Following crypto’s disastrous 2022, American regulators have kicked off the new year by going on offense — a flurry of enforcement activity at the state and federal level that has intensified in recent days, raising questions about the long-term viability of the industry in its current form. This morning, the New York Department of Financial Services announced it had ordered Paxos, the issuer of the world’s third-largest stablecoin, Binance USD, to stop minting new units of the crypto token. The Securities and Exchange Commission has also told Paxos it intends to sue the firm over Binance USD, according to the Wall Street Journal, alleging that the token is an unregistered security Last week, the target was crypto exchange Kraken: On Thursday, it settled a $30 million over its provision of “staking” services that help customers earn a form of interest on deposited tokens. And on the same day, the IRS filed a petition to enforce an unanswered 2021 summons seeking information on Kraken customers to determine their tax liabilities. The Justice Department, meanwhile, is expanding its criminal crypto inquiries, according to a Bloomberg report earlier this month detailing a fraud probe of the crypto-friendly bank Silvergate Capital over its dealings with FTX. And the Federal Reserve is pushing back, too, rejecting crypto-friendly Custodia Bank’s application for a master account late last month. No evidence has emerged that the crackdown is being centrally coordinated. But to industry insiders that take an especially suspicious and antagonistic view towards regulators, the flurry of enforcement actions looks like one big wave, and they’re dubbing it “Operation Choke Point 2.0.” That’s a reference to an Obama administration initiative to choke off the financial system access of industries it deemed exploitative or otherwise undesirable, such as payday lenders and gun sellers. (POLITICO’s Morning Money points out that, unlike the current crackdown, the Obama era program played out covertly.) One of Washington's top watchdogs on crypto, SEC chairman Gary Gensler, suggested on Friday that the stakes for crypto finance were existential: “If this field has any chance of survival and success,” he told CNBC, “it’s time-tested rules and laws to protect the investing public” He also warned crypto firms were running out of time to proactively comply with the commission’s view of securities law by registering their products, such as staking services and stablecoins, as securities products with the agency. “The runway,” he said, “is getting awfully short.” It's clear that crypto firms can no longer treat regulators as a nuisance to be avoided, much as they like to see themselves as a counterpoint to the establishment. But they also make an argument that would be familiar to a lot of legacy industries: That an overweening regulator (in this case, the SEC) is taking an overly broad view of its mission — and that the real problem is that Washington needs to pass new rules to account for innovations that weren't anticipated when existing laws were drafted. In the absence of those rules, they're bracing for regulatory moves week to week, almost ad hoc. So where could things go from here? Industry participants and observers see a few possibilities: Exodus. One DeFi developer at an early-stage startup I spoke to over the weekend shrugged at the crackdown, saying that though his small team was based in San Francisco and New York, it would simply offer its product abroad while restricting U.S. users. For regulatory reasons, many decentralized finance products are already only available outside the U.S. So, the industry could thrive abroad even if it shrivels here. (Though Americans sometimes find ways to access such products anyway.) Similarly, the hobbling of crypto firms could prompt more users to switch to DeFi services that run on decentralized software without the need for a centralized service provider. Replacement. On Friday, Gensler reiterated his position that the SEC has nothing against blockchain technology itself. The battering of crypto-native finance could give slower-moving financial incumbents an opening to pull ahead with their own forays into blockchain, a path that would integrate technological upgrades into the existing financial order with less disruption. The current crackdown on dollar-pegged stablecoins, meanwhile, could clear the way for the Federal Reserve to issue its own digital dollar. Already, scrutiny from the New York’s Department of Financial Services has prompted PayPal to pause the impending release of its stablecoin, according to a Friday report in Bloomberg. In that case, much of the financial and technological innovation associated with crypto could survive, even as many of the firms that pioneered them get crowded out. Congress Ex Machina. The industry has invested heavily in lobbying and political giving in pursuit of new laws that would supersede regulators’ interpretations of the ones already on the books. Could Congress call off the executive branch? Lobbyist Alexander Grieve of Tiger Hill Partners said he expects regulatory proposals from the GOP-controlled House in the second quarter of this year. But Grieve conceded that given the growing distrust of crypto in the wake of the FTX collapse, industry-friendly measures will have a hard time making it through the Democratic-controlled Senate, limiting the near-term prospects for legislative relief. Grieve cast the industry’s setbacks as a catalyst for legislation that will better serve both the industry and consumers. “Any substantive legislation that materializes will be much more rigorously thought-through than that of a year or even six months ago,” he said. “Opposition forces you to really hone messaging and legal arguments.” Rapprochement. Finally, crypto upstarts and their regulators could come together, find common ground and sing kumbaya. Then again, this is how Kraken’s CEO Jesse Powell responded to Gensler’s explanation of last week’s settlement: “Oh man, all I had to do was fill out a form on a website and tell people that staking rewards come from staking? Wish I'd seen this video before paying a $30m fine and agreeing to permanently shut down the service in the US. How dumb do I look. Gosh.” So, that’s looking unlikelier even than the rise of magic internet money.
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