• Despite being a disruptive force, crypto has also seen its own series of bank runs.
• These so-called ‘crypto shadow banks’ may become more destructive in the future.
• US regulators could protect crypto shadow banks from runs or protect the real economy from exposure to them.
Crypto Shadow Banks and Bank Runs
Despite being a disruptive force that pits itself in opposition to traditional finance, crypto has also witnessed its own series of bank runs, and some observers believe future runs of what some call ‘crypto shadow banks’ could become more destructive, according to Matt Levine, an opinion columnist for Bloomberg.
Fractional Reserve Banking and the 2008 Shadow Banking Crisis
The analyst stated that, while cryptocurrencies started as a form of backlash to fractional reserve banking and the 2008 shadow banking crisis, by 2022 the crypto industry had matured to the point that it managed to recreate “both fractional reserve banking (but without regulation!) and a 2008-style shadow banking crisis.” People in crypto did not trust the banks due to their risky practices but still wanted access to their services such as maturity transformation: People with crypto wanted to park it somewhere safe, earn interest and have access to it whenever they wanted; other people wanted to borrow crypto without the risk of having to give it back early.
Crypto Shadow Banks
Levine identifies a number of what he describes as crypto shadow banks, including FTX, Celsius and Voyager among others. Deprived of most regulations these companies were enabled to offer their services aggressively but also tank most of their customers’ money.
Two Scenarios for Crypto Shadow Banks
According Levine there are two ways US regulators could go about addressing this issue: they could either protect crypto shadow banks from runs by covering them with deposit insurance and regulation or make it difficult for traditional financial systems from developing ties with them.
US regulators seem on track towards protecting the real economy from exposure to these ‘crypto shadow banks’ which is likely both preferred by regulatory bodies and those within the cryptosphere itself.