Several groups of US regulators are striving to stake their claim in regard to whether, how, and by whom crypto assets will be regulated
Amid the collapses of Signature Bank and Silicon Valley Bank and the closure of crypto-heavy Silvergate Bank, the U.S. Financial Accounting Standards Board (FASB) proposed accounting and reporting guidance for certain crypto assets.
Current crypto regulation in the U.S. is ambiguous. Capitol Hill outrage produced lively testimony related to the fall of FTX, but little viable regulatory progress has ensued, even as some firms in the crypto industry would welcome guardrails and the ability to participate fully in regulated markets.
Apart from the Internal Revenue Service (IRS), federal agencies are divided in how to regulate this evolving asset class. Unlike the securities and derivatives market, no single regulator oversees cryptocurrency or the brokers or exchanges that trade it.
Further, the current balance of power in Washington will likely delay any meaningful short-term reforms. The House Financial Services Committee and the House Agriculture Committee split oversight of the financial industry and its regulators. In 2022, there were at least 13 bills introduced in the House and an additional 13 bills introduced in the Senate that touched cryptocurrencies, digital assets, or blockchain.
Fed, FDIC & OCC Joint Statements
The Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) have issued several joint statements urging caution on this asset class, focusing on the safety, soundness, and compliance within the banking system.
The agencies’ joint statement issued January 3 notes that key risks for crypto-assets and crypto-asset sector participants of which banking organizations should be aware, include significant volatility in crypto-asset markets, fraud risks, legal uncertainties, and heightened risks associated with open, public, or decentralized networks. While the February 23 joint statement points out that the liquidity risks posed by crypto-assets due to the scale and timing of deposit inflow and outflows.
The Fed continues to regulate and enforce those crypto assets under its authorization purview but regularly signals the need for more coordinated oversight at a higher level. In January, the Fed quickly rejected Custodia Bank’s application for membership in the Federal Reserve System. Custodia is a special purpose depository institution, chartered in Wyoming, that wanted to issue crypto assets.
A March 9 speech by Fed Vice Chair for Supervision Michael Barr signaled the need for additional oversight help: “But obviously there is a set of activities going on that is mostly not in the banking sector. It is mostly outside the banking sector, and other market regulators and Congress need to think about the appropriate role for regulation of those entities.” This is consistent with the Fed’s stance when it issued its January 2021 white paper on the benefits and risks of a central bank digital currency (CBDC).
The Fed made it clear that it does not intend to proceed with a CBDC without clear support from the executive branch and Congress, ideally in the form of a specific authorizing law. On February 7, the Fed’s Board of Governors issued a policy statement clarifying permissible activities by member banks which would “presumptively prohibit” member banks from holding most crypto assets as a principal. Member banks wishing to issue dollar tokens will need to prove certain security measures and receive formal approval prior to their use in banking transactions.
FDIC & OCC
In November 2021, the President’s Working Group on Financial Markets (PWG), along with the FDIC and the OCC, issued a report on stablecoins. The PWG report notes that well-designed and appropriately regulated stablecoins could potentially support faster, more efficient, and more inclusive payment options.
The report also noted that the potential for the increased use of stablecoins as a means of payment raises a range of concerns related to the potential for destabilizing runs, payment system disruptions, and concentration of economic power. The PWG report highlights gaps in the authority of regulators to reduce these risks. To address the risks of payment stablecoins, the PWG report recommends that Congress act promptly to enact legislation that would ensure that payment stablecoins and payment stablecoin arrangements are subject to a consistent and comprehensive federal regulatory framework.
Financial markets regulators
Federal agencies are divided over how to regulate this evolving asset class. Unlike the securities and derivatives market, no single regulator oversees cryptocurrency or brokers. A security subject to the U.S. Securities and Exchange Commission (SEC) oversight is defined in the Securities Act of 1933 and the benchmark interpretation is based on a 1946 U.S. Supreme Court case that resulted in the Howey test. This test established four criteria to determine if an investment contract exists and is subject to U.S. securities laws: investment of money; a common enterprise; to be derived from the efforts of others; and the expectation of profit.
According to legal experts, whether a digital asset qualifies as an investment contract largely depends on whether there is an “expectation of profit to be derived from the efforts of others.” This answer is subject to interpretation, and there is a sharp divide between crypto-entrepreneurs and the SEC. In fact, the U.S. Commodity Futures Trading Commission (CFTC) took an early lead on enforcing cryptocurrencies when it allowed bitcoin futures to start trading in 2017, but its powers are mostly limited to overseeing derivatives.
Absent guidance from Congress, the SEC continues to bring new enforcement actions, mainly on the basis that the Securities Acts of 1933 and 1934 make it clear that digital assets are securities. This has become a major topic of debate in Congress.
Subcommittees from the House Agriculture Committee and the House Financial Services Committee held a joint hearing to discuss The Future of Digital Assets, which mostly covered whether the CFTC or the SEC should have jurisdiction over digital assets but reached no binding conclusion.
Like the SEC, the CFTC is also making some high-profile enforcement actions, including charging Payward Ventures (known as Kraken) for illegally offering margined retail commodity transactions in digital assets and failing to register as a futures commission merchant. The CFTC also charged Digitex and its founder with illegally offering futures transactions on a platform other than a designated contract market and with attempting to manipulate the price of the Digitex Futures native token.
Crypto firms and those financial firms supporting the crypto industry should expect enforcement actions to accelerate by all regulators. Unfortunately, piecemeal enforcement and regulation will continue until Congress passes legislation that authorizes and delegates crypto asset oversight to an appropriate regulatory agency.
The recent bank collapses that were related at least in some way to crypto assets will likely chill the appetite for any legislative efforts to allow crypto players to participate more fully in financial markets and continue innovations, especially around stablecoins.
This post was based a report on U.S. crypto regulation from FORVIS, and a full copy of the report can be found here.