Banks: Coinbase, Galaxy Digital abandon Silvergate after bank warns about its viability

Products: Record-high digital asset investments in February 2023: CryptoCompare’s Monthly Review

Ethereum: Ethereum’s ERC-4337 Account Abstraction Smart Contract is Live

Miners: TeraWulf’s Nuclear Bitcoin Plant Is Just One Piece of the Green Mining Puzzle

Stablecoins: Japanese Banks to Test Stablecoins on ‘Japan Open Chain’

Digital asset markets ended the week to March 3 with the largest flash sell-off crypto has seen in some time, as the overall cryptocurrency market cap dumped close to $50 billion within an hour’s time on Thursday evening. That pushed the unit price of Bitcoin (BTC) in USD terms down to $22,200 – about -7.0% below weekly highs close to $23,900. Year to date, the price of BTC is up by roughly 33.5%.

Last night’s rapid decline was likely due to the combination of regulatory pressure facing US crypto firms, the legacy banking industry’s response, and what appears to be the ongoing collapse of crypto-friendly Silvergate Bank. Digital assets had remained quite durable in the face of these developing headwinds throughout most of February, holding slight gains while major equities indices largely declined for the month, but all of these narratives seemed to come to a head on Thursday, and market participants could no longer ignore several threats facing the so-called “on-ramps” to crypto markets – particularly exchanges.

As we’ve highlighted in recent treatments on a sudden uptick in SEC scrutiny of companies operating in the crypto space, the commission’s actions and statements appear to be heavily focused on custody – a hot topic in digital assets following the collapse of several prominent exchanges and crypto “lending” firms throughout 2022. These bankruptcies that have left traders and depositors at the back of the line to make a claim on the funds they thought were theirs. The reality is that users of most exchanges are subordinated to the level of unsecured creditors and their assets belong to the exchange once transferred into the firm's custody.

Moreover, exchanges sometimes don’t even own the crypto assets they display to their customers. For instance, court filings from failed crypto exchange FTX’s bankruptcy case show it owes customers almost $1.6 billion worth of BTC. However, only $1 million of BTC assets have been located. That comes as no surprise, as the company’s balance sheet listed no liquid Bitcoin assets whatsoever. For some exchanges, their users’ balances only reflect what the firm owes users, not the profile of what assets are actually being held within their actual reserves. This is not always the case, but a relationship with an exchange typically requires a certain amount of trust. By contrast, investors who hold the “keys” to their cryptocurrency, the digital signature that allows certain coins/tokens to be transacted, are verifiably in custody of their assets, which always remain on the blockchain.

SEC Chairman Gary Gensler noted yesterday that he supports a new framework for deeming platforms “qualified custodians” of registered investment advisors’ client funds. Gensler noted that crypto exchanges may not currently be in compliance with these measures. To be a qualified custodian under the new rule, Cointelegraph reports that a firm would need to ensure that all assets are properly segregated, submit to annual audits from public accountants, and undertake other transparency measures. Per a transcript of Gensler’s remarks to the Investor Advisory Committee: “Make no mistake: Our current custody rule, adopted in 2009, covers a significant amount of crypto assets. Advisers, in complying with the current custody rule, are required to safeguard investors’ crypto funds and securities with qualified custodians.”

For individuals, self-custody of assets remains the most secure means of storage for cryptocurrencies. This was a critical component of the vision of Satoshi Nakamoto, the pseudonymous inventor of Bitcoin, who emphasized as little reliance as possible on trusted third parties. MRP has previously highlighted popular forms of “cold storage” for crypto investors; most prominent among them, the “hardware wallet”, which is typically a small, portable device that securely store private keys to one’s crypto assets offline so that no one without the keys can transact those assets without the presence of the device. The keys are guarded by a randomly-generated seed phrase, which can act as a recovery method if the physical device were to be damaged or lost. MRP has stressed the relevancy of the old  crypto adage “not your keys, not your coins”, and highlighted a boom in sales at hardware wallet firms like Ledger and Trezor that followed the meltdown of FTX.

Obviously, the ongoing SEC crackdown and fears of instability at major exchanges creates near term pressure on digital asset prices, but it has a potentially positive knock-on effect for the future of the crypto industry. The number of Bitcoin exchange deposits tracked by Glassnode has recently fallen toward two-year lows and continues to trend downward as larger numbers of cryptocurrency investors are researching and adopting self-custody solutions. The utilization of exchanges is still necessary to facilitate the purchase of cryptocurrencies, but an emphasis on custody and the disclosure of accounts balances held by centralized entities should change the face of the crypto industry, which has only recently begun to embrace widespread transparency. MRP has previously highlighted some of the new measures being rolled out by exchanges to re-assure clients, including proof-of-reserves accounting with the use of Merkle Trees.

February 22, 2023: Ethereum May Face Contagion from SEC Crackdown on Crypto Exchanges’ Staking Services →

February 14, 2023: Staking Services and Stablecoins in SEC Crosshairs as Crypto Industry Preps for Court Battles →

January 24, 2023: Bitcoin Mining is Back to Profitability, Hash Ribbon Shows Peak Capitulation May Have Finally Passed →

October 18, 2022: Fallout From Ethereum “Merge” Bolsters Bitcoin’s Hash Rate as Some Criticisms Still Linger →

October 7, 2022: Ethereum’s Post-Merge Era Conquers Key Goals, Yet Centralization and Regulation Concerns Linger →

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