All eyes are on Fed VCS Barr to specify the way forward on crypto regulations

The Federal Reserve’s top regulator is set to deliver his first speech on cryptocurrency oversight this week.

Fed Deputy Chairman for Supervision Michael Barr will provide comments on the topic Thursday morning at the Peterson Institute for International Economics. His address comes at a time when banking regulators in Washington are carving out their positions on digital assets policy guidance.

Fed, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency issued two joint statements on crypto risk management during the first eight weeks of 2023. While not binding, the statements have raised concerns among industry participants about a de facto ban on banking involvement with crypto.

Barr is not expected to deviate from the skeptical stance regulators have taken in recent weeks, but both proponents and opponents will analyze his words to see if they leave any daylight for crypto to enter the banking system and under what conditions.

Cody Carbone, vice president of the Chamber of Digital Commerce, a crypto lobbying firm, said he expects Barr to stick to the Fed’s stance of neutrality and note the need to foster innovation, while still focusing heavily on the risks involved in crypto and the need. to rein them in.

Carbone said he will listen for any indication from Barr that the Fed’s support for innovation in the crypto space is more than lip service.

“If you see opportunities, put your money where your mouth is and make some proposals, work with industry to make sure those opportunities happen here in the U.S. and that they’re done in a safe and secure environment within the U.S. regulatory system,” he said . “We just haven’t seen it. It’s all been about risk.”

Meanwhile, those who favor the regulator’s efforts to keep banks’ exposure to crypto to a minimum will be looking for more of the same from Barr.

“The most important thing for the financial regulators to do, including, importantly, the Fed, is to hold the line and continue to ignore the pressure from the crypto industry and their political allies to save crypto by giving them an unwarranted and dangerous access to Fed facilities and interconnections with the banking system,” said Dennis Kelleher, head of the consumer advocacy group Better Markets. “There is literally no legitimate, legal use of crypto, and most of the crypto activity is currently the illegal offering, sale and trading of unregistered securities and commodities.”

Barr has touched crypto a handful of times as part of broader speechesin one-off remarks during public appearances and period testify before lawmakers. His comments have generally focused on the risks associated with digital assets and the need for better oversight in the space, although he has insinuated that they belong under the jurisdiction of other agencies, such as the Securities and Exchange Commission and the Commodity Futures Trading Commission.

In October, Barr dedicated part of his speech to “Managing the Promise and Risk of Financial Innovation” to crypto-assets. In it, he said it was important to ensure that the activities in the space were regulated in accordance with similar activities taking place in regulated markets. The concept of applying similar regulation to similar activities has received support from both ends of the Fed Board of Governors’ ideological spectrum.

Barr also flagged the risks of banks holding a concentration of crypto-backed deposits, including their susceptibility to volatility given the interconnectedness of the digital asset sector. In particular, San Diego-based Silvergate Bank, a Fed-supervised state member bank which focuses cryptobank, was subject to this exact type of deposit run just weeks after Barr’s remarks, amid collapse of the cryptocurrency exchange FTX

The Fed, FDIC and OCC issued a joint statement on management of liquidity risk in crypto deposits last month.

During FTX’s fall in November, Barr testified before the Senate Banking Committee along with the heads of the FDIC and OCC. He told the committee that the episode talked about potential systemic risks which could occur “if interconnections are developed between the cryptosystem that exists today and the traditional financial system.”

Barr and other banking regulators often credit the limited connections between banks and crypto companies with preserving financial stability during crypto’s turbulent year in 2022.

Kelleher said the regulator’s efforts to keep digital assets at arm’s length from the banking system likely averted a crisis on the scale of the 2008 subprime crisis.

“That would have meant contagion and bailouts, and that didn’t happen because these regulators resisted the pressure and put the public interest in safety and soundness first,” he said. “Our view is that they have done an unrecognizable, wonderful job of protecting the American people, and they should continue to do so.”

Others worry that this strategy will allow risks and illegal activities to build up in parts of the economy beyond the reach of regulators.

Bryan Hubbard, an independent consultant to financial firms and a former spokesman for the OCC, said he is concerned that this approach could lead to regulatory gaps and blind spots that could lead to spillovers into the traditional financial system.

“It’s very dangerous to, instead of finding a way for banking-like activity to happen in the full sunlight of the banking area, instead of making it happen in dark corners,” Hubbard said. “What I’m looking for is regulators that provide a path for existing banks to engage with new technology that their customers can benefit from, and for companies that are engaged in new financial intermediation to be able to engage with banks in a way that enable them to conduct business in a safe and sound manner.”

Barr’s latest comments on crypto regulation came during a question-and-answer session with Michael Strain, director of economic policy studies at the American Enterprise Institute on December 1. During that call, Barr said some of the volatility in the crypto sector could have been dampened. through regulation and that even if the links between the banking system and digital assets are few, it is worth investigating how they can be managed for the best possible protection of financial stability.

Still, Barr also noted that whatever approach the Fed takes, it won’t be one that tries to shut down the digital asset sector entirely.

“It’s important for us not to set up a regulatory environment that stifles innovation. Innovation is really critical to the financial sector. It’s critical to the American economy. One of the reasons we have an incredibly vibrant economic system is because we allow, encourage , allow that kind of innovation,” he said. “And so we have to find the right balance. We have to have really good guardrails, so that investors and consumers are protected, so that the safety and soundness of the financial system is protected. And then we have to allow innovation to flourish within those guardrails, so that we not locking in old technology or incumbents. And getting that balance right is very, very difficult. We clearly don’t have it right now in the world as we see it.”