Key Insights:

• Chicago Fed report reveals the causes and fallout of significant cryptocurrency surges in 2022.
• High-yield investment allure and customer withdrawals triggered widespread crypto runs and platform collapses.
• Regulatory measures are urgently needed to protect investors and stabilize the volatile crypto-asset market.

The Federal Reserve Bank of Chicago (Chicago Fed) recently published a comprehensive report encompassing the significant cryptocurrency surges in 2022. In this detailed correspondence, the bank highlights the intriguing historical context, extensive data, and the precise dates when these prominent companies faced financial distress. The document provides readers with a thorough overview of the cryptocurrency journeys of Celsius, Voyager Digital, BlockFi, Genesis, and FTX.

As per the Chicago Fed’s report, various crypto-asset platforms faced a substantial setback in 2022 due to significant losses incurred in investments and many user withdrawals. These platforms were known for providing a broad spectrum of cryptocurrency-related services and products, including trading, custody, and high-yield investment opportunities.

However, the Chicago Federal Reserve raised concerns about the vulnerability of business models employed by platforms due to the unrestricted withdrawal capabilities of clients and the platforms’ utilization of funds for speculative and precarious investments. These factors expose the platforms to potential risks. A noteworthy occurrence transpired on the FTX platform when clients withdrew a quarter of their funds within a single day.

Beyond Conventional Choices: High-Yield Allure

Clients seeking lucrative returns were enticed by the allure of high-yield investment products, making them the prime focus of these platforms. The appeal lay in the promise of guaranteed interest rates surpassing those provided by conventional investment options, successfully capturing the attention of discerning investors.

Regarding investment choices, clients were presented with various options, primarily stablecoins and non-stablecoin crypto-assets. These offerings boasted interest rates from 7.4% to 9%, providing an attractive range for potential investors. Notably, certain platforms went a step further by promoting lesser-known crypto-assets that promised even higher interest rates, surpassing the typical offerings available in the market.

Crypto Chaos: Tracing Bankruptcy Fallout

Through an in-depth analysis of bankruptcy records, valuable insights have been unearthed regarding the withdrawal of customer funds from various platforms. The downfall of Three Arrows Capital (3AC) and the catastrophic collapse of the TerraUSD stablecoin emerged as critical catalysts behind the widespread occurrence of crypto runs.

Customers swiftly withdrew their funds as a precautionary measure to mitigate potential losses, triggering a significant contagion effect due to the platforms’ exposure to Three Arrows Capital (3AC), which had extended billions of dollars in loans to the hedge fund. The liquidity challenges faced by these platforms were further exacerbated by the massive outflows following FTX’s bankruptcy in November 2022.

According to data from the Chicago Fed, withdrawals from Celsius between May 9 and June 12, 2022, amounted to $1.4 billion and $0.58 billion. FTX experienced the highest volume of withdrawals between November 6 and November 11, 2022, totaling over $7.81 billion.

The collapse of crypto-asset platforms in 2022 is a compelling case for the immediate implementation of regulatory measures.

Addressing the issue of regulatory scrutiny, the Chicago Fed highlighted, “The offering of high-yield investment products by platforms has been under regulatory scrutiny since at least 2021 when Coinbase disclosed receiving a warning from the U.S. Securities and Exchange Commission (SEC) regarding the potential classification of a prospective investment product as a security.”

The absence of deposit insurance and the allure of high-yield investments created a volatile environment prone to runs and financial crises. Policymakers must prioritize investor protection and uphold the stability of the crypto-asset market by addressing these concerns.