The crypto industry is no longer just a backlash to traditional finance as it has recreated both fractional reserve banking and a shadow banking crisis. While people in crypto were initially distrustful of traditional banks, they still wanted the benefits of maturity transformation, hence the rise of crypto shadow banks. However, these companies operate without much regulation and have the potential to trigger bank runs, according to Matt Levine, an opinion columnist for Bloomberg.
Levine identifies several crypto shadow banks such as FTX, Celsius, and Voyager, among others. These companies offer their services aggressively, but also have the ability to tank most of their customers’ money. With these companies becoming more interconnected with the real economy, future runs on them could be more destructive.
Levine presents two potential scenarios. The first is that US regulators could cover crypto shadow banks with deposit insurance and regulation, similar to traditional finance institutions. However, this option seems unlikely as regulators seem to be choosing to protect the real economy from exposure to crypto shadow banks. This would make it difficult for the traditional financial system to develop ties with crypto firms.
The second possible explanation for the lack of liquidity buffers in crypto shadow banks is that their business of lending against volatile collateral was incredibly risky and prone to bank runs. Even if US banking regulators had supervised these platforms, they still would have had runs and gone bust. However, implementing higher liquidity buffers could have mitigated the damage caused by such runs.
In conclusion, while crypto shadow banks offer attractive services to people in crypto, they are also a potential source of risk and instability in the financial system. As such, US regulators are unlikely to provide the same level of protection to them as they do for traditional banks.
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