Yesterday the U.S. Financial Stability Oversight Council (FSOC) published a report on Digital Asset Financial Stability Risks and Regulation. It identified three regulatory gaps and made several recommendations.
The first issue is that cryptocurrencies not classified as securities lack a direct regulator. Hence it proposes that Congress enact legislation to close that gap. While not suggesting which regulator is appropriate, the report notes that the Commodity Futures Trading Commission (CFTC) primarily has experience in dealing with wholesale markets as opposed to retail investors.
While the CFTC has responsibility for crypto derivatives, it can only take enforcement action in the cash market if there’s manipulative or fraudulent behavior, but it’s not the cash market supervisor or regulator. The report was careful only to classify Bitcoin as a non-security crypto-asset, referring to “possibly other crypto-asset that are not securities.”
In the meantime, Congress has already taken steps in that direction with Senator Stabenow’s proposing a Bill on regulating digital commodities such as Bitcoin, the Digital Commodities Consumer Protection Act, which has already had a reading before the Senate Committee on Agriculture.
The second regulatory gap is one of regulatory arbitrage and a lack of oversight by any regulator over a cryptocurrency platform that might have multiple subsidiaries.
Thirdly, most cryptocurrency exchanges and other platforms deal directly with retail investors. Not only does this raise consumer protection issues, but also financial stability issues. With conventional assets, there’s a split of activities between the exchange and broker dealers. The biggest risk relates to leverage which is usually provided by broker dealers rather than the exchange. The FSOC is concerned with leverage on crypto exchanges.
“Automated liquidations without appropriate regulatory guardrails are likely procyclical, exacerbating balance sheet distress at a time of falling asset values and potentially creating a cascade of automated liquidations,” says the report.
The CFTC has already started exploring the topic of exchanges dealing directly with the public, following a submission from FTX US, which has a derivatives license through its subsidiary LedgerX.
Yesterday’s FSOC report makes ten recommendations, including ongoing enforcement. We did not see a call for clarity about which crypto-assets are considered securities, and that wouldn’t be a stability issue anyways.
The top recommendations were:
- pass legislation to provide oversight over spot cryptocurrency markets
- legislation over stablecoins
- legislation allowing a regulator to have oversight over an entire crypto platform, including visibility and supervision of subsidiaries and affiliates
- service provider regulation
- to study the potential vertical integration of crypto-asset platforms.
FSOC’s ten voting members includes the heads of all the major financial regulators, including the Treasury, Federal Reserve, SEC, CFTC, OCC, FDIC.