Crypto, which was born during the 2008-2009 financial crisis, is about to see how it handles the next one.
That is something Michael Gronager, CEO of blockchain data firm Chainalysis, finds very interesting, he told PYMNTS recently.
“The idea was, basically, to build this very transparent value transfer network — non-censorable, everyone had access, very open and so on,” he said. Fourteen years later, he added, “here we are again.”
The first cryptocurrency, bitcoin, was very much a response to the sub-prime mortgage crisis and what its anonymous creator, Satoshi Nakamoto, saw as the corrupt behavior of the traditional financial system and the complicity of the governments and regulators that were supposed to be overseeing them. The very first bitcoin block mined on Jan. 3, 2009, had a note attached that cited a headline from that day’s Times of London as a sort of timestamp — pointedly, it was about a British bank bailout.
Gronager, whose firm specializes in tracking cryptocurrency transactions along the blockchain, often for law enforcement investigators or companies chasing stolen funds, said that “the initial thoughts around crypto were that this is behaving like gold, digital gold.”
That argument was widely embraced for several years, until it became clear that bitcoin and the broader crypto market was following the stock market — particularly tech stocks — and was “driven by a lot of the same mechanics,” Gronager said.
“So, when the market took a correction on its traditional financial side, we also saw correction in crypto, which to me almost indicates that it wasn’t really a crypto crash, it was just a market crash,” he said. If crypto got hit harder, he suggested, part of it was that people who had both needed liquidity quickly, and crypto provided that.
Gronager also said that looking at the crypto market will show that while small retail traders might be selling, “traditional big holders, they actually buy the dip. People who’ve been long in crypto and still have high conviction and they’re actually buying more.”
Maturing Markets
One big difference, he added, is that the crypto market is a lot more mature than during previous bear markets, such as 2013 and 2018.
The crypto market had a lot of problems at those times, Gronager noted, “There was hardly proper compliance. There was concern around criminal activity. The companies in the space were relatively small” and there was very little participation from traditional financial firms.
“If you look at it today, you will find big payment companies have entered the space” like Block and PayPal, even traditional financial firms like Bank of New York Mellon, Gronager pointed out. “That’s a big, a big change — a lot of the problems that needed solutions have been solved over the last 10 years or more specifically over the last couple of years.”
At the same time, he added, crypto is now seen as not just a payments instrument competing with credit cards and NFC payments, he said.
“What people have realized is that there are so many other opportunities in the crypto space in terms of building other financial instruments … that’s more likely an area for growth than in the payment industry,” Gronager said. “I still think payments are important, and I would probably say the most important payments where crypto is being used today is clearly in remittances and cross-border transfers, where there’s a lot of friction.”
Stablecoins Now
Still, the problem with crypto payments, Gronager said, is that if you’re a retailer and want to buy things or get a salary paid, you probably want an instrument that’s tied to how you pay taxes — a national currency.
“Basically, you want to use a stablecoin or CBDC,” he said, referring to central bank digital currencies. “There’s not really a lot of use cases that are not solved” by those digital currencies.
That said, one big difference between the two is that stablecoins have been among the fastest-growing and most-traded assets in the crypto space, while CBDCs don’t really exist yet, other than a few small, fledgling ones, he said. (Although the eventual launch of China’s digital yuan will change that.)
As for stablecoins, Gronager said he views them as “tokenized dollars,” which both makes them very strong and “paves the way for tokenizing other assets.”
While stablecoin regulation has become a key focus of governments, regulators and elected officials over the past couple of years, that it something, he said, that the crypto industry “has been longing for.”
By regulating something, Gronager said, you are endorsing it. “You’re basically saying, this is accepted,” he added. “This is something we do, this is how we do it, and these are the common rules” so companies “know what they can do and how they can best operate.”
Pointing to New York’s BitLicense — which was very unpopular in the industry due to the difficulty of meeting its requirements — Gronager said it nonetheless made New York “the biggest center for crypto worldwide.”
