prices of regular securities.

As SEC chair, Gensler has become a top foe of the crypto industry because of his repeated warnings that the unregulated market is a big risk to investors.

“If I’m Gary Gensler, I’m pouncing on this. It’s an ‘I told you so’ moment,” said one former regulator who requested anonymity due to their employment at a crypto venture fund.

The SEC declined to comment.

There will also likely be renewed focus on the types of projects that receive support from blue-chip investment firms.

Terraform’s backers included major institutional investors and crypto heavyweights like Galaxy Digital CEO Mike Novogratz — a former Fortress Investment Group executive who has a tattoo referencing 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 industry data provider Messari. “It’s a storm to weather and, you know, it’s certainly cause for introspection, amongst the major crypto market participants that were caught with their pants down. Now is a good time to think about the next phase, and how we take the gains from the last few years and redeploy them into even building a foundation for the next cycle.”

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

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