Crypto collapse ‘wake-up call’ and ‘opportunity to reset,’ top bank regulator says

Acting Comptroller of the Currency Michael Hsu said this week that hype is a serious risk for cryptocurrencies and likened certain crypto transactions to Ponzi schemes, warning that the crypto space is very dangerous for investors of modest means.

The comments come after the collapse of stablecoin TerraUSD (UST-USD) on May 9 reverberated through the cryptocurrency market.

“The recent collapse of the TerraUSD stablecoin and associated sell-off in crypto markets has shown that hype-driven growth can lead to bubbles, harm consumers, and crowd out productive innovation,” Hsu said in a speech Tuesday before the Digital Chamber of Commerce .

“What has become clearer to me … is that these developments are indicative of the crypto economy’s dependence on hype…the recent events in crypto should serve as a wake-up call and an opportunity to reset and to recalibrate the problems the industry is trying to solve,” he added.

Hsu says that contagion risks within crypto are real, underscoring that the collapse of algorithmic stablecoin Terra spread to the largest stablecoin, Tether (USDT-USD), and to the broader crypto ecosystem.

Still, Hsu was encouraged that the cryptocurrency rout didn’t seem to hurt traditional banks. He said the OCC’s work to require banks to ask permission to engage in crypto activities has helped limit exposure.

“No banks are under stress or even rumored to be under stress due to crypto exposure,” Hsu said.

WASHINGTON, DC – AUGUST 03: Acting Comptroller of the Currency Michael Hsu testifies during a hearing before Senate Banking, Housing and Urban Affairs Committee at Dirksen Senate Office Building August 3, 2021 on Capitol Hill in Washington, DC. The committee held a hearing on “Oversight of Regulators: Does our Financial System Work for Everyone?” (Photo by Alex Wong/Getty Images)

The self-described crypto skeptic also warned that crypto is highly fragmented. He noted that the daily addition of new blockchains creates the need for cross-chain bridges — systems that enable the transfer of cryptocurrencies between blockchains — that exposes the system to hacks.

“It is as if instead of converging on a single standard railway gauge to connect the country, innovators are incentivized to build customized railcar systems from scratch,” he said.

Hsu also says there is not enough clarity about how custody works and who owns crypto assets bought from an exchange. “Establishing clear standards for the ownership and custody of digital assets would protect consumers while enabling sustainable, long-term growth,” he said.

The acting comptroller is also worried about crypto products that offer what he calls “unsustainably high” yields. Offering high yields is the top way to attract investors to crypto, he noted, especially in the decentralized finance space. In particular, Hsu likens yield farming — essentially lending out one’s crypto using smart contracts in return for yield — to a Ponzi scheme.

“There seems to be growing acknowledgment that yield farming today may have more in common with Ponzi schemes than with productive innovation,” he said.

Cowen analyst Jaret Seiberg says he thinks Hsu’s comments infer that banks will have a challenging time participating in crypto. “Hsu is arguing that current crypto valuations cannot be trusted,” Seiberg said. “That means the best way to protect the banking system is to limit its exposure to crypto.”

Seiberg also says it’s hard to see the OCC issuing limited-purpose charters for financial entities to participate in crypto given that Hsu wants to protect the banking system from crypto risks.

Jennifer Schonberger covers cryptocurrencies and policy for Yahoo Finance. Follow her at @Jenniferisms.

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