The regulators are signaling that they want more control an expanded cryptocurrency universe that has penetrated Wall Street operations without the investor and consumer protection that traditional securities and financial services offer.
The catch: In contrast to the securities and derivatives markets, no single regulator controls crypto exchanges or brokers. Regulators only intervene if they believe US law applies to a particular cryptocurrency or transaction based on the way the asset was sold or traded.
Once a whimsical asset that required navigation through specialized exchanges, cryptocurrencies can now be easily purchased from apps through mobile apps
PayPal stocks Inc.,
Cash app and Robinhood Markets Inc.
“There’s a lot more money being invested, a lot of trading, and usage seems to be expanding,” said Dan Berkovitz, a commissioner for the Commodity Futures Trading Commission. “I see concerns about a shadow financial system developing and that should be a question for all regulators.”
Securities and Exchange Commission chairman Gary Gensler told House lawmakers that investor protection rules should apply to crypto exchanges, similar to those that cover stocks and derivatives. Regulated exchanges are required by law to have rules that prevent fraud and promote fairness. But crypto exchanges don’t have such a standard, Gensler said at the Piper Sandler Global Exchange and FinTech Conference last month.
“If you go to one of these exchanges, you don’t know whether the order book is showing the bids and offers correctly,” said Gensler. “You don’t really know if there is front running. They don’t know whether part of the reported trade is real or fake. ”Front running involves misusing customer information to trade for one’s own benefit.
Consumers said they lost nearly $ 82 million to crypto scams in the fourth quarter of 2020 and the first quarter of 2021 more than ten times the amount from the same half of last year, according to the Federal Trade Commission. Much of the losses came from scammers targeting retail investors on social media, the FTC said.
The House of Representatives Financial Services Committee recently formed a working group of 12 Democratic lawmakers to look into possible legislative changes for digital assets, such as a supervisory regime as recommended by Mr Gensler.
Lawmakers are still learning about the industry, but many Democrats welcomed Mr. Gensler’s appeal, said Rep. Jim Himes (D., Connecticut), a member of the working group. “For centuries there has not been a single evidence that new financial systems or new currency systems grow organically without regulation and produce good results,” he said.
Cryptocurrencies have developed with practically no regulation. In 2014, then Federal Reserve Chairman Janet Yellen said The central bank had no authority regulate Bitcoin or similar cryptocurrencies. At the time, the total market value of Bitcoin was $ 4.3 billion. It is now valued at about $ 622 billion, with millions of individual investors and a handful of publicly traded companies including
Hold Bitcoin or similar cryptocurrencies.
The Treasury Department, now headed by Ms. Yellen, is currently considering whether its powers to regulate payment networks could apply to some crypto assets. One possible tool: using the Financial Stability Oversight Council, a body of top regulators led by Ms. Yellen, to target crypto assets like cash-backed stablecoins that some regulators believe could become a source of systemic risk, so people familiar with the discussion. Such a move would allow regulators to set rules for these activities and give the Fed authority over stablecoins.
Some policymakers have said that stablecoins could fuel financial panics if users question the value of the underlying collateral. “It will be virtually impossible for the Treasury Department and FSOC not to study the financial stability risks of digital assets and how to use their agencies to address those risks,” said David Portilla, a former Obama-era Treasury Department employee now partner at. is Cravath, Swaine and Moore LLP.
The diverse forms and uses of crypto make it difficult to assign the entire asset class to a regulator. Some coins make payments easier, while stablecoins replace national currencies and make it easier to switch from one crypto asset to another. Others reward programmers who validate transactions on blockchain networks or develop new applications.
Right now, the SEC is the de facto overseer of the industry. But its regulatory model frustrates crypto companies who say that investor protection rules don’t always apply to the use of cryptocurrencies. For example, the SEC has not made it clear how brokers can keep crypto assets that are considered securities safe because the method of custody differs significantly from holding stocks.
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The SEC’s enforcement actions have also rocked the market, creating uncertainty about whether assets were legally issued and traded. The SEC last year sued Ripple Labs Inc., the company behind the cryptocurrency XRP, claiming the sale violated investor protection rules. At the time, XRP was the third largest cryptocurrency in the world by market capitalization. Ripple denies the SEC’s claims and is fighting the agency in federal court.
Crypto firms say regulators should write rules that fit their industry, rather than relying on enforcement measures to set precedents. In the absence of federal regulations, some companies have committed to a code of conduct modeled on a model developed for the global foreign exchange market, said Michelle Bond, executive director of the Association for Digital Asset Markets, which developed the framework.
“There needs to be a high level of regulatory engagement,” said Ms. Bond. “Attempts to regulate digital assets will hardly be successful without engineers, developers and programmers, because the technology can be very complicated.”
Newer crypto innovations are likely to further challenge traditional regulation. Peer-to-peer networks, for example to exchange digital tokens or to enable investors to earn interest on their deposits, are gaining market share. The networks function like stock exchanges, but do not hold investor assets.
These decentralized exchanges, or DEXes, lack traditional regulatory touchpoints like the involvement of brokers who earn fees by connecting people who want to trade.
Mr Berkovitz, the CFTC commissioner, said in a speech last month that some activities on decentralized exchanges, such as trading in derivatives, may be illegal. Selling of commodity futures contracts in the United States must generally be in regulated markets regulated by the CFTC.
“There are organizations that review the Code, but can you really trust that a private entity is looking out for the public interest?” Said Mr. Berkovitz. “Traditionally, this has been a government job to judge whether these things are in the public interest.”
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