Crypto Review Ahead of the State of the Union
As President Biden prepares to address the nation and the members of the 118th Congress with his State of the Union speech, this article reviews the last year in crypto and highlights the big ideas and events that will drive the conversation in 2023.
The crypto industry has spent significant time and resources educating policymakers about the ecosystem over the last year, and real strides have been made. However, there’s still a significant gap between perspectives in the public and private sectors, and a lack of understanding regarding DeFi. Good policymaking - that’s inclusive of relevant education and advocacy from the industry - can bridge the gap and find a right solution for everyone.
The below list includes some of the key recent events and ideas that will drive policymaking this year:
Terra Luna Crash
The precipitous fall of the Terra/Luna ecosystem in the spring of 2022 was a major wake-up call for policymakers who’d been watching the valuations of digital assets swing up and down. For the first time, they witnessed a prominent crypto collapse that wiped out an estimated $60 billion of value from the digital assets space.
Volatility in crypto has been largely accepted by policymakers, but the instability of the Terra “stablecoin” caused skepticism to grow. The crash undermined the legitimacy of an algorithmic stablecoin, and made US dollar backed stablecoins look like a much better alternative. Stablecoin policy is at the top of the agenda for crypto legislation in the new Congress.
FTX and Alameda
The collapse of the centralized crypto trading platform FTX and the subsequent revelation of its allegedly fraudulent and irresponsible practices will reverberate into 2023 and beyond. FTX, and its associated investment fund, Alameda Research, had business relationships across the industry, dragging down many others in its fall and creating the sentiment that the crypto space is filled with bad actors, at worst, or unwise operators, at best.
Prior to the collapse of FTX, its founder and CEO, Sam Bankman-Fried, portrayed himself as a “white knight” representative of the crypto community, and worked hard to build relationships with policymakers in the nation’s capital. With SBF now facing criminal charges, many influential policymakers may see their first crypto acquaintance serving time behind bars – an objectively negative data point for the movement.
The regulatory silver lining of the FTX collapse is that the only CFTC-regulated entity in the FTX ecosystem, FTX Derivatives, formerly LedgerX, has continued operating as usual throughout this time of upheaval. LedgerX is based in the US, unlike FTX.com, and is a regulated exchange under the CFTC. This disparity of circumstances and outcomes shows the importance of developing a regulatory environment for crypto that allows companies to innovate and succeed in a responsible manner.
Critically, the fall of FTX underlined the resilience of crypto at the technology level. While token values in secondary markets took a hit, from a fundamental, operational point of view, they were unbothered. The loss of faith in centralized companies also caused users to shift their activities to DeFi protocols like dYdX. Decentralized trading protocols do not custody customer assets and are designed such that the abuses carried out by FTX are rendered impossible.
One of the few positive events in the minds of Washington’s regulators and legislators in 2022 was Ethereum’s shift from a proof-of-work to proof-of-stake consensus mechanism . Not only did this assuage fears around crypto’s energy usage, it also showed that a decentralized community can effectively work together to make positive changes to a protocol. By changing the way network participants validated transactions on the Ethereum blockchain, the network reduced its energy consumption by about 90% and bolstered its cybersecurity resilience.
The Merge did not go unnoticed by crypto-focused members of Congress and by the Biden Administration. September’s White House report, Climate And Energy Implications Of Crypto-Assets In The United States, detailed proof-of-stake consensus mechanism and the positive impacts it would have on energy consumption.
Crypto Aid to Ukraine
When Russian President Vladimir Putin ordered his troops across the Ukrainian border in February 2022, the entire world was on alert and started thinking of novel ways to send aid to the people of Ukraine. Led by the US, nations sent tens of billions of dollars in humanitarian, financial, and military assistance through legacy channels. The Ukrainian government made a novel plea to citizens of the world for donations through bitcoin, ether and stablecoins. The crypto community contributed over $50 million US dollars, which were used to purchase body armor, food, and UAVs. At the time, some regulators expressed concern about the evasion of sanctions regulations, but those concerns were overshadowed by the unique, prompt, and efficient response of the crypto community.
The Demographics of Crypto Participants
Precise user data is difficult to collect (a feature, not a bug, of crypto), but extensive attempts have been made in the past year to get a sense of who is using digital assets. The best surveys indicate that younger people and minorities have adopted digital assets at a rate outpacing their participation in the traditional financial market. People are attracted to permissionless assets like crypto because they’ve locked out of the traditional ecosystem and are hungry for alternatives.
An important aspect of good policymaking is to protect the most vulnerable from manipulation, deception, and instability. The realization that many vulnerable citizens are leading the way in adoption should create urgency in the minds of policymakers.
In August 2022, the US Treasury Department’s Office of Foreign Asset Control (OFAC) announced that they were imposing an unprecedented sanction on Tornado Cash, a decentralized protocol for private transactions. OFAC accused Tornado Cash of enabling the laundering of over $7 billion US dollars worth of virtual currency since 2019, including millions stolen by North Korean state-sponsored hackers. Unlike most sanctioned entities, Tornado Cash is a decentralized protocol made up of code, and not primarily operated by individuals.
OFAC’s decision to add Tornado Cash to the Specially Designated Nationals (SDN) list, which enumerates entities with whom Americans and American businesses are not allowed to transact, caused a mix of responses on Capitol Hill. Some members of Congress saw the move as an unprecedented policy shift with potential negative consequences for privacy and innovation, while others applauded it as a positive action to stop the laundering practices of bad actors.
The Tornado Cash saga is not over, as lawsuits have been filed against OFAC for its actions. And the discussion around relevant topics, such as the freedom of speech, and the freedom to create open-sourced or permissionless software, will continue to be crucial issues during this 118th Congress.
Conclusion: A Busy 118th Congress
The above major events and themes from 2022 combined to paint a muddled picture, with limited but notable redeeming aspects in the eyes of policymakers in Washington. As the administration continues its work on crypto, which initially stemmed from Biden’s Executive Order in early 2022, the White House issued informal guidance advising caution to the legislative branch regarding crypto. Congress will likely forge ahead and hold several hearings on issues ranging from stablecoins to centralized exchanges and DeFi. Achieving good policy outcomes this year will require the industry and policymakers to listen and work hard to see from one another’s perspective.
dYdX is the developer of a leading decentralized exchange on a mission to build open, secure, and powerful financial products. dYdX runs on audited smart contracts on Ethereum, which eliminates the need to trust a central exchange while trading. We combine the security and transparency of a decentralized exchange, with the speed and usability of a centralized exchange.