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Crypto Bloodies Chainsaw Massacre Digital Exchanges

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Cryptocurrencies only seem to “work” when prices are rising. On the way down, nothing works as it should – a common trait of Ponzi schemes throughout history. In the current market carnage, exchanges that have promoted digital currencies have a lot to answer for.

Bitcoin, meant to be a store of value and a hedge against inflation in the eyes of luminaries such as Jack Dorsey or El Salvador’s Nayib Bukele, fails on both counts. It was down around 56% in six months as investors ditched it for the traditional fiat currency that crypto was meant to disrupt.

Stablecoins such as Terra and Tether, designed to avoid wild price swings through algorithmic management or backed by regular currencies and other traditional assets, have become unstable. TerraUSD bounced around 66 cents while Tether fell below 95 cents on Thursday as selling pressure pushed them away from the US Dollar.

And cryptocurrency exchanges, which have made great billionaires into figureheads like Binance’s Changpeng “CZ” Zhao or FTX’s Sam Bankman-Fried, aren’t trading. Binance announced temporary suspensions, network congestion, and derivatives delistings this week.

This equates to a system-wide evaporation of money, trust, and trust – ironic enough for a technology-based infrastructure that claims to revolutionize finance. The long-running online debates over the case for individual token investment don’t boil down to a mountain of magic beans in times of stress. The unwinding of speculative excesses made little distinction between NFT fuel Ethereum (down 57% year-on-year), SWIFT competitor Ripple (down 75%), or Elon Musk favorite Dogecoin (down 75%). 90%).

What might normally result in falling knives worth catching is more like “standing outside when it’s raining chainsaws,” as Max Gokhman, chief investment officer at AlphaTrAI, put it earlier this week.

It would obviously be dangerous to assume that animal spirits have evaporated for good. And given the feedback loop facing traditional financial markets, with crypto losses likely to prompt a flight to cash rather than the stock market, regulators have good reason to further increase the pressure on an agile, tech-savvy industry that always seems to stay one step ahead of supervisors.

“Traditional financial regulation is not perfect, but at least it has safeguards to avoid conflicts of interest and market manipulation,” explains Aurore Lalucq, member of the European Parliament’s Monetary and Economic Affairs Committee. “Crypto products should be regulated like financial assets, that’s what they are.”

While the current market meltdown will clearly put the spotlight on cryptocurrencies themselves, particularly the $120 billion stablecoin market which regulators say poses a risk to financial stability, c It is the outsized role played by crypto exchanges in this largely unregulated market that deserves the most urgency. Warning.

Despite the widespread use of the term exchange, companies like Binance and Kraken behave more like platforms. They combine several roles, including brokerage, custody and lending, which raises the possibility of conflicts of interest. As Securities & Exchange Commission Chairman Gary Gensler told Bloomberg News this week, there are no guarantees of proper walls between asset protection, market making and profit seeking that would prevent platforms to trade against their clients.

What makes this even more murky is the position of the platforms at the heart of the stablecoin complex. The three largest stablecoins – Tether, USD Coin, and Binance USD – are all affiliated with exchanges, as Gensler also pointed out. They serve as fuel for the broader crypto market, bypassing the banking system and helping to keep prices afloat. And exchanges have also made money by offering stablecoin-related products backed by unsustainable rewards, such as the 19.6% returns offered for TerraUSD.

As supposedly unthinkable events like the unpecking of major stablecoins become reality, fundamental questions about counterparty risk are coming back to haunt investors. Would exchanges survive a Tether explosion, with a market value of over $80 billion? How much confidence can we have in an ecosystem where most activity takes place at sea? And if a US-listed platform like Coinbase Inc. were to go bankrupt, what would happen to its clients’ assets? Recent revelations on this exact point have only added to the pain for Coinbase’s equity and debt securities.

As Martin Finnegan of Punter Southall Law wrote last year, the risk of publishing funds in a world dominated by unregulated trading platforms “cannot be underestimated”. Yet these risks have arguably been overlooked, as evidenced by the money pouring into stock exchanges by venture capitalists and institutional investors. Financial penalties related to market integrity issues such as sham trading have done little to deter bad behavior and look, in hindsight, like inadequate digital slaps on the wrist.

After the unraveling of the pandemic trade boom and rising inflation across much of the world, crypto is just one example of an investment gone bad. But if regulators fail to seize the opportunity, all markets will be viewed with suspicion. The house doesn’t always have to win.

More from Bloomberg Opinion:

• Gold’s strange behavior shows it’s not a safe haven: Jared Dillian

• The whole of Davos is reborn in the crypto metaverse: Lionel Laurent

• Crypto mortgages are as crazy as they look: Mark Gongloff

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering digital currencies, the European Union and France. Previously, he was a reporter for Reuters and Forbes.

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