Don’t let the crypto winter go to waste

by Arthur · September 20, 2022

The cryptocurrency market has given American policy makers the opportunity of a lifetime. Less than a year ago, it was on the verge of becoming a systemic threat, gathering followers, influence and political influence faster than regulators could catch up. Then the danger miraculously disappeared: the market imploded before it reached critical mass, entering the “crypto winter” that persists to this day.

This deadline may not last long. Politicians should act now to introduce some much-needed regulations to this market.

The problem areas are clear. No. 1 are stablecoins, or digital tokens that pretend to be worth a dollar and are used by speculators to gain leverage or to park funds between bets. At their peak, such coins had attracted more than $160 billion, which their issuers invested in assets ranging from corporate debt to Bitcoin to nothing at all. The danger is that a sudden loss of confidence could trigger an exodus, as happened with the Terra stablecoin in May. The more regular assets issuers have, the greater the chances of broader disruptions — for example, in markets that real companies rely on to pay wages and raise working capital.

Another threat arises if commercial banks are exposed to crypto, either directly or via lending to companies and hedge funds. If, for example, major banks had been among the creditors of the now-bankrupt entities Celsius or Three Arrows Capital, which at their peak had tens of billions of dollars in combined liabilities, the crypto meltdown could have done much more damage. Fortunately, regulators appear to have averted such an outcome and remain vigilant, although they have yet to enact any formal rules.

Beyond that, myriad digital tokens and trading venues—including major exchanges operated by Coinbase and Crypto.com—mostly do not meet the same standards of consumer protection, disclosure, governance, security, and soundness that traditional assets and financial intermediaries do. . The market is therefore rife with hacks, manipulation, self-trading and outright fraud, as regulators such as the Securities and Exchange Commission and the Commodity Futures Trading Commission struggle to figure out how to respond and who should be responsible for what.

Ideally, Congress would impose some order. There are plenty of bills, some of them good. A bipartisan bill would (reasonably) require stablecoins to be backed with regularly disclosed high-quality assets and establish oversight of crypto tokens and exchanges. That said, it would also complicate matters by creating a new category of “linked assets” for certain digital tokens, and include questionable measures such as tax breaks for the “miners” who process blockchain transactions. With midterm elections looming, lawmakers are unlikely to move forward anytime soon.

Officials don’t have to wait for Congress. Banking regulators, in turn, have the power to create a limited charter for stablecoin issuers: Those who met the necessary standards, including for assets and governance, could receive privileges such as access to accounts with the Federal Reserve; others would face strict scrutiny and possible sanctions. Authorities may also adopt strict capital requirements, to ensure that any exposure to crypto is funded with equity that banks can afford to lose.

When it comes to tokens and exchanges, the SEC and CFTC should work together. It hardly matters whether a thing is called a value or a commodity, as long as some semblance of transparency and accountability is established. To that end, former CFTC Chairman Timothy Massad and Harvard Law School professor Howell Jackson have a promising proposal: the agencies should create an industry-funded organization (similar to the Financial Industry Regulatory Authority) that would set reasonable standards for all relevant crypto instruments and institutions. As with stablecoin issuers, entities that do not comply will face legal consequences.

The technology underlying crypto may yet provide benefits, but the speculative frenzy surrounding it still has the potential to do a lot of damage. Rarely in history has the authorities been given a second chance to avert such an obvious threat to the financial system. Don’t let it go to waste.