On February 14, the U.S. Senate Committee on Banking, Housing, and Urban Affairs (Committee) conducted an open session hearing entitled “Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets.”
The chosen title of the hearing very clearly highlights two issues that continue to plague the digital asset market: (1) the financial harm imposed on consumers by the continual entry of unsupervised cryptographic-based financial products into the U.S. economy; and (2) the lack of a basic, all-encompassing federal regulatory regime that ensures digital asset-related firms are empowering consumers to make well-founded financial decisions through the provision of transparent disclosures. As Committee Chairman Sherrod Brown noted during his opening remarks, “time-tested financial safeguards can help protect against the harms and risks of crypto products.” These financial safeguards include certain fundamental principles of financial regulation: (1) clear disclosures and transparency; (2) prohibitions on conflicts of interest and self-dealing; (3) protection of customer funds; (4) internal governance and risk management; (5) strong consumer and investor rights and protections; (6) anti-money laundering and fraud prevention; and (7) oversight and supervision. Each member of the witness panel before the Committee provided testimony that examined these principles in some way. However, the witnesses offered varying proposals for how Congress should integrate these principles into the emerging digital asset market.
Lee Reiner, an ex-examiner at the Federal Reserve Bank of New York, noted that “most people invested in crypto simply because they thought they could sell it to someone else at a higher price in the future.” Therefore, Reiner agreed with Securities and Exchange Commission (SEC) Chairman Gary Gensler that “most cryptocurrencies are securities subject to SEC registration and disclosure requirements.” However, Reiner declared that some cryptocurrencies, like Bitcoin, are commodities traded in spot markets that currently sit outside of the purview of either the SEC (which regulates securities) or the Commodity Futures Trading Commission (CFTC) (which regulates commodity derivatives). According to Reiner, although cryptocurrency exchanges are required to register with the Financial Crimes Enforcement Network (FinCEN) as a “money services business,” cryptocurrency exchanges are effectively unregulated at the federal level due to the SEC-CFTC regulatory gap. To mend this gap, Reiner proposed that Congress “carve out [the term] security from the definition of commodity in the Commodity Exchange Act” and “recognize cryptocurrencies as securities under a special definition of securities laws,” which would vest the SEC with exclusive authority to regulate all aspects of the digital asset industry.
Linda Jeng, general counsel and chief regulatory officer at the Crypto Council for Innovation, urged the Committee to consider certain themes when developing a digital asset regulatory framework: (1) empowering consumers; (2) ensuring open markets; (3) increasing efficiency; and (4) lowering costs for consumers. Unlike Reiner, Jeng argued that the “SEC has not initiated any formal rulemaking process to update securities laws that are decades old to account for the unique attributes of digital assets that are determined to be securities.” Consequently, Jeng proposed that Congress “pass thoughtful, comprehensive legislation that establishes a federal regulatory framework for digital assets — addressing both securities and non-securities.” Ranking Member Tim Scott seemed to agree with Jeng’s position regarding the regulatory inaction as he explained “the regulators have permitted activity in this space without providing clear rules of the road, which has unfortunately led to the multiple failures” that acted as catalysts for the Committee’s hearing on Tuesday.
Yesha Yadav, an associate dean and professor of law at Vanderbilt University, chose to focus exclusively upon a burgeoning consumer protection issue during her opening remarks: digital asset custody arrangements. The recent uptick in bankruptcy filings by digital asset-related firms has forced bankruptcy courts to decide how the mechanics of digital asset custody arrangements should function in practice, and the bankruptcy courts’ current stance — irrespective of its legitimacy — has left many consumers without options for recourse. To expedite the implementation of a clear regulatory framework, Yadav proposed that the Committee approve a “self-regulated regime” in which digital asset exchanges “are tasked with oversight of the market as a whole.” According to Yadav, a digital asset-self-regulatory organization (SRO) would achieve three objectives and complement forthcoming Congressional legislation of the digital asset market: (1) oversight, by subjecting the digital asset SRO to the supervision of an existing federal regulatory body; (2) accountability, by imposing monetary penalties on cryptocurrency exchanges that fail to comply with rules promulgated by the digital asset SRO; and (3) stability, as digital asset exchanges that would serve as members of a digital asset SRO would be required to exercise their knowledge and proximity to blockchain technology to make the digital asset industry “much more driven towards protecting customers.”
While presenting questions to the panel of witnesses before the Committee, Ranking Member Scott stated that “consumers deserve to better understand the investment they are making” before those consumers choose to enter the digital asset market. Although the Committee and the witnesses offered differing viewpoints concerning the digital asset market, consumer protection was a recurring theme. As we previously discussed here, the complexities underpinning blockchain-based ledger systems are vast and obscure and the Committee seemed to recognize this reality. Therefore, any future consumer disclosure regime likely will not only be geared towards notifying consumers of the apparent risks associated with digital assets, but will also likely place emphasis on increasing consumer literacy of blockchain technology.