Crypto stocks like Coinbase continue to rise. If the rally can last.

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Bitcoin might be one of the best performing investments this year, but some crypto companies’ prices are putting it to shame. Tread carefully Uncle Sam may soon crash the party.

Bitcoin is up around 65% in 2023 to $27,350. This is after the oldest cryptocurrency limped off to 2022 as a series of scandals and bankruptcies sent the industry into a tailspin. Few expected token prices to recover so quickly. Some analysts have attributed the recent run since March to the regional banking crisis, which proponents of the token say strengthens the case for bitcoins as an alternative to the traditional financial system.

But the performance of the tokens pales in comparison to some of the companies that do business there. Crypto trading platform Coinbase Global (ticker: COIN) has soared 81% to $60.94 so far this year. Shares of Bitcoin miners Marathon Digital Holdings (MARA) and Riot Blockchain (RIOT) rose 192% and 254%, respectively.

Even enterprise software company MicroStrategy (MSTR) whose CEO Michael Saylor stepped back from the lead role in recent years, the crypto downturn has more than doubled this year to $310 per share, backed by the company’s large bitcoin holdings.

Investors who rely on these gains to continue over the long term should take this into account. Crypto companies depend on both token prices continuing to rise and their ability to continue making money from the market. These two pillars are threatened.

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On a symbolic level, recent gains have largely been driven by the same factors that have helped all risky assets: the prospect that interest rates are about to stop or even start to fall.

Higher rates tend to hurt investment returns with the least prospect of short-term profit. By design, Bitcoin and other crypto tokens generally do not generate revenue. Proponents say Bitcoin will one day be widely used as a store of value, and other tokens will eventually have practical value as their blockchains become useful to the real world. But since those days still seem distant, higher rates have an outsized negative impact on returns, as they do on other higher risk investments.

So this year, the prospect that the Federal Reserve is nearing the end of its rate hike campaign has been a huge boost for token prices. The problem now is that the tailwind has probably passed. Investors have not only priced in a pause in rates, but expect the Fed to begin cuts later this year. It’s a risky bet, and if discounts aren’t in sight, token prices could turn to a dime.

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Any indication of further rate hikes could lead to sideways trading in crypto assets until there is more clarity, analysts at Compass Point Research & Trading said in a note last week.

The second big problem for crypto companies extends beyond token prices themselves and into a regulatory sphere that is as negative for the industry as it has ever been.

Even since the crash of FTX last year, the tone in Washington has changed from one where they were open to talking about crypto to one of We really want to stamp this out,” says Fred Thiel, CEO of Marathon Digital Holdings . Although I am no conspiracy theorist, there is certainly a concerted effort, coordinated or not, from different branches of government to put pressure on the industry.

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To wit, last week the White House proposed a 30% tax on electricity used by crypto miners, a move the Biden administration has said is necessary to offset the environmental impact of mining. The miners, for their part, say their practices encourage the development of sustainable energy sources and help power companies sell excess energy that would otherwise be wasted.

For crypto platforms like Coinbase, the biggest threat comes from the Securities and Exchange Commission, which in March sent the company a notice saying it is likely to sue the company for securities violations. Although the company said the agencies target was not entirely clear, executives say they believe it is likely looking at the tokens it lists, as well as the products it offers to customers who generate yield. Coinbase has long denied offering securities on its platform.

Coinbase executives on an earnings call last week noted that the smaller tokens and staking products the SEC might target represent a relatively small portion of the company’s current earnings. However, analysts who cover the stock have seen the yield business as one of the company’s most promising growth areas.

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We continue to believe that retail crypto volumes will remain weak and the regulatory overhang will persist for some time, BofA Global Research analysts wrote in a note after the earnings report. Analysts rate the stock Underperform.

And while last year it seemed there was growing support in Congress to pass legislation that could limit the powers of the SEC, now crypto-skeptics seem to have the upper hand and are applauding the crackdown.

The problem isn’t regulatory ambiguity, it’s massive non-compliance, Rep. Stephen Lynch (D., Mass.) said during a hearing Wednesday.

This is not a good sign that crypto firms will get Congressional protection from enforcement agencies and certainly not a good environment for their profits as long as scrutiny continues.

Whether it’s a rude awakening from the Fed on token prices or an SEC assault on corporate profit centers, risks for crypto stock investors abound.

Email Joe Light at [email protected]

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