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Capitol Report

June 22, 2021, 7:45 a.m. EDT

After China causes bitcoin to crater, threat of new U.S. regulations loom over crypto market, experts say

Chris Matthews

The world’s most popular cryptocurrencies took it on the chin Monday after the Chinese government continued its regulatory crackdown on bitcoin miners and companies that provide payment services for crypto-related transactions.

The People’s Bank of China said in a notice Monday that “virtual currency trading activities disrupt the normal economic and financial orders, breed the risks of illegal cross-border transfer of assets, money laundering and other illegal and criminal activities, and seriously infringe the people’s property safety.”

The central bank’s statement came a day after the regional Chinese government in Sichuan announced it would close more than two dozen suspected cryptocurrency-mining operations in the hydroelectricity-rich region.

The dollar price of bitcoin (COINDESK:BTCUSD) tumbled roughly 11% early Monday morning before paring those losses slightly. Ether (KRAKEN:ETHUSD) was trading 13% lower Monday afternoon , while dogecoin (KRAKEN:DOGEUSD) was down about 25%.

The moves underscore the influence that large governments, like China and the U.S., hold over the price of bitcoin and other cryptocurrencies, experts say.

Famed author, mathematician and investor Nassim Nicholas Taleb on Sunday published a paper critical of bitcoin enthusiasts, who he said seriously underestimate the threat that government power poses to cryptocurrencies.

“By its very nature, bitcoin is open for all to see,” he wrote, referencing the pseudonymous, rather than anonymous, nature of bitcoin. “The belief in one’s ability to hide one’s assets from the government with a public blockchain…not just read by the FBI but by people in their living room, requires a certain lack of financial seasoning and statistical understanding — perhaps even simple common sense.”

Meanwhile, regulators are clearly signaling they will continue to enact more regulations on the cryptosphere, including new rules that would hold exchanges and banks to stricter know-your-customer and anti-money-laundering regulations.

Securities and Exchange Commission Chairman Gary Gensler has repeatedly discussed the need for greater regulation of crypto exchanges to protect investors, while saying that he considers many of the thousands of extant cryptocurrencies trading on exchanges to be unregistered securities that are subject to SEC enforcement actions.

Sarah Brennan, an attorney at the law firm Harter Secrest & Emery, told MarketWatch that bolder enforcement against cryptocurrency firms that are selling unregistered securities is a major risk for her clients.

“It’s frustrating to work in this space because you don’t have clarity on a lot of things,” she said, adding that she was surprised that the SEC wasn’t bringing more enforcement actions against cryptocurrency companies that have raised money through auctioning their tokens, which often violates federal rules. “But the SEC has been…really mum on their agenda and their enforcement priorities,” she added.

Indeed, earlier this month the regulator released a rule-making agenda outlining its priorities for the coming year, and any planned rule-making on cryptocurrencies appears to have taken a back seat to the regulator’s other priorities, including new disclosure rules on climate-change risk.

Stablecoin regulation is perhaps the largest threat to the broader cryptocurrency market, experts say. A stablecoin is a kind of virtual currency that aims to maintain a peg to a stable asset, like the U.S. dollar (IFUS:DXY) , which facilitates trading from one cryptocurrency to another.

Many critics say the growth of stablecoins like Tether, USD Coin, and DAI, pose significant risks to financial stability, especially after it has been revealed that some of these dollar-pegged tokens are not backed by actual U.S. dollars, but a combination of much riskier assets. In February, the New York State Attorney General Letitia James banned the use of Tethe r and an associated crypto exchange, Bitfinex, in the state.

Following a settlement of the investigation, Tether revealed that the currency was not backed one-to-one by U.S. dollar reserves, but l argely by short-term loans to commercial entities. Tether Ltd., which issues the currency, said in a statement at the time that “Under the terms of the settlement, we admit no wrongdoing. The settlement amount we have agreed to pay to the Attorney General’s Office should be viewed as a measure of our desire to put this matter behind us and focus on our business.”

Tim Swanson, founder of the tech advisory Frim Post Oak labs, wrote in January that stablecoins were “parasitic” because they operated just like “non-bank financial intermediaries that provide services similar to traditional commercial banks, but outside normal banking regulation.”

This kind of behavior puts not only stablecoin holders at risk but could potentially threaten financial stability in general, if a run on a stablecoin causes the asset and other cryptocurrency prices to collapse, he argued. Given that more than 75% of bitcoin trading is done in Tether, such a collapse could also disrupt the market for bitcoin and other popular cryptocurrencies, according to crypto services company FlowBank.

Which regulator will step up to address these issues remains unknown, according to Brennan, who argued that federal bank regulators, securities regulators and state regulators have overlapping jurisdiction over cryptocurrencies and that this has been complicated by the fact that President Joe Biden has yet to nominate someone to run the Office of the Comptroller of the Currency, which oversees national banks.

“There will be a regulatory slap fight here, and the SEC and the Commodity Futures Trading Commission haven’t scrambled to say ‘this is ours,'” she said. “Congress or federal bank regulators will have to come in to address the underlying issues with stablecoins from a market stability and safety perspective, to ensure that issuers have internal control and disclosure obligations and aren’t going to just collapse and cause market instability.”

Link to MarketWatch's Slice.