Cryptocurrency Regulators Rush To Create First Major Rules

WASHINGTON — After largely standing aside for years as cryptocurrency grew from a digital curiosity into a volatile but widely embraced innovation, federal regulators are racing to address the potential risks for consumers and financial markets.

As both established and new firms rush to make a profit out of the huge cryptocurrency wealth, their concerns only grow.

The Treasury Department and other agencies are now focusing on a rapidly growing product called a stabilize coin, which is the first target for tighter regulation.

Stablecoins, which are issued by many firms that are not well regulated under a patchwork state rules, act as a bridge between traditional economic markets and cryptocurrency markets.

Stablecoins are supposedly equal in value to the US dollar, gold, or any other stable asset. The idea is to make it easier for people holding cryptocurrency — which is notorious for its frequent price swings — to carry out transactions like purchasing goods and services, or to earn interest on their crypto holdings.

Regulators are increasingly worried that stablecoins may be unstable as they have seen a rapid increase in use. This could lead to a digital-era financial crisis. Just this year, dollar-tied stablecoins such as Tether token, USD Coin and Pax Dollar have jumped from $30 billion in circulation in January to about $125 billion as of mid-September.

“It is important for the agencies to act quickly to ensure there is an appropriate U.S. regulatory framework in place,” Nellie Liang (under secretary of Treasury), is leading the effort.

The push by the Biden administration to exert some control over stablecoins is the leading edge of what is likely to be a far more expansive debate over the government’s role in regulating cryptocurrencies — a topic generating increased concern in Washington.

“I have seen one fool’s gold rush from up close in the lead-up to the 2008 financial crisis,” Michael Hsu, the acting comptroller of the currency said, in remarks on Tuesday. “It feels like we may be on the cusp of another with cryptocurrencies.”

Although cryptocurrency is primarily used as a tool for speculation, it is now being used to transform finance and banking. This is causing debates over whether governments should issue their own digital currencies to supplement or replace traditional currencies.

Stablecoins now underpin a growing share of cryptocurrency transactions globally, at a time when the total value of outstanding crypto tokens like Bitcoin is about $2 trillion — roughly the same value as that of all United States dollars in circulation.

Executives in the cryptocurrency industry have been lobbying for changes to the law. In recent weeks, they have been meeting in person and virtual with financial regulators to discuss the new rules. They are largely accepting that federal oversight is necessary.

Regulators are concerned that stablecoin issuers do not have sufficient liquid assets to cover the currency’s value.

In addition to cash and short-term Treasury bonds — which are considered safe and easy to redeem — issuers of stablecoins USDT and USDC, for example, also have at least until recently held reserve assets like unsecured debt in corporations, which is much riskier and harder to quickly turn into cash, especially in times of financial turmoil. That “commercial paper” is entwined with other key parts of the financial system.

Officials from the Treasury Department want to be sure that stablecoin firms are able to deal with large transactions and that customers don’t get into trouble by trying to cash out.

Already, there have been problems. The Solana blockchain, a relatively new network that said it has seen an “exploding” number of stablecoin transactions, suffered a 17-hour outage on Sept. 14. The company blamed “resource exhaustion in the network” that prevented or slowed customers from buying or selling during the crash.

Federal officials said in interviews that they are considering using expansive powers created under the Dodd-Frank law, enacted in the aftermath of the 2008 financial crisis, to initiate a review and potentially declare stablecoins “systemically important,” a finding that would likely subject them to strict federal regulation.

“Regulators really start to care more when risks get greater for society,” Circle, a payments and cryptocurrency company, was led by Jeremy D. Allaire. “You naturally see regulators want to come up with ways to address those risks.”

USD Coin is up 750% this year and has approximately $30 billion in circulation. According to Mr. Allaire, the USD Coin is expected reach over $200 billion by 2023 at its current growth rate.

The Treasury Department will likely issue a report this fall with recommendations as the first step. Industry executives, lobbyists, regulators, and others gave an outline of what they anticipate to be covered in the recommendations. These will serve as a template for future regulations.

