Today’s announcement that crypto derivatives exchange, FTX, raised the largest private equity round in the industry’s history, is another sign of the euphoria and exuberance enveloping all things crypto. This April, cryptocurrency markets reached $2 trillion for the first time, which is more than double the level at the beginning of 2021. These last few months have reminded me greatly of the late 1990s when I saw investors frenetically piling millions of dollars into Russian treasuries (GKOs) and into any company with the word ‘internet’ on it. The 1998 Russian crisis and the tech meltdown should have taught legislators, regulators, and investors a lot, at the very least, that when the music stops, lots of people end up on the floor, because there are never enough chairs for everyone in ‘too good to be true’ markets.
It is only July 2021, and there have already been eight significant fundraising rounds of crypto and blockchain companies; these companies represent over 50% of the top 12 fundraising rounds in this sector, which have taken place since 2018. It would be very easy to ignore these fund raisings by saying that it is private equity and venture capital firms investing into crypto companies. Yet, given pension funds’, insurance companies’, securities firms’, and banks’ investments into private equity firms and venture capital firms, I would urge regulators and ratings agencies to pay a lot more attention to these investments.
Also of note is that at least sixteen fund managers have doubled their investments into crypto assets. Typically, it is banks, insurance companies, securities firms, and pension funds that invest in every type of mutual fund. A current cryptocurrency investor trend is akin to repurchase agreements, where crypto currency owners lend their assets to earn higher rates of interest. These investors are exposed not only to crypto volatility but also scams. A recent Bank for International Settlements annual economic report described how an incredibly accommodative monetary policy environment is influencing the current significant appetite for risk “across all asset classes, including real estate, commodities and cryptocurrencies. Retail investors played a disproportionate role – a typical sign of overstretched valuations.” The BIS report also points out that “by now, it is clear that cryptocurrencies are speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes. Bitcoin in particular has few redeeming public interest attributes when also considering its wasteful energy footprint.”
Yesterday’s meeting of the President’s Working Group on Financial Markets to discuss stablecoins, a fast growing cryptocurrency, is a very positive development. The group is comprised of the U.S. Treasury, the Federal Reserve, the Securities Exchange Commission, the Commodities Futures Trading Commission, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. These regulators regulate different financial institutions, non-financial corporations, and financial instruments. Yet, because investments in and trading of stablecoins and other cryptocurrencies impacts all types of financial institutions such as banks, private equity firms, asset managers, as well as retail investors, the cooperation and coordination of these regulators is urgent and critical. For the next meeting, I would include the New York Department of Financial Services in this group, given that Wall Street is in New York.
According to the BIS, “Stablecoins attempt to import credibility by being backed by real currencies. As such, these are only as good as the governance behind the promise of the backing. They also have the potential to fragment the liquidity of the monetary system and detract from the role of money as a coordination device. In any case, to the extent that the purported backing involves conventional money, stablecoins are ultimately only an appendage to the conventional monetary system and not a game changer.”
Congress and U.S. regulators need to work jointly to develop a regulatory framework for the cryptocurrency industry. It is very important that the President’s Working Group on Financial Markets take a good look at all types of cryptocurrencies, not just stablecoins. The interconnections of crypto investing and trading to the entire financial system should not be ignored. Moreover, I have no doubt that regulating stablecoins and other cryptocurrencies will require cooperation between foreign financial regulators and international standard setters such as the Basel Committee on Banking Supervision, the Financial Stability Board, and the International Organization of Securities Commissions.