The Brookings Center on Regulation and Markets and the Hutchins Center on Fiscal and Monetary Policy recently hosted “The future of crypto regulation,” which was presented by Commodity Futures Trading Commission (CFTC) Chairman Rostin Behnam. Benham’s keynote was followed by a discussion with experts representing a range of perspectives, including regulatory agencies, academia and industry. Here are five takeaways from the event, which you can watch in full here.
1. Higher levels of retail participation in crypto than traditional commodity markets pose unique challenges for regulators.
One in five Americans report having traded cryptocurrency, and polls suggest that crypto trading is more common among younger adults, men and racial minorities. This is quite different from other financial instruments regulated by the CFTC, Benham noted. “You’re going to have more vulnerable investors … It’s our duty to educate, to inform, to disclose the risks involved.”
Michael Piwowar, a former Securities and Exchange Commissioner and now executive director of the Milken Institute Center for Financial Markets, linked increased attention from Congress to growth in retail crypto: “If you have one in five households that have interacted with crypto… [members of Congress] are going to start hearing it from their constituents.” Legislation to regulate digital assets has been introduced by Senators Lummis and Gillibrand, Stabenow and Boozman, and Toomey, as well as Representative Gottheimer. Treasury is actively negotiating bipartisan stablecoin legislation with House Financial Services Committee Chair Waters and Ranking Member McHenry. Benham said stablecoins, digital currency meant to always be equal to one dollar, are more of a “payment mechanism” and should therefore be regulated by banking regulators.
Digital asset regulation may require addressing crypto exchanges and digital wallets. American University Law Professor Hilary Allen noted that the stablecoin legislation under discussion does not, saying, “There is a gaping hole… Almost every major stablecoin… is affiliated with an exchange that profits from trading that stablecoin.” Mark Wetjen, a former CFTC commissioner and current head of policy and regulatory strategy for FTX (one of the largest crypto exchanges), agreed: “The exchanges are the gateways to the whole crypto space, and so their oversight is probably the most important.” He pushed back. that there was no current regulation, noting the requirement for state-level licenses such as New York’s Bitlicense: “If you want to list derivatives on bitcoin, for example, you need a license … so it might not as serious as situation.”
2. Crypto challenges the traditional regulatory distinction between securities and commodities.
Traditionally, the SEC regulates securities while the CFTC regulates commodities and derivatives. Whether crypto is a security or a commodity remains unclear, as various sub-components of the crypto ecosystem challenge existing regulatory divisions. For example, the SEC recently claimed that nine different crypto tokens were securities in an insider trading case, while a federal judge ruled that virtual currency like Bitcoin constitutes a commodity.
Benham asked Congress to clarify which of the hundreds — if not thousands — of coins in existence are securities versus commodities: “Ultimately, we want to see the law draw lines.” Piwowar said the lack of clarity creates unwelcome delays as many crypto-related applications before the SEC “don’t get an answer” as to whether their products represent securities. The result is that some crypto firms are “going outside the US” to locate their business. However, Allen warned that Congress’s action could also be an indication that the government is supporting crypto. She warned against letting crypto into the regulated sphere for fear of giving it “implicit guarantees.”
One solution to the regulatory battle could be to merge the SEC and CFTC, which Piwowar supported, as did many others. However, Congress has shown little appetite to do so given the various congressional committee jurisdictions involved.
3. The CFTC will restructure to better protect consumers and more effectively regulate markets.
Benham announced several changes at the CFTC during the Brookings event. First, LabCFTC will become the Office of Technology Innovation, reporting directly to the Chairman’s office. Behnam justified this by saying, “We’re past the incubator stage, and digital assets and decentralized finance technologies have grown out of their sandboxes.” Second, the CFTC’s Office of Customer Education and Outreach will be reorganized within the Office of Public Affairs, which Behnam said will “leverage resources and a broader understanding of the issues facing the public to address the most critical needs of the most vulnerable communities.” Restructuring in a regulator may seem like a bureaucratic shuffle, but may reflect changes in internal power, agency focus and prioritization. Direct reporting to the chairman increases an office’s authority and prestige.
4. Is crypto a passing fad (or worse, a bubble threatening financial markets)?
Allen argued that crypto is “intentionally less efficient and more complicated than a more centralized system,” and has no societal value. FTX’s Wetjen disagreed: “The difference here with blockchain as the underlying way you can transfer value is that there are absolutely no gates.” Piwowar largely agreed with Wetjen that “We’re going to have the new generation of Amazons and Googles coming out of these things,” but cautioned that while at the SEC, “nine out of ten [crypto applications] were outright frauds, and out of one in ten, nine out of ten were probably frauds.” Since January 2021, over 46,000 people have collectively lost over $1 billion to scams involving crypto.
Everyone wants to avoid a repeat of the global financial crisis of 2008. To do so, regulators have focused on avoiding and reducing “systemic risk” to the financial system. Asked if he sees a “clear and present danger to the existing financial system,” Benham said he did not, pointing out that crypto is not sufficiently interconnected to pose systemic risk. He noted that the decline in crypto values in recent months did not cause ripples in the financial system or the broader economy. Piwowar turned the question of systemic risk back to the actions of financial regulators asking, “What is systemic risk? It’s the risk that a federal decision-maker is going to bail out a bank, either directly or indirectly.” Allen agreed that bailing out crypto would be a mistake, noting: “If anything was going to be capable of failure, it should be crypto, which doesn’t … fund productive economic capacity.”
Allen also noted the similarity in arguments centered on US global competitiveness that promoted lax regulation of derivatives: “It’s almost identical to the rhetoric we saw around swaps in the 1990s.” Credit swaps, like crypto now, faced loose regulation and ultimately fueled the subprime mortgage crisis. Behnam noted that one of 2008’s biggest lessons was the need for the CFTC to promote market transparency in “OTC” [over-the-counter] derived space.” Crypto proponents point to the underlying technology as inherently more transparent, while critics point to the lack of understanding of aspects of the market, such as what makes coins like Tether stable.
5. Does crypto increase financial inclusion?
Proponents of cryptocurrency often cite financial inclusion as a major benefit linking the higher adoption by youth and communities of color who have higher rates of being unbanked or underbanked by traditional finance. Allen warned against “predatory inclusion” and argued that “Because there is no manufacturing capacity behind them, their value comes from finding someone else to buy them from you.” Wetjen’s responded, mixing his experience as a CFTC commissioner with his time in the crypto industry: “From my own experience … at the CFTC, there is enough authority already in place for the agency to … be quite thoughtful and relatively prescriptive , even in terms of what should actually be disclosed to, especially retail investors, or users of a platform like FTX.” He argued that the right policy is “to give people the opportunity to be involved and invest in the space they like, but to make sure it’s done with the right safeguards.”
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