Why regulators must stop tarring all crypto companies with the same brush

The collapse of Celsius and FTX has caused contagion in the sector, with scores of successful virtual asset players now being targeted by regulators

Alex Mashinsky, co-founder of bankrupt crypto platform Celsius. A US judge has ruled that the $4.3 billion in the platform's accounts belong to the failed business. Getty

In the first weeks of 2023, news emerged that Celsius founder Alex Mashinsky is being sued by the New York attorney general for defrauding investors by covering up the dire position of his company while continuing to accept their deposits.

At practically the same time, however, a judge ruled that the $4.3 billion stuck in Celsius’s various interest-bearing cryptocurrency accounts belonged to the failed business, not its customers.

Taken together, these two announcements are confounding.

If the customers of Celsius were swindled out of their hard-earned capital, those assets should be returned to their rightful owners.

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Any terms and conditions set out in the small print should be null and void if fraud is involved.

Yet, just as we saw during the global financial crisis, it is the customers who bear the brunt of an institution’s financial collapse.

With the ruling regarding the ownership of Celsius’s assets, legislators have once again failed the public.

Let us see how they do now. If and when the trials of both FTX co-founder Sam Bankman-Fried or Mr Mashinsky go ahead, we must hope that — if they are found guilty of defrauding millions of people — there will be fair and just sentencing.

However, we must be careful to ensure that innocent people do not get dragged into the fray as legislators make a show of cleaning up cryptocurrencies.

We have to ask ourselves why two out of three developers of Tornado Cash, the crypto-mixing service that was sanctioned by the US Treasury Department last summer, are in custody without charge, while Mr Bankman-Fried is out on bail.

History repeats itself

It is worth remembering that almost no one went to prison for the reckless behaviour of global financial institutions that caused the 2008 financial crisis, which required government bailouts totalling $3 trillion printed between 2008 and 2014.

At great cost to the taxpayer, the very bank executives that caused the collapse walked away with not even a slap on the wrist and continue to earn millions in bonuses up to the present day.

The cryptocurrency systems that are failing us today are modelled on these same financial institutions that failed us 15 years ago.

It is no surprise, then, that we are seeing them crumble in the same fashion, with eerie similarities.

However, we can at least expect trials for the founders that have caused so much financial ruin after the collapse of FTX and Celsius, which is more than can be said for anyone at Lehman Brothers, Fannie Mae and Freddie Mac, Wells Fargo, Royal Bank of Scotland, et al.

In a worrying signal, though, we are now witnessing the US regulator go after scores of successful players in the cryptocurrency sector that have been injured by contagion from these disasters, as well as reputable platforms that have survived the downturn.

Watch: What is Bitcoin and how did it start?

After circling around Binance since the end of last year, the Department of Justice is now investigating connections to American hedge funds.

Similarly, Digital Currency Group (DCG), the owner of embattled crypto prime broker Genesis, is facing investigations by the Department of Justice and Securities and Exchange Commission.

It is DCG’s connection to FTX and Binance's position as FTX’s biggest competitor that are attracting this regulatory scrutiny, and it is having a detrimental effect on the confidence of their customers.

Binance, for example, is experiencing unprecedented outflows as a result, with $12 billion leaving the platform in less than two months.

Where punishment is due

It is not, however, Binance and DCG whose heads should be on the chopping block.

It is the malicious characters at the helm of FTX, Celsius, 3AC and Terra Luna who are to blame, and we look forward to seeing justice done.

In the meantime, the cryptocurrency industry is moving on to build a better and stronger ecosystem unburdened by the noxious cult of personality.

Cryptocurrencies — in pictures

The crypto market, which includes currencies such as Bitcoin, pictured, has lost $2 trillion of its value in six months. Unsplash

The price of Ethereum, the second largest cryptocurrency by market size, has fallen by 70 per cent this year. Investors and analysts are watching to see if it will dip below $1,000. Unsplash

Dogecoin, supported by Elon Musk, is about 90 per cent down from May last year, yet it is outperforming Bitcoin and Ethereum in the current crash. Unsplash

The government of El Salvador has invested $105 million in Bitcoin. President Nayib Bukele's embrace of the cryptocurrency as legal tender is being questioned as the market crashes. Getty

Changpeng Zhao, founder of crypto exchange giant Binance, has compared the current market turmoil to the dotcom bubble of the early 2000s. Still, the company is aggressively pursuing licensing in international jurisdictions and introducing new products. Getty

Tether is the biggest issuer of stablecoins, a type of cryptocurrency pegged to a traditionally stable asset like the US dollar. Most stablecoins are meant to maintain a constant price of $1 and are backed by real reserve funds, making it easy to convert crypto investments into cash. But Tether's financial statements show that may not be true, leaving the issuer and its investors vulnerable. Unsplash

The recent crypto crash can in part be attributed to the collapse of TerraUSD, a stablecoin pegged to the US dollar through algorithms and linked to a "sister" cryptocurrency named Luna. When the price of Luna plummeted, TerraUSD also fell, creating a “death spiral” to practically zero for both coins. Unsplash

On June 12 crypto lender Celsius Network said it had paused customer withdrawals, saying it needed “to stabilise liquidity and operations”. Investors are still waiting, with no signs that the current meltdown will let up. Getty

The industry is still in its infancy. It hasn’t had the luxury of centuries of trust-building enjoyed by traditional financial institutions.

The events of 2022 are a huge setback, but those truly committed to the cause will continue building a system that is transparent, open source, immutable and governed by consensus.

It will take time to build this industry to the point of mainstream adoption.

But it would be a far easier and smoother process for everyone involved if global decision makers were on our side.

Blockchain technology and the cryptocurrency ideal is not the enemy here. It is the people who have abused trust and cheated their way into building billion-dollar houses of cards who should pay the price.

Stefan Rust is the founder of Laguna Labs, a blockchain development house, and former chief executive of bitcoin.com