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Crypto industry fears regulatory backlash over lending crisis

A new crypto crisis is looming — and companies fear the regulators’ ax is about to drop.

One of the biggest lenders within the crypto market, Celsius Network, is struggling as the booming sector turns sour. The lender announced early Monday morning that it was suspending withdrawals and crypto trading functions due to “extreme market conditions,” a decision that will make it impossible for people to access the digital assets they had deposited with the company. 

Celsius’s decision effectively froze the digital assets of more than 2 million customers, many of whom had made deposits on the promise of advertised annual yields of as high as 18 percent — rates that are unheard of among traditional bank accounts. 

A collapse could leave those depositors penniless.

The company’s balance sheet has been in a freefall since late last year, shortly after it raised $750 million from top venture capital firms and a major Canadian pension system, with reported assets plummeting by 50 percent since late December. Celsius’s digital token, CEL, has also deteriorated in price, from trading close to $4 in late 2021 to just 0.32 cents now. Another rival company has already offered to scoop up certain assets in light of “what appears to be the insolvency” of Celsius.

Crypto companies are already on high alert after weeks of uncertainty in a market downturn that has seen the value of the whole market drop by two-thirds since its $3 trillion peak in early November. Crypto markets are also reeling from the recent collapse of TerraUSD, a so-called stablecoin whose popularity soared thanks to the sky-high returns promised through a connected lending platform. Celsius’s tumble has done little to help the market turmoil, with the price of Bitcoin falling further to around $22,000 — a far cry from its November high of $67,000.

Crypto companies are already on high alert after weeks of uncertainty in a market downturn that has seen the value of the whole market drop by two-thirds since its $3 trillion peak in early November | Jack Taylor/Getty Images

The ongoing crisis has raised new fears that market regulators could put the kibosh on the nascent crypto lending businesses that have positioned themselves as alternatives to traditional banks. 

“I am pretty angry at how reckless[ly] Celsius is conducting their business,” Crypto Finance’s chief executive, Patrick Heusser, said in an email, referring to the company’s promises of high yields. “My guess is that a rather strong or overreacting measure by the regulators will be the result (instead of a thoughtful one).”

“In the end, the consumer is getting punished (again) and also all the serious service providers that act thoughtful and in a compliant and regulated way,” he added.

Heusser is far from alone. At an Amsterdam fintech conference last week, attendees working for crypto companies were whispering concerns about Celsius and fearing a regulatory backlash. Among the few who were comfortable speaking about it publicly was Stephen Richardson, vice president of product strategy and business solutions at the crypto company Fireblocks.

Regulators would be “very swift” to address a crisis in crypto lending, he told the audience, especially after the recent crisis in the stablecoin market saw investors lose billions. “We need to be careful there,” he said.

Celsius didn’t respond to POLITICO for comment.

A watchful eye

Market volatility is nothing new for most crypto companies. This time is different, however, because the regulators on both sides of the Atlantic are watching — and overall market sentiment is much more bearish.

For more than a year, American state and federal agencies have been ramping up their efforts around the lending businesses, which is more widespread in the U.S. BlockFi agreed to pay $100 million to the Securities and Exchange Commission and to nearly three dozen state regulators last year to settle charges that it had operated an illegal lending business, while Celsius and other businesses were slapped with cease-and-desist letters from at least four state regulators. 

“It’s mind-boggling to me,” John Reed Stark, a former chief of the SEC’s Office of Internet Enforcement, said in an interview, adding that lending platforms have become “a plague with no regulatory oversight, no consumer protections. No fiduciary infrastructure of any type.”

The EU’s executive arm and legislators in Brussels are also keeping an eye on things as they close in on a new bill that aims to regulate Europe’s markets in crypto assets, dubbed MiCA.

The bill will set the standard for stablecoins, digital assets that are pegged either to a national currency or to a basket of liquid assets to keep their value steady. TerraUSD’s recent collapse strengthened legislators’ resolve for these rules, especially since the “algorithmic” stablecoin relied on financial engineering to keep the link to the greenback.

MiCA doesn’t target crypto lending. But it sets strict industry standards and supervision for crypto token-issuing companies that set up shop in Europe after the rules come into force. Celsius’ crisis shows the need to strengthen those draft rules to ensure that preexisting crypto companies are also in scope, according to Green MEP Ernest Urtasun.

Celsius’ crisis shows the need to strengthen those draft rules to ensure that preexisting crypto companies are also in scope, according to Green MEP Ernest Urtasun | Ozan Kose/AFP via Getty Images

“The mis-selling scandals are growing in the crypto sector while consumer and investor protection rules for [retail investors] do not adequately address the reality of this new sector,” said the Spaniard, who has played an influential role in negotiating MiCA and anti-money laundering rules for crypto in the European Parliament.

He also took aim at a grandfathering clause in the European Commission’s proposal of MiCA that “would prevent the application of the new EU set of rules to actors already operating.” That measure would in theory leave Celsius exempt from MiCA, because the lender already has an office in Lithuania. “Cases like Celsius are showing once again the need to remove such provision,” he said.

Collateral damage

Chief among the concerns of market entrepreneurs is that regulators could restrict or ban crypto lending altogether. While the EU has no uniform set rules for lending outside of mortgage and credit loans, the fear is the European Commission could feel compelled to shut the sector down. That’s unlikely to happen within the remainder of its legislative cycle, which ends in 2024, unless the crisis is too big to sit idle.

Certain lenders, such as Celsius — which billed itself as a bridge between traditional banking models and crypto-based decentralized finance — have lured retail investors onto their platform by advertising high returns if they deposit their crypto assets with them. Like traditional banks, these platforms lend these funds out to borrowers in exchange for collateral that’s confiscated if loans aren’t repaid.

Many of these loans are used by big crypto investors to buy more digital assets because their interest rates are much lower than they would otherwise be on traditional financial markets. This strategy can bring huge returns on crypto investments in boom times. The losses, however, can be massive if the market turns sour.

Like its competitors in the business, Celsius uses its deposits for lending and profits from the difference in interest.

But authorities in New Jersey and Texas have found that the platform also generates revenue “through cryptocurrency trading, lending, and borrowing,” as well as “engaging in propriety trading” — the practice of investing for direct market gain rather than on behalf of clients. Their concern is that Celsius became overexposed through these practices, leaving its depositors on the hook.

“We are now seeing the negative effects of unregulated … lending platforms that are under-collateralized” in the crypto market, said Marshall Hayner, chief executive of Metal Pay, a U.S.-based crypto payments company.

Hayner fears that the regulator’s axe would also hit crypto lenders in the decentralized finance (DeFi) space, where computer programs execute and record transactions in multiple online ledgers without the use of a central entity.

DeFi borrowers often have to provide collateral that’s worth more than the loan that they’re seeking from a consortium of crypto investors — much like peer-to-peer lending.

“It’s important we protect innovation for crypto in America, while preserving the safeguards we have come to expect in banking and traditional financial services,” Hayner said. “A good step is a strong framework for stablecoin regulation that is not reactionary in nature but thoughtful and supportive for competition.”

This article is part of POLITICO Pro

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