Will the U.S. Government Ban Crypto?

If you asked the average person on the street or someone from the traditional financial system, they would most likely say to ban crypto. Some politicians have also expressed that they believe crypto should be banned. 

Many of these people know little about cryptocurrencies. They form their decisions based on a preexisting bias or ignorance. Many people also form opinions about crypto based on what they hear from the mainstream media. Instead of taking the time to educate themselves, they turn to the media for a quick fix.

What they hear lately from the mainstream media, especially in 2022, are stories about one crypto failure after another. They hear the usual talking points that crypto is used for money laundering, supporting terrorism and as a way for rogue nations to skirt sanctions. 

They also hear stories about crypto scams or exchange customers losing vast sums of money when exchanges go under. To be fair, these instances happen in the crypto sector, which has gone through one crisis after another in 2022. However, crypto has more to offer than these scenarios. 

The Macro Cryptocurrency Environment

Saying that 2022 has not been a good year for the cryptocurrency sector would be an understatement. But the crypto sector is not alone; many markets suffer from macro events, including the Russia-Ukraine war and rampant price inflation. 

Over the summer, the inflation rate hit its highest level in over 40 years. To combat this problem, central banks worldwide have been raising interest rates. These actions have caused the U.S. dollar to hit its highest level in 20 years. Interest rate hikes also have spiked bond yields and led to the most significant drop in stock markets since the COVID-19 crash in 2020.  

The crypto sector has also been hit hard, with Bitcoin dropping by over 75% since the peak in November 2021. As a whole, the crypto sector has shed $2.2 trillion in value. Crypto bear markets are nothing new, but the high-profile failures this year have added to the already negative sentiment.

The Crypto Sector in Crisis: Prelude to a U.S. Crypto Ban?

Looking back at the series of failures in 2022 and the renewed scrutiny by regulators and Congress, this year could be the crypto equivalent of the 2008 financial crisis. In the last seven months, one high-profile failure after another has occurred. 

This crisis has also exposed just how interconnected the crypto sector has become. With such relationships, all it took was one domino to fall to ignite arguably the worst crisis the crypto sector has faced. It is still unknown if the worst has already occurred or is yet to come. 

The first high-profile failure was the Terra Luna collapse in May 2022, when its UST stablecoin and LUNA token fell to near zero. The chart above shows the magnitude and speed at which the LUNA token collapsed.

The Terra blockchain and its UST stablecoin were two of crypto's top 10 assets, magnifying this failure's enormity. What led to this failure is complicated and would take too long to detail in this article. Anyone interested in learning more can click this link.

The shock waves from this debacle were felt throughout the crypto sector. With many companies in the crypto sector already spiraling, it didn’t take long for the Terra contagion to take down its first victim. In early June, Celsius froze its user's funds and eventually filed for Chapter 11 bankruptcy. But this was only the beginning, as the Terra contagion was just starting.

The failure of the multi-billion dollar crypto fund Three Arrows Capital (3AC) was the next domino to fall. What ultimately killed Three Arrows Capital were heavy losses incurred from the collapse of The Terra blockchain. 

Next in line was the failure of the crypto exchange Voyager Digital, which froze customer accounts in July 2022. As it turns out, Three Arrows Capital had defaulted on a loan from Voyager Digital worth hundreds of millions of dollars. 

Fast forward to the beginning of November, when a balance sheet for Alameda Research was leaked and Coindesk reported that much of its reserves were based on the FTT token. The FTT token is the native token of the FTX exchange. The report also highlighted potential solvency and leverage concerns involving Alameda Research. Alameda Research was run by FTX CEO Sam Bankman-Fried’s trading firm. 

To make a long story short, the collapse of FTX happened over 10 days beginning on Nov. 2. FTX filed for Chapter 11 bankruptcy protection on Nov. 11, 2022. The failure also took down Alameda Research and FTX.US, which were supposed to be totally isolated from FTX. 

