This Week in Policy (6/22)

This Week in Policy (6/22)

Bonjour les passionnés de fintech… No hints, especially since croissants are having an identity crisis.

First of all, check out last week’s article in case you missed it. It covered the Lummis-Gillibrand crypto bill—the most substantial and comprehensive crypto legislation in the U.S. to date.

The crypto winter has officially come, with ramifications throughout the crypto ecosystem. On June 13, the major crypto lending platform, Celsius, announced on its website that it has frozen withdrawals and transfers between accounts "to stabilise liquidity and operations” while taking steps “to preserve and protect assets." With this announcement, 1.7 million customers were left unable to redeem their assets. Celsius had promised its customers annual earnings up to 18.6% APY paid weekly. Over last year, however, customers saw the value of Celsius's token fall by about 80%. The U.S. Securities and Exchange Commission and Securities regulators in Alabama, Texas, New Jersey, and Kentucky have initiated communications with Celsius, perhaps in anticipation of a formal investigation.

Can you see the pattern that has swung us into this crypto winter vortex? It starts with a booming economy, with low inflation and interest rates, and investors aggressively searching for yield. Assets like Celsius's token become very popular given the very high yield they offer investors. So, investors race to buy them, driving their prices up, creating a bubble, and…boom! The macroeconomic conditions suddenly change: inflation becomes too high; the central bank (the Federal Reserve) intervenes to raise interest rates; investors ditch riskier assets across financial markets; the price of Celsius's token and the likes collapses; investors run to redeem their crypto assets in USD in a fashion that is no different than a conventional bank run; entities like Celsius announce freezing of withdrawals in order to avoid a liquidity crisis (because they cannot pay back all depositors at the same time); investors endure big losses, depending, of course, on the terms of the deposit agreement; and contagion throughout the financial system, which begins with the struggling entity and the entities connected to it, becomes more likely. Nightmarish, no? The bad news is that we should expect more of these runs in the near future, and the best we could hope for is to avoid a large-scale contagion.

Questions to consider: What are crypto-lending platforms? Here’s an answer. Should they be considered part of the shadow banking system? How can we remedy runs on cryptocurrencies? And can we avoid runs in the first place? Perhaps it would be worthwhile to investigate some of these questions in future articles.

Absent a comprehensive regulatory solution to the downward spiral described above, investors seek to recover their deposits ex post through legal proceedings (which are expected to increase sharply in the coming months). Lawsuits are being filed not only against crypto-lending platforms but also cryptocurrency issuers, as exemplified by the class action that was filed yesterday by investors in UST-Luna against Do Kwon, the CEO and founder of TerraForm Labs, among others. The plaintiff cites the defendants’ violations of “the provisions of the California Common Law by possessing the monetary value of Terra tokens at an inflated value which rightfully belongs to the Plaintiff and members of the Class.”

In general, how optimistic are you about investors’ recovering their investments through legal proceedings?

In different news, last week, the Internal Revenue Service (IRS) announced ‘Operation Hidden Treasure’ to clamp down on crypto tax evaders who omit their crypto gains on tax returns. The IRS put together a task force of experts in tracking crypto income and has tied together the civil and criminal departments of the IRS for Crypto Tax Fraud Enforcement. The main objective of the new operation is to address the novel techniques of crypto tax evasion, such as carrying out frequent transactions below the reporting threshold of $10,000 or trading in digital assets without revealing one’s own identity. So, watch out evaders, the IRS is coming after you!

What else would you like to see the IRS do to combat crypto tax evasion?

I welcome all your thoughts and opinions in the comments section.

See you next week!