Regulators Raise the Heat On Crypto's Biggest Players

"The walls are closing in around crypto. Regulators hadn't taken action against many of the industry's biggest players, but are now cutting off access to products and services central to the digital-currency business.

On Monday, New York regulators shut down new issuance of the world's third-largest stablecoin, BUSD, prompting investors to flee the coin and raising worries about the future of crypto-exchange giant Binance, which gives the coin the "B" in its name.

Binance's partner in issuing the coin, Paxos Trust Co., is facing a potential Securities and Exchange Commission lawsuit.

The New York Department of Financial Services ordered Paxos Trust, which issues and lists Binance's dollar-pegged cryptocurrency, to stop creating more of its BUSD token, Binance said in a statement. Paxos will continue to manage redemptions of the product, the exchange said.

The New York regulator found Paxos failed to conduct periodic risk assessments and due diligence of Binance and customers holding BUSD issued by Paxos, according to a person familiar with the matter. The department ordered Paxos to stop issuing BUSD after it failed to address those and other deficiencies, the person said.

A few days earlier, the SEC fined the parent of another big crypto exchange, Kraken, and forced it to stop offering a popular type of crypto-yield product to U.S. investors. Banking regulators are quietly pushing banks to cut ties with crypto customers, limiting their ability to plug into the real-world financial system.

The actions came after years of slow-moving investigations and debate in Washington over how best to handle the fast-growing industry. Some observers detected a shift in officials' tone after the collapse of FTX, which strengthened the hand of politicians and regulators calling for tougher enforcement. Now, crypto executives are bracing for more regulatory lawsuits and investigations, and investors have started to flee suspected targets.

"It certainly feels, from an industry perspective, like there's a crypto carpet bombing going on right now," said Kristin Smith, chief executive of Blockchain Association, an industry group.

Over a 24-hour period from Sunday to Monday, there were $2.7 billion of outflows from Binance, according to blockchain data provider Nansen. On Monday morning, some $144 million of BUSD were redeemed for dollars, according to Nansen. Paxos said Monday it "categorically disagrees" with the SEC's assertion that BUSD must comply with federal securities laws.

Binance's in-house token, BNB, fell 8% on Monday, according to CoinMarketCap.com. The coin is often seen as a gauge of investor perceptions of Binance.

The scope of such actions suggests the SEC and other regulators want to rein in pillars of the crypto market such as stablecoins -- digital coins that maintain a price of $1 -- and staking, a way for investors to earn interest on crypto.

Worries of a crackdown have taken the wind out of the sails of an early-2023 rally in the digital-currencies market. Bitcoin was trading at about $21,621 at 5 p.m. ET on Monday, down 9% from its price on Feb. 1.

Banking regulators have signaled a pessimism about whether lending institutions can be safely involved with the industry. Some banks pared back their involvement with crypto.

Last week, Binance said it would suspend U.S. dollar bank transfers. The move came after the exchange said its banking partner, Signature Bank, would no longer support crypto transactions below $100,000. Signature started pulling back from the crypto business last year.

The SEC has been the crypto market's principal cop since the beginning of the Trump administration, when regulators expressed interest in the novel technology underpinning cryptocurrencies. Many of the SEC's earlier enforcement actions targeted frauds such as Ponzi schemes. That gave the market the impression that the industry's best-known brands faced less regulatory risk.

Then FTX, one of the world's best-known trading platforms, failed in November after a report revealed its affiliated hedge fund, Alameda Research, was heavily exposed to an illiquid digital asset issued by FTX. The disclosure triggered a run on customer deposits that caused the firm and its affiliates to enter bankruptcy.

FTX emboldened the SEC, said Coy Garrison, a former regulator and a partner at Steptoe & Johnson LLP who advises clients on crypto legal issues. "There is a political incentive to bring bigger cases post-FTX to be viewed as the responsible cop on the beat," he said.

The SEC in January sued crypto lender Genesis Global Capital LLC and its partner Gemini Trust Co. LLC, alleging their program allowing users to earn interest on crypto tokens violated securities laws. Gemini, which operates one of the largest U.S. crypto exchanges, said it plans to fight the lawsuit.

Crypto executives were spooked by last week's settlement between the SEC and the parent of the Kraken crypto exchange, in which the company paid a $30 million penalty and agreed to stop offering staking services to U.S. investors. It didn't admit wrongdoing.

The case suggests the SEC might force other companies to stop offering access to staking, in which investors lock up their digital assets in return for an interest-rate-like yield. The loaned assets allow the borrowers to facilitate transactions on the assets' underlying blockchain network. "This really should put everyone on notice in this marketplace," SEC Chair Gary Gensler said on CNBC last week.

Mr. Gensler has warned since FTX's fall that crypto companies are running out of time to voluntarily comply with investor-protection rules.

Binance.US, the American affiliate of Binance which offers staking services, has said it is monitoring the situation. Coinbase CEO Brian Armstrong has pledged to fight the SEC if the agency attacked how it offers staking. "We will happily defend this in court if needed," he tweeted on Sunday.

In early January, a trio of bank regulators issued a statement expressing skepticism that digital assets could be safely held by financial institutions. Within a week, Metropolitan Commercial Bank, a small New York bank that dipped its toes into crypto, said it was closing its crypto business.

Two companies trying to win banking licenses are in limbo after winning preliminary approval in early 2021 from the Office of the Comptroller of the Currency. Paxos National Trust and Protego Trust Co. applied to start banks that would custody crypto assets and facilitate trading. Protego's conditional charter expired recently. The company believes the agency's increasingly anti-crypto stance played a role in it not yet getting full approval, according to people familiar with the matter.

Paxos said it remains in discussions with the regulator. "Paxos has not been asked to withdraw its application for a national trust bank charter from the OCC, nor has it been denied the charter," Paxos said in a statement on Twitter." [1]

1. Regulators Raise the Heat On Crypto's Biggest Players
Michaels, Dave; Osipovich, Alexander; Benoit, David.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 14 Feb 2023: A.1.