FTX CEO Sam Bankman-Fried was arrested on Dec. 12, 2022, on federal charges of wire fraud, conspiracy and other allegations. Click on this link for more details about the FTX debacle. 

It is still unknown if there will be additional casualties from these failures. One thing is clear, an untold number of customers have lost an enormous amount of money they may never see again. If they can recover anything from the bankruptcy proceedings, it will most likely be pennies on the dollar. 

One lesson from this experience is not to store crypto on a centralized exchange. If you engage in lending, staking or yield farming, you must accept the risk of losing everything. 

Will the U.S. Ban Crypto?

What the argument is for the U.S. banning crypto? The main argument for making crypto illegal seems to be as a way to protect investors from losing money.  

The collapse of FTX, FTX.US and Alameda Research, the highest profile failures of 2022, has caught the attention of the U.S. Congress because of the financial damage it has caused to over 1 million customers. This loss has led to several congressional hearings, with more hearings to come. 

Some members of Congress have expressed the belief that crypto should be banned for several reasons, including protecting investors. If the goal is to protect U.S. citizens from losing money, which on its face sounds very noble, then why are people allowed to lose vast sums of money in so many other ways?

Here are a few examples:

• Legalized gambling: A National Council on Problem Gaming report shows that 2 million U.S. citizens suffer from a severe gambling addiction. Another 4 to 6 million have mild or moderate problems.
• Lotteries: U.S. citizens spent almost $29 billion on lotteries in 2019.
• Day trading: A study of forex traders by the U.S. Securities and Exchange Commission (SEC) found that 70% lose money every quarter and typically lose 100% of their money within 12 months.

A total crypto ban is unlikely to happen. One reason it is doubtful is because of the vast amount of institutional investment that has flooded into the crypto sector over the last few years. Plus, a U.S. ban on crypto would cause technical innovation to flee to friendlier jurisdictions. Such a ruling would be costly to the U.S. as the brightest minds who want to work on this technology would relocate to other countries. 

Also, a U.S. ban on crypto would ultimately do more harm to investors than good, as it would eliminate a way to further diversify investor portfolios. Because of its volatility, most investors should avoid holding a large portion of their investment portfolio in cryptocurrencies. But an age-appropriate percentage of crypto in a portfolio is not irresponsible. 

Is More Regulation The Answer?

Yes, instead of a ban, an emphasis should be put on developing common-sense regulations for centralized exchanges. They should be required to be audited by an outside firm to prove their solvency. They should also be required to show proof that customer funds are isolated from corporate funds.

How cryptocurrencies are defined and categorized needs to be made clear. Whether a cryptocurrency is classified as a security or commodity determines if it is regulated by the SEC or the Commodity Futures Trading Commission (CFTC). The regulations vary for each classification, and the regulatory confusion will continue until clear guidelines are enacted. 

Educating the general public should also be a priority. Educating investors on the dangers of storing their crypto on exchanges could have eliminated some losses. 

The Current State of the Crypto Market

It has been said that you know when a crypto bear market is nearing its end when investor sentiment is about as low as it can go. An argument could be made that the crypto market may be approaching that point. With all the failures and turmoil this year, investor sentiment is probably at a low for this bear market. 

The news is filled with the same old stories that come around every bear market. Here are common expressions of doubt:

• Is crypto dead?
• Can crypto survive?
• Crypto is a scam! 
• Crypto is a Ponzi scheme!
• All crypto is used for is drugs and money laundering!
• Crypto has no value!

No one knows at what price or when Bitcoin will bottom, but if historical patterns continue, the bottom could hit soon. Except for the bull market peak in 2011, all other peaks and bottoms occurred in November, December and January. 

This chart illustrates how much value has been lost since the November peak. Over $2.2 trillion has evaporated from the crypto sector, but the percentage loss is still lower than that seen during the 2018 bear market.

Will Crypto Come Back in 2023?

Hopefully, everything the crypto sector has endured will result in a more robust asset class. It will take time to restore investor trust over the next year or so, but 2023 could be a year of rebuilding. 

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