Though investors are sceptical of cryptocurrency regulations and many consumers are even wary of government legislation, many investors support regulation, and many consumers actually appreciate it for maintaining stability in the markets – a sense of security that they believe makes cryptocurrency investments in the first place.
Regulators are forced to respond after high-profile trading platform failures, sharp price declines and data breaches. To act properly, investors must comprehend this situation.
The SEC’s Role
The SEC is a powerful regulator, empowered to enforce certain investor protections on the US stock markets, including cryptocurrency markets. They have the same power to regulate and enforce against cryptocurrency trading as they do against trading in stocks and in mutual funds.
Cryptocurrency regulation may include registering and licensing cryptocurrency exchanges; rules on the order execution of trades; ensuring DeFi platforms comply with AML/CTF protocols; and ensuring wallets comply with cybersecurity standards – the list goes on … not to forget consumer licensing and protection!
The SEC chair Gary Gensler has become widely disliked for taking a harder line on regulation than his predecessors. His agency hasn’t promulgated many regulations per se, but it’s taken actions on enforcement that beef up investor protections. His approach may be controversial, but at least they’ve shown they’re ready, willing and able to apply securities laws broadly to digital assets – whether that proves sufficient remains open to question.
Regulation of Exchanges
Indeed, despite their popular image of being beyond regulation, there are now only a handful of jurisdictions that don’t have rules of some kind over digital currencies. That process has taken a step forward with a refreshed push for regulatory clarity, led by the White House Framework for Responsible Cryptocurrency Regulation. Prior to this effort, a number of agencies – most notably the Securities and Exchange Commission and the Commodity Futures Trading Commission (CFTC) – have undertaken steps toward regulatory clarity.
Some would apply only to crypto exchanges and digital wallets that the SEC perceives as ‘broker-dealers’ because they facilitate ‘buying and selling’ securities ‘for the account of others’ – eg, anti-money laundering/countering the financing of terrorism (AML/CFT) protocols, or reporting requirements for transactions involving multiple customers. Some of the new rules might even reclassify a number of exchanges for behemoths like Elon Musk’s Dogecoin and Jack Dorsey’s Bitcoin and Square’s Cash App as ‘banks’.
Stablecoins pegged to traditional fiat currencies or even some assets and reserves might also be subject to further rules, regarding not only the reserve management and disclosure arrangements, but also how the issuer of the stablecoin manages its finances. The FCA has issued a discussion paper – DP23/4 on systemic stablecoin arrangements. The closing date for comments is 6 February 2024.
Regulation of Tokens
It might be tempting to write off all this Arcane Regulatory Stuff as technocratic Rube Golbergery. But clarity about trading rules matters just as much as anything else to uplift markets, protect investors from massive Ponzi schemes and misrepresentations, and stop the very real seizures of consumer wealth in losses that – in total – would be ‘in the billions’. Crackdowns on crypto by the US Securities and Exchange Commission (SEC) against Ripple and Coinbase, and more than a dozen bankruptcies in the wake of FTX, have now caused the whole world to move dramatically.
More recently, crypto provisions within the 2021 bipartisan Infrastructure Investment and Jobs Act considered cryptocurrency markets like traditional securities markets. Crypto exchanges will be treated like brokers, and will be required to identify their customers and report suspicious transactions. Last year, the Financial Crimes Enforcement Network (FinCEN) classified stablecoins as money.
Yet regulators thus far have been unwilling to offer up clear definitions for digital assets. An agnostic stance might well prove more nimble – as technology changes fast in the marketplace – while a study of how regulation affects the digital asset market showed that tighter regulation for a subset of digital assets created more efficient markets; accordingly, policymakers should be careful not to overregulate digital asset innovation.
Regulation of Lending
Though crypto lending has grown rapidly in the past few years, regulators have been slow to keep up. That may soon change. A wave of SEC activity could reshape the industry in a way that is more protective of US investors.
Most significant is that classification, whether a coin is defined as a security, commodity or currency, might determine a coin’s regulation. Classified as securities and traded on exchanges, SEC might become involved. Classified as a commodity and traded on regulated exchanges, the CFTC.
In the case of crypto lenders, the recent collapse of FTX demonstrated that they run an unregulated business model. It is fairly easy for crypto lenders to set up shop across jurisdictions and market themselves as disruptors who do not place the same restrictions on and use the same capital standards as traditional financial intermediaries. But crypto lenders should be licensed and registered and subjected to prudential requirements to manage liquidity or maturity mismatches and risk-based capital adequacy and supervision – so they actually have the capacity to compete with traditional financial firms on a level playing field.
