What will the crypto market look like after the great crackdown?
For several years, I have felt that the crypto market as we knew it was an artificial, temporary experiment.
There cannot be financial markets that are trusted at scale, and trustworthy over time, without regulation. We know this because there never have been, in the history of finance. Pose to the world the opportunity to make money--a lot of money--by cheating or lying or manipulating, and sooner or later, someone will take you up on it.
Note that the integrity of Bitcoin, or other blockchain-based systems, does not disprove my claim. A blockchain is not a financial market. You can trust that one bitcoin is one bitcoin, so long as you hold the private key. Without regulation, that inevitably morphs into trusting one wrapped and leveraged bitcoin showing on your FTX account statement, which is quite a different thing. Some people, like the old-time gangster Willie Sutton, rob banks because that's where the money is. New-fangled gangsters like Bernie Madoff and Sam Bankman-Fried cut out the middleman by building banks with holes in the vault.
Let's imagine that regulators do what they've been suggesting for five years. They declare the overwhelming majority of tokens other than Bitcoin and Ether (potentially) to be securities, and impose some modified version of securities disclosure and antifraud obligations. They impose bank-like audit and capital requirements on stablecoins, and anti-money laundering obligations on virtually everyone that's a someone. They ban conflicts of interest, questionable related-party activities, wash trading, front-running, and similar market manipulation by exchanges, and sanction any U.S.-based or regulated entity that interacts with those outside the regulatory perimeter.
In this world, most of the tens of thousands of digital assets are effectively killed, at least in Western markets. More important, five of the six most valuable tokens, beyond Bitcoin and Ether, go the same way. Most of the large exchanges not based in U.S. or Asian jurisdictions with strong regulation (Japan, Singapore, and South Korea) disappear as well. What’s left?
Take a look at the digital asset market today.
There is Bitcoin...and things like it. (Decentralized payment tokens.)
There is Ethereum...and things like it. (Smart contract app platforms.)
There are stablecoins.
There are appcoins.
Stablecoins are simpler to model. They are, pretty much by definition shadow banks: they hold depositor assets and create credit. They will be regulated like banks, like money-market funds, or in some variant that allows for slightly more risk-taking and higher yields. Everything unwilling or unable to comply with such rules will be banned, in the US at least, with some uncertainty about MakerDAO and other asset-backed on-chain stablecoins. As Circle demonstrates, regulated stablecoins are a great business when interest rates are high or controls on risks are limited; less so when they aren't.