A Long Slog
As for U.S. regulation, Gronager suggested that he thinks it might take longer than some people in industry hope, despite talk of a comprehensive crypto regulatory framework being passed next year.
“I was part of a lobbying group around the Fifth Anti-Money Laundering directive” in the EU, he said, noting that building a proper regulatory framework started in 2015. “It took four to five years before anything actually became law and rolled out.”
One of the areas most in need of regulatory clarity, he said, is whether cryptocurrencies are securities and how that classification is defined. That has been a big bone of contention, with the U.S. Securities and Exchange Commission (SEC) saying nearly every cryptocurrency except bitcoin is a security, and the industry arguing that they are more like commodities.
“It’s still somewhat of a gray area and it’s something that needs more clarity,” Gronager said, adding that from his perspective “if you look at underlying protocols like bitcoin, like ethereum, like other things, I would clearly call them commodities more than securities.”
But it very much depends of the underlying use cases of the tokens associated with any particular project, he added. Which is exactly what the broader crypto industry says, and what the SEC currently disagrees with.
Settling this question “is not close,” Gronager predicted, saying it hasn’t mattered much in traditional finance because there weren’t “a lot of securities that were, I would say, accessible by a huge crowd of investors,” in the way that cryptocurrencies are.
Another big area of regulatory focus is and needs to be decentralized finance, or DeFi, he said.
Follow the Money
Gronager’s firm recently called 2022 the biggest year for crypto hackers yet, noting that more than $3 billion has been stolen — the vast majority of it from “bridge” projects developed to facilitate cross-blockchain payments.
These bridges, he noted, automate the process of changing one cryptocurrency to another without having to go actually trade it on an exchange. They do this by locking crypto into a wallet that lets users take out another cryptocurrency for a specific transaction, and then return it in exchange for their original tokens.
North Korean hackers have taken particular advantage of bridges, he said, noting that they are thought to be behind more than $1 billion in thefts.
“What’s happening here is, of course, it’s new technology being rolled out” mainly in 2021 “when the market was growing like crazy,” Gronager said. “When things grow very, very fast, people become very focused on getting things to market very fast.”
When that happens, “the risk of making mistakes, not having audited the code enough, not having thought [the project] through well enough” increases, he said. “Certainly you will see hacks.”
What is needed, Gronager said, is not just better security for those projects, but “better ethics around ensuring that security is high.”
Say Freeze
At the same time, he said, with proper investigations into these cases, freezing of stolen funds is possible.
Chainalysis is typically “able to reach out to our networks of crypto exchanges when hacks happen and freeze funds,” he said. “When funds are frozen in an exchange, they can actually be given back to the project from where they were stolen. And at the same time, it disables the hackers from actually [off-ramping] the funds.”
Pointing to the $625 million Ronin Network bridge hack in March, Gronager said that about 10% has been recouped and paid back to the victim.
“The majority of the funds still haven’t been laundered,” he added. “They still sit on the blockchain and can’t be moved because we are on the loop. If they move into an exchange, they might get frozen. So it’s very hard for the hackers to move them from there. So things are being done in this space to prevent it, but it has been a bad year.”
At the same time, he pointed back several decades to the rollout of Windows 95, which was on almost every computer.
“If you just opened an email — not even opening it, just looking at the preview of the email, your computer could get hacked,” Gronager said. “Suddenly your computer could be taken over, some of these hacks could actually ruin your hard drive, they could steal important information.”
What that did not do, he added, was stunt the growth of the internet.
“At the same time as the internet was growing, a lot of companies were building security,” like anti-virus scanners, he said. “Today the operating systems are far more stable, far more secure than they were in the late ’90s and early 2000s.”
That is where the crypto industry is today, Gronager said.
“The technology is young,” he said. “It’s less than 10 years old for the most part. And it’s still being hardened by the day.”
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