Crypto: To stem the tide

Judith Arnal

5 mins - 16 de Febrero de 2023, 07:05

The year 2022 (and the beginning of 2023) is proving to be particularly turbulent for the world of cryptocurrencies. After reaching a trading peak of $3 trillion in 2021, the market value of cryptocurrencies plummeted to $1 trillion. 

Behind this turbulence is a succession of incidents, for which many experts have pointed out that the new EU regulation, popularly known as MiCA and due to come into force in 2024, would have provided a solution. Therefore, it is worth reviewing what has happened in the crypto world in recent months, in order to determine whether or not MiCA would indeed be the answer.

It is necessary to be clear that cryptocurrencies and all their associated services generate two types of risk: technological and financial. The MiCA regulation focuses primarily on financial risks, therefore, the materialisation of many technological risks would have remained uncovered even when it were to have been in force.

During 2022, technological risks materialised on several occasions, affecting various players in the crypto world. Firstly, several blockchain bridges, which are necessary for communication between the different chains, were attacked by hackers. Thus, attacks on Ronin Bridge, BNB, Wormhole and Nomad caused losses of $2 billion. Secondly, the Slope wallet was also hacked, resulting in losses of $8 million for some 10,000 customers. Finally, exchange platforms did not remain safe from these incursions, with hacks recorded at Bitmart, Ascendex and Coinbase.

If the materialisation of technological risks has sown uncertainty in the crypto world, financial risks have not lagged behind.
Let us start with the bankruptcy of TerraUSD (UST), classified as a ‘stablecoin’ because it guarantees the stability of its value at a certain level. Stablecoins can guarantee their value through various systems, mainly through the backing of fiat currency or other cryptocurrencies, or algorithmically. UST was an algorithmic stablecoin, which aimed to maintain its value stable at $1 through interaction with another crypto, Luna. Although, in May 2022, UST’s value decoupled from the dollar, triggering a massive sell-off and plummeting its value to $0.20. 

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With the collapse of UST and Luna, the private equity fund specialised in crypto investments, Three Arrows Capital, had to declare bankruptcy in May 2022, given its high exposure to the misnamed stablecoin. Far from being confined to this area, the financial earthquake also hit the financial firm Voyager Digital, which in July 2022 had to declare bankruptcy when it was unable to recover the loan of more than $600 million it had made to Three Arrows Capital. Celsius was also another victim of the UST and Luna reverberations, declaring bankruptcy in July 2022. 

Just when things looked like they were starting to calm down, along came the mother of all bankruptcies, labelled by some as the Lehman Brothers of crypto: the exchange platform, FTX, one of the largest in the world. In November 2022, the misuse of funds deposited by customers on FTX, the absence of minimum financial control standards, as well as FTX’s financial entanglement with its trading arm, Alameda Research, were uncovered. Rival exchange Binance, tried to come to FTX’s rescue, but after conducting due diligence, it rethought its decision. To get an idea of the importance of FTX, one only has to look at the list of some of its creditors, which include companies such as Apple, Netflix, Twitter, Meta, LinkedIn and Amazon. FTX’s bankruptcy has dragged in the financial company BlockFi, which FTX had to rescue from the fallout generated by UST and Luna. And as we enter 2023, the latest crypto incident has occurred: the financial company Genesis likewise has declared bankruptcy.

The European Union is at the forefront in the regulation of crypto and all its associated services. It is no coincidence that MiCA will enter into force in 2024. It is true that MiCA could have prevented or mitigated many of the financial risks that have materialised in recent months: from requiring adequate reserves for USTs and Luna, to imposing significant transparency and governance requirements on exchange platforms such as FTX or financial firms such as Three Arrows Capital. 

However, there are three major drawbacks to all of this, in addition to its failure to protect financial users from many technological risks. First, MiCA does not apply to many of the increasingly important ‘Non-Fungible Tokens’. Second, the investor protection provided by MiCA is not at the same level as for financial assets: there is no investor guarantee fund, the supervision of price manipulations is much laxer as there is no transaction reporting to the supervisor, and the custody requirements are also much less burdensome. In other words, when MiCA is in force, cryptocurrencies and their services will become regulated products but with less protection mechanisms in place than financial assets. Third, the MiCA regulation will not prevent a crypto-asset service provider established in a third country that does not comply with MiCA requirements from providing services to an EU citizen who so requests. 

In other words, as ECB President Christine Lagarde has already called for, it is necessary to start thinking about MiCA 2.0. It is also important that financial supervisors continue to warn investors, especially retail investors, of the risks of investing in crypto-assets. And above all, a comprehensive approach to cryptocurrency regulation is imperative. Otherwise, any effort, while producing certain positive effects, will be nothing more than an attempt to stem the tide of a rising ocean.

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