Crypto boom turns to bust as regulators circle

On February 13th a mysterious QR code bounced like the ball in the game Pong across almost 37 million television screens in the United States and more around the world that were tuned in to watch the Super Bowl, beckoning smartphone users to scan and follow a link. Paid for by cryptoasset exchange Coinbase, it was one of several crypto-related spots to feature during what is arguably the premiere advertising event of the calendar year.

But less than four months after forking out $14 million (€13.16 million) for the prime time slot, Coinbase – a totem of the broader sector’s increasing legitimisation after its initial public offering in April 2021 – announced plans to shed 18 per cent of its global workforce in the face of a global meltdown in crypto asset prices. The company, which like many of the biggest players in the industry has its European headquarters in Dublin, cut more than 1,000 jobs over the next month, a number of them in Ireland.

That meltdown would wipe an estimated $2 trillion off the overall market capitalisation of the crypto industry from its peak in May 2021.

A sea of red in crypto markets would also eventually overwhelm several high-profile victims, chief among them the Terra algorithmic stable coin and Sam Bankman-Fried’s FTX exchange, as disgruntled investors moved to withdraw their funds and cut their losses.

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Arrested in December on wire fraud charges over the alleged diversion of billions of dollars worth of customer deposits, the fall from grace of Bankman-Fried and FTX has been the catalyst for a further decline in values. Bitcoin, the crypto world’s bellwether asset, is down more than 62 per cent this year so far to $15,700, and 20 per cent weaker since the start of November when the outline of the FTX scandal was beginning to emerge.

After two years of soaring asset prices and a growing feeling that the industry was possibly on the verge of joining the financial mainstream, it wasn’t supposed to be like this. In accounts filed in September, Coinbase’s Irish arm reported a more than 300 per cent increase in profits after-tax in 2021 to €2.7 million on revenue of €64.5 million. On foot of a pandemic-related boom in crypto asset prices, it and other exchanges like Binance had reaped the rewards, charging investors – many of them amateurs – fees for any transactions conducted via their platforms.

But the tumble in asset prices this year has also seen a decline in crypto trading volumes that began in the early summer of 2021, which has wiped out a portion of the estimated 22,000 coins and tokens on the market. Consequently, exchanges like Gemini are preparing for a much leaner set of figures in 2022 as investor interest wanes, a phenomenon known in the industry as “crypto winter”.

Inflation and its impact on the disposable incomes of the retail investors crypto has attracted in recent times, coupled with the general flight from risk assets, have also been big factors underlying the meltdown. But FTX’s collapse towards the end of the year is also making this latest crypto winter a particularly hard – if not existentially threatening – one. Bloomberg reported earlier this month that daily average trading volumes had halved between the end of October and the early December as fears around contagion and the security of customer deposits mount.

“I think with it doing so well for a period of time, [the correction] was predictable in the sense that people probably thought that it couldn’t go on forever,” says Rachel McCausland, an associate solicitor with law firm Taylor Wessing, who has advised crypto and other disruptive technology companies. “But I don’t think that anyone anticipated all the other factors which then led to the reduction that we’ve seen.”

As 2022 winds to a close and with winter having well and truly arrived, the assets and the ecosystem that supports the crypto sector are in tatters. But it hasn’t been all bad news for the sector, at least on the regulatory front.

This year Gemini and Coinbase registered as Virtual Asset Service Providers (Vasps) with the Central Bank of Ireland, bringing the US-listed crypto exchange under its supervision for the purposes of anti-money laundering and criminal financing regulations. European regulators have long taken an arms-length approach to crypto assets, fearing that the volatility observed in asset prices and trading volumes could harm consumers or even spread to the “traditional” financial system if the asset class was dragged into official supervision and treated similarly to other financial products.

Against this backdrop, the Central Bank continued to warn crypto investors about the unregulated asset’s dangers. “People should only put their money into crypto if they are prepared to lose all of it,” governor Gabriel Makhlouf said in November, although spillovers from the collapse in crypto prices this year into the broader financial system have “remained limited”.

With the European Union’s vaunted Markets in Crypto Assets (Mica) regulations set to come into force in 2024, the question is how financial authorities can be seen to bring some semblance of law and order to the wild West of crypto without effectively legitimising a once-fringe asset class that has displayed such volatility, affected so many consumers and hobbyist investors, and suffered so much reputational damage in 2022.

The Government is also keen to foster the development of the broader blockchain industry in Ireland, as outlined in its revised Ireland for Finance strategy in October. All of this makes for a difficult regulatory and political balancing act.

“It is a difficult space to regulate,” says McCausland. “I think the difficulty comes with trying to achieve equilibrium between innovation, investor protection and market integrity. Mica has been a long time coming and it’s a welcome development. But the difficulty with this industry is, as it develops and grows at such a rapid speed, it’s almost impossible to keep up with developments at a regulatory level. But [Mica] will go a long way.”

Not everyone agrees, however, and a number of MEPs have recently poured scorn on the proposed Mica regime in the wake of FTX’s collapse, wondering aloud whether it would prevent a similar catastrophe from happening in Europe. The EU Council and Parliament are still expected to ratify the package in the first quarter of 2023. Barring any delays, entities that fall within the scope of the regulation will have 12-18 months to apply for authorisation by one EU member state to passport their services across the bloc. Given that many of the biggest and most well-known exchanges have their European base of operations in Dublin, Central Bank officials are anticipating a busy year ahead.