Crypto Collapses and Security Concerns Renew Debate Over Digital Assets Policy

Oct. 16, 2023

There has been significant upheaval in the digital assets market over the past year, and Washington continues its efforts to regulate this sector. As we approach the start of fall—and a renewed debate about crypto’s role in banking—community bankers are understandably wondering what will come next.

In a series of blog posts, we will review key regulatory and market developments over the past several months, including proposals by the Securities and Exchange Commission, the launch of PayPal’s stablecoin, ICBA’s efforts to ensure any regulatory framework will continue to shield community banks from crypto’s myriad risks, and our ongoing efforts to oppose a U.S. central bank digital currency.

Remaining aware of developments in the digital assets industry is critical as crypto entities seek greater access to the traditional financial system and policymakers in Congress deliberate paths forward.

Crypto Collapses Raise Policy Questions

Last year, the crypto markets were rocked by one major event after another, starting with the implosion of TerraUSD and culminating in the spectacular collapse of FTX and the indictment of its leader, Sam Bankman-Fried. The digital assets markets suffered a tremendous blow from all those failures, and countless crypto investors and users now await lengthy bankruptcy proceedings to see if they will ever be able to recover assets from these ruined companies.

While those bankruptcy proceedings advance, regulators and Congress continue to evaluate how to develop effective safeguards for consumers and the financial system against crypto’s myriad risks.

Cryptocurrencies, however, are not the only cause for concern. Stablecoin issuers are fighting for an unequal regulatory framework that could potentially lead to a patchwork of 50 different state approaches, thus opening the door to regulatory arbitrage and heightened risks to the financial system. The Biden administration also remains interested in the possibilities of a U.S. central bank digital currency, or CBDC, and they are advancing efforts to research the technology.

Crypto Market Struggles with Price Declines

After setting all-time high prices in 2021, the cryptocurrency market now finds itself in the doldrums and struggling for direction. As of mid-September, the total crypto market stands at about $1.04 trillion, with bitcoin and Ethereum accounting for approximately 67 percent of that value.

Likewise, stablecoins, a type of crypto-asset backed by other assets and typically pegged to the U.S. dollar, are also on the decline. At the start of the year, there were $139 billion worth of stablecoins in circulation, but the total has fallen to $122 billion following an overall drop in retail crypto trading.

Decentralized finance (DeFi) has also witnessed less activity. DeFi is generally measured by total value locked (TVL), which is the full amount of crypto-assets committed to DeFi protocols. Today, TVL hovers around $37 billion, a far cry from its peak of nearly $200 billion in late 2021.

Fraud, Exploits, and Hacks Continue

Last year underscored the connection between cybercriminals and the crypto world. For example, TRM Labs, a blockchain analytics company, uncovered a significant rise in terrorist groups using the Tether stablecoin to raise money. In fact, the company found “there was a 240 percent year-on-year increase in the use of Tether.” Bad actors also stole nearly $4 billion in crypto-assets, with North Korean-affiliated hackers responsible for almost half that amount.

According to the Financial Action Task Force, North Korea’s theft of crypto last year “enabled an unprecedented number of recent launches of ballistic missiles (including inter-continental ballistic missiles).” In response to North Korea’s increasingly sophisticated crypto attacks and operations, the Office of Foreign Asset Control sanctioned Tornado Cash, a virtual currency mixer than helped North Korea launder nearly half a billion dollars. This decision marked the first time the United States ever sanctioned a decentralized cryptocurrency mixer.

Yet despite these unprecedented moves, North Korea continues to look to crypto to fund its illicit weapons, and it has found new mixers to use. In July, Lazarus hackers used a fake job offer to trick an employee with CoinsPaid, the world’s largest crypto payments company, into uploading malware that allowed the group to steal almost $40 million in crypto. Most recently, the FBI released a statement confirming that North Korea’s Lazarus Group was behind the early September $41 million theft of crypto assets from the crypto gambling site. Moreover, the FBI revealed that North Korea has now stolen at least $200 million in crypto-assets so far this year.

However, the U.S. government is bolstering its efforts to combat North Korea’s criminal activity. The Financial Crimes Enforcement Network hosted a meeting at the end of August that brought together representatives from law enforcement, the financial system, and Treasury to discuss ways to curtail this rogue nation-state. The question is now: What more can policymakers do to constrain North Korea’s illicit activities?

The profound perils posed by cybercriminals targeting crypto-assets cannot be overstated. Year to date, cybercriminals have stolen nearly $1 billion in crypto-assets.

ICBA recognizes the serious threat that crypto cybercrime poses, and that is why we continue to urge policymakers to focus on these concerns first and foremost. Put simply, protecting national security and implementing anti-crime measures must be the primary drivers of cryptocurrency policymaking and regulation.