‘Appropriate Regulation’ Needed Over Crypto, Government Report Recommends

A new report published by government regulators and advisors calls digital assets a potential risk to the stability of the U.S. financial system if their scale or interconnections with the traditional financial system were to grow without adherence to “appropriate regulation.”

The Financial Stability Oversight Council released its 124-page report on digital assets today in response to U.S. President Joe Biden’s March 9, 2022, Executive Order, “Ensuring Responsible Development of Digital Assets.”

In September, the White House released its “Comprehensive Framework” for crypto regulation and development in the United States. The FSOC, created in 2010 with the passage of the Dodd-Frank Act, followed that with the report on “Digital Asset Financial Stability Risks and Regulation.”

“Given that most crypto tokens are securities, it follows that many crypto intermediaries are transacting in securities and have to register with the Securities and Exchange Commission (SEC) in some capacity,” SEC Chair Gary Gensler said regarding the report.

U.S. agencies—including the U.S. Department of the Treasury, the Securities and Exchange Commission, and the Commodity Futures Trading Commission—have stepped up their efforts to regulate digital assets over the last year, in what some in the space called “regulation by enforcement,” with cumbersome results.

“Digital assets have grown significantly in scale and scope over recent years,” said Secretary of the Treasury Janet Yellen in a statement regarding the report. “They have attracted a large amount of capital and interest from both retail and institutional investors.

“At the same time, we have seen very significant shocks and volatility within the crypto-assets system, particularly over the last year,” she continued. “With the potential for this kind of instability in mind, at our February meeting, the Council named digital assets as one of its key priorities for the year.”

Currently, the global cryptocurrency market capitalization is $981 Billion, down from $2.2 trillion at the same time in October 2021, a loss of $1.24 trillion, according to CoinGecko.

The report points to four key issues:

• “Acutely amplified instability within the crypto-asset ecosystem,” including a lack of risk controls to protect against run risk or excessive leverage.
• Prices driven by speculation rather than fundamental economic use cases
• Repeated significant and broad declines.
• Crypto tokens associated with entities with “risky business profiles and opaque capital and liquidity positions.”

The report also points to the risk of concentration (centralization) of key services and vulnerabilities.

“This market isn’t so decentralized,” Gensler said. “Now, we see this industry populated by large, concentrated intermediaries, which often are an amalgam of services that typically are separated from each other in the rest of the securities markets.”

In his statement, Gensler reiterated his view that most cryptocurrencies are securities. Gensler has previously singled out Bitcoin as an example of a crypto asset that is not a security, and that should be regulated under the Commodity Futures Trading Commission (CFTC).

“We can’t let this market undermine our broader capital markets or the economy,” he said.

The Council recommends increasing the enforcement of existing regulations and closing regulatory gaps, including increasing its member’s capacities related to monitoring, supervising, and regulating cryptocurrency activities.

In addition, the Council recommends the passage of legislation that would give financial regulators authority over the spot market for digital assets that are not considered securities, as well as give regulators authority to supervise the activities of all of the affiliates and subsidiaries of crypto-asset entities and study potential vertical integration by crypto-asset firms.

“In all, these reports provide a strong foundation for policymakers as we work to mitigate the risks of digital assets while realizing the potential benefits. They also provide a valuable addition to the public’s understanding of digital assets,” Yellen says.