Although a panel of state and federal financial regulators has identified three areas in which new laws could help plug holes in U.S. cryptocurrencies rules, widely seen as a necessary precursor to broader adoption of blockchain-based finance, Congress may not be able to act on them any time soon. That could leave the market overseen by regulators competing for jurisdiction, encouraging the crypto industry to move offshore.
“New technology often requires a fresh look at regulation. It’s clear that we need a regulatory framework for stablecoin and crypto spot markets,” Kristin Smith, executive director of the Blockchain Association, tells Forbes. She is more optimistic than other observers about the outlook for rapid progress “Legislation is moving fast in Congress, and it’s possible we will see something before the end of the year. If not, we expect quick action in 2023.”
With mid-term elections looming next month, however, it is hard to see how legislation could be passed in 2022.
The three areas identified in an Oct. 3 report by the federal Financial Stability Oversight Council, created after the Great Recession that began in 2007, are:
- Spot trading of crypto assets not considered securities
- Regulatory arbitrage, where market participants seek to take advantage of different rules among agencies
- Lack of traditional intermediaries, such as brokers and clearinghouses, in transactions involving retail investors
“There is no state or federal regulator with authority to regulate spot-market trading activity. If done correctly, regulation could provide for better consumer protection and lead to additional investment by institutions,” says Smith.
The report considers spot trading of crypto assets a regulatory gap because the lack of rules could result in conflicts of interest and market manipulation that would be damaging to investors and the economy.
Arbitrage issues arise when “the same activity can be carried out lawfully under more than one regulatory framework.” Consequently, says Smith, the report indicates there could be “a wide range of financial-stability implications if activities that bear the same risks are subject to different rules or if firms can operate in a manner that prevents regulators from assessing the totality of an entity’s risks.”
The third area of concern is the lack of buffers in financial transactions with retail investors. In the stock market, investors are protected by intermediaries such as brokers, exchanges and clearing houses. Many crypto firms offer vertically integrated services that allow retail customers to directly access the markets. According to the report, risk arises from credit, or leverage, provided by the platforms. Automatic liquidations and margin calls raise investor- and consumer-protection issues.
“With legislation, the devil is in the details. We believe the political environment is in a place where legislation is inevitable. The key for us is that we get the legislation done right, and we are willing to take the time needed to ensure that there aren’t any unintended consequences as a result,” says Smith.
With Congress having failed to define rules in these areas, regulators are taking matters into their own hands by bringing actions against crypto-market participants based on the assumption that certain digital assets fall under their jurisdiction.
Last week, Kim Kardasian settled with the Securities and Exchange Commission for $1.2 million for promoting Ethereum
Currently the SEC Chairman Gary Gensler considers most cryptocurrencies to be securities; while he maintains the grandfather of crypto and the largest by market capitalization, Bitcoin
Meanwhile, the Commodities Futures Trading Commission charged Ooki DAO, a decentralized autonomous organization, on Sept. 22 with illegally offering leveraged and margined trades without a know-your-customer program. The CFTC generally oversees commodities, while the SEC is mainly concerned with securities including stocks and bonds.
While the regulators battle for jurisdiction, the financial industry is eagerly awaiting regulatory clarity to incorporate digital assets into its services. Just last week Nasdaq, the second-largest stock exchange in the world, announced that it had no plans of launching a cryptocurrency exchange in the U.S. without clear regulations.
“The education gap in lawmaker crypto knowledge is always a challenge. At the Blockchain Association, we have worked hard to be a resource to members of Congress. This is an ongoing process. Better policymaker education will lead to better legislation,” says Smith.
Although there have been many proposals on crypto regulation, uncertainty remains over what may make Congress act.
Ironically, while the U.S. has no official crypto regulation, it still has some of the tightest crypto rules in the world, according to market information provider Forex Suggest.
The company ranked the U.S. along with seven other countries a five out of five for each of these categories: Legalizing the ownership of crypto, requiring a license for crypto business, taxing crypto as an asset, having crypto widely used to purchase goods and having central banks developing their own digital currency to protect investors by offering less volatile alternatives to traditional cryptocurrencies.
Joining the U.S. with top rankings were Australia, South Korea, the U.K., Denmark, Japan, Norway and Canada.
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