They stated that the rules will require that there are sufficient reserves to cover redemption requests and that software systems that handle these transactions are capable of avoiding crashes and slowdowns in dealing with large simultaneous transactions.

They also predicted that new stablecoins will be required to create security systems to protect consumer privacy and data, as well as the creation of new stablecoins. Separately, the Treasury Department is also preparing to impose rules intended to prevent cryptocurrency from being used in illicit activity such as money laundering and tax evasion.

There have been moves to crackdown on the sector.

The world’s most popular stablecoin is USDT, issued by Hong Kong-based Tether; it currently represents more than half the global stablecoin supply. New York State regulators in 2019 opened a fraud investigation into Tether, an inquiry that was settled this year with an agreement prohibiting the company from doing business with customers in New York and ordering it to regularly disclose what types of reserve assets back up its stablecoin.

Circle has already announced plans to voluntarily shift its reserves to more liquid assets as of this month.

There will be winners and losers. Some industry players are better equipped to accept the new rules than others. Others may need to adapt their business models in order to comply with them.

Paxos, a stablecoin issuer, supports regulation of stablecoins. But it is opposed to the use of the powers created under the 2010 Dodd-Frank Act that allows an entity called the Financial Stability Oversight Council — made up of the Treasury secretary, the Federal Reserve chair and 13 other top federal and state financial regulators and financial experts — to effectively extend its reach to stablecoins by declaring stablecoin activity or companies “systemically important.”

But at Circle, its chief executive said he does not object to the designation.

“Large-scale full reserve, asset-backed dollar stablecoins that can be used across the entirety of the internet will be at that point, they will be at that systemic designation,” Circle’s Mr. Allaire said.

Another option is to create a new type of banking charter that addresses all regulatory concerns for stablecoin issuers.

The Securities and Exchange Commission also could use its powers to demand that certain stablecoin issuers with reserves backed by securities — such as commercial paper, bonds or money market funds — register as securities, which would require companies to provide more disclosures to investors.

Gary Gensler (S.E.C.) chair has pointed out that the agency could use its powers to demand that certain stablecoin issuers with reserves backed by securities — such as commercial paper, bonds or money market funds — register as securities. This would require companies to provide more disclosures for investors. chair, has pointed out, the agency did just that with the mutual fund industry in 2016 after a major fund that relied on risky debt collapsed and had to halt customer withdrawals. According to him, cryptocurrency demands similar actions.

“Frankly, at this time, it’s more like the Wild West or the old world of ‘buyer beware’ that existed before the securities laws were enacted,” Mr. Gensler testified.

In an effort to keep the looming regulations from choking off the industry’s growth, industry executives have been fanning out to make their case to cabinet secretaries, Federal Reserve governors, key White House staffers and leaders in Congress from the Senate Banking and House Financial Services Committees, as well as financial regulators.

Trade groups and crypto businesses have been hiring former regulators and lobbyists to advocate for them in Washington.

Representatives from industry and companies met with Treasury Department officials recently. These representatives included stablecoin issuers like Tether, Circle, and Paxos; top cryptocurrency exchanges like Coinbase, Gemini, and old-school and new-school financial service companies like BlockFi and Mastercard.

These industry executives claimed that cryptocurrency, which relies in part on stablecoins to provide banking and payment services to billions more people around the world, is a way to expand access to financial services.

They claim that stablecoins are essential to this vision. It is that picture that American executives painted for El Salvadoran officials and crypto fans all over the world ahead of the Central American nation’s recent adoption of Bitcoin as legal tender.

If regulators severely restrict the growth of crypto through tight new regulations, industry executives say, the U.S. will drive innovation abroad, risk the dollar’s primacy and kill the promise of digital finance.

“If we think back on the 20th century, first you had key innovations like aviation or automobiles,” Tomicah Tilmann, an ex-Senate adviser to President Biden, now works at Andreessen Horowitz, a venture capital company that is a major investor in crypto. “And then you have investments in regulatory frameworks that helped to bring the benefits of those technologies to larger numbers of people.”

Latest News

Related Articles


Please enter your comment!
Please enter your name here