Notes 3/10: Regulation Arbitrage, Silvergate Failure, and Bitcoin Price

Much of the bad news in crypto this past month has been about regulatory action. And so, a Senate hearing was held yesterday to discuss the “coordinated” attack on cryptocurrencies by government agencies. While it provided a forum for the community to air their grievances, the hearing did not offer solutions or a way forward.

Events in crypto in the last year are more than enough proof that it needs a reset. Whether it is stablecoins that fail to hold their peg and implode or lending firms that pour customer funds into risky assets, crypto is treading the same path, and making the same mistakes, as Wall Street. Unlike the mainstream system, however, there are no central banks to bail out failing firms or regulators to corral the chaos into order.

A consequence of this might be the defection of crypto firms to foreign shores that offer greater clarity for crypto regulation. Or so they say.

An Expensive Business

The loss of an edge in innovation is an oft-repeated argument for crypto regulation. Will regulatory clarity make it easier to do business in the sector?

The answer to that question is complicated. The clunky and hack-prone systems designed by crypto startups are hardly the sort of systems that will be able to execute trader strategies at Wall Street.

It is also neither easy nor advisable to dismantle legacy financial infrastructure in the United States. The systems underpinning Wall Street may be slow and intermediated, but the amount of capital locked in them will have serious consequences to disruption. It will have reverberations around the globe.

A move to other jurisdictions is also expensive for startups. The volatile price movements of cryptocurrencies have already set a high cost to doing business in the sector. It will be costly to run a crypto startup after regulations are put in place. Innovation is undergirded by thrift not expense. Significant capital will be required to enable the sort of world-changing innovation that is possible in other sectors.

Even abroad, where governments are working towards regulation instead of discussing its possibility, regulatory requirements act as steep hurdles to new crypto businesses. For example, the European Union’s MiCA regulation plans to have different reserve requirements for stablecoins as compared to those for its banks and other financial services institutions.

Silvergate’s Demise: Banking Crisis or Crypto Crisis?

Silvergate’s voluntary liquidation yesterday gave more ammunition to crypto critics. But Silicon Valley Bank’s closure today has disarmed them, somewhat. There are, of course, several common strands between the two bank failures.

One was their decision to make unwise investments with client deposits.

Another is their exposure to customers who might have, otherwise, had problems finding banking services. Startups comprised a major chunk of Silicon Valley Bank customers. The state of their finances is dependent on regulation and economic cycles.

A Limited Lesson

Do these bank failures have lessons for students and finance professionals? It is unlikely. They are ordinary bank failures caused due to bad debt and exposure to a specific type of customer. They will not result in far-reaching changes in the industry.

The economic impact of these failures is also limited. The Federal Deposit Insurance Corporation (FDIC) has already stepped in to protect account holders with Silicon Valley Bank. While it is being reported that Silvergate is in talks with FDIC, it has not entered the agency’s receivership program. [And, perhaps, may not since it claimed to have adequate funds on hand to make customers whole].

If anything, the two crises have reduced the diversity of options available to startups and crypto firms and pushed them into the fold of established banking firms. The disruptors have become the disrupted.

Bitcoin Price Continues Fall

Prices for Bitcoin and Ethereum’s ether continue to crash. They began their descent yesterday after the New York Attorney General’s (NYAG) office filed a case alleging that the latter token was a security under its laws. Bitcoin price fell below $20,000, a drop of 8%, for the first time since January and ether rapidly descended by 15%, below $1,500, in fifteen minutes after the news was made public.

A positive economic indicator for crypto this morning was the increase in the unemployment rate – a sign that the Fed might not be aggressive in raising interest rates during its latest meeting. In response to the news, Bitcoin made a brief bid to revive this morning before shedding its gains.

According to estimates, crypto markets have lost $70 billion in the last 24 hours. As of this writing, bitcoin price is $19,892, down 7% from 24 hours ago. Ether is at $1,406.73, down almost 8% a day earlier.

A cocktail of regulatory uncertainty, economic headwinds and continued action by authorities will depress prices further. Bitcoin’s network is functioning on a status quo i.e., the supply of new coins remains constant with falling hash rates and network difficulty.

But there are fewer buyers for the coins. Whales continue to depart from the bitcoin ecosystem. According to data from Coinglass, recent days have witnessed $250 million in long position liquidations of the cryptocurrency.

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