WHEN Federal Reserve chairperson Jerome Powell said last week that he is not looking to ban cryptocurrencies, a wave of relief washed over its investors. The price of bitcoin, the largest of the digital currencies, surged more than 10%, to its highest level in nearly two weeks.
But, behind the scenes, there's a gathering fear. After allowing the sector to grow from an obscure project to a $2 trillion behemoth, in little more than a decade, Washington regulators are now preparing to unleash a torrent of rules, aimed at bringing crypto to heel.
In recent days, regulators have put the industry on notice. Powell, in the same appearance, indicated he wants to impose federal standards on stablecoins, a type of digital asset that has exploded in recent months and, typically, maintains a steadier price by pegging itself to a national currency. His comments came as details began to leak about a key Biden administration report, expected to recommend that regulators develop bank-like rules for stablecoins.
Just last week, Securities and Exchange Commission chairperson Gary Gensler likened stablecoins to “poker chips at the casino” in a Washington Post Live event, adding that he doesn't believe cryptocurrencies have much “long-term viability”. Acting comptroller of the currency Michael Hsu said the crypto craze resembles a “fool's gold rush”, similar to one that prefigured the 2008 financial crisis.
The impending regulatory reckoning has some industry insiders trembling with the fear that federal rules will squash the sector before it finds its footing. Others are cooperating with Washington policymakers, in the belief that the technology's potential, to streamline banking and payment options for consumers, is too great to snuff out – and that it may be time to impose some order onto the digital currency chaos.
“In so many ways, these innovations are enabling totally new markets and new capabilities of what you can do with a dollar if it existed on the internet,” said Dante Disparte, the chief strategy officer for Circle, a top stablecoin issuer, in an interview. “It's starting to break into not being ’too big to fail’ but being ’too big to ignore’,” added Disparte.
The forthcoming report from the Biden administration will start to chip away at the project of regulating crypto, by focusing on stablecoins.
Stablecoins, pegged to the dollar, have seen their circulation rise from $29 billion at the start of the year, to $126 billion today. So far, they are primarily used by investors to settle trades between different crypto assets, though their issuers say they have the potential to transform payment processing for average consumers.
Top regulators fear stablecoins could invite a sort of bank run, if the reserves backing them aren't sufficiently large or liquid to meet a sudden demand for redemptions.
The President's Working Group on Financial Markets – a group that includes Gensler, Powell and Treasury Secretary Janet L Yellen – is nearly done with recommendations for regulating the assets.
Its report – final drafts of which have circulated to relevant agencies – is set to suggest imposing rules derived from banking regulations on stablecoin issuers, according to a senior administration official. That could involve demanding the companies to secure a new type of charter, which would require Congress to create one.
The group also will propose the possibility of a review of stablecoins by the Financial Stability Oversight Council, a super-committee of regulators, established in the wake of the 2008 financial crisis. If that panel finds that the assets could grow to pose a risk to the stability of the financial system, the Federal Reserve would be tasked with developing rules to contain the threat. Details of the report were first reported by the Wall Street Journal.
A third option, according to the senior administration official, would use a provision of a 1933 banking law to regulate stablecoins as deposits, though the Justice Department would need to approve this approach. The regulators involved in the process all declined to comment.
The public probably won't see the report until after the Federal Reserve publishes a separate paper exploring whether the US government should issue its own digital currency. Powell, who said last week that the paper is coming “soon”, has said such a currency could eliminate the need for private crypto products.
“You wouldn't need stablecoins, you wouldn't need cryptocurrencies if you had a digital US currency,” the central bank chair said, in congressional testimony this summer, calling that “one of the stronger arguments in its favour”.
Josh Lipsky, director of the Atlantic Council's GeoEconomics Center, said the stablecoin recommendations and the Federal Reserve's report on its own digital currency “are deeply connected”, since the two assets “could easily become competitors. On the other hand, a digital dollar could be used for core government functions, like taxes and stimulus, while a well-regulated private stablecoin could be used in retail. But all of it impacts each other and the end goal, which is tricky, is building a health digital currency ecosystem.”
Adding to the regulators' challenge, they are seeking to build a system of rules for the industry essentially from scratch.
“There's no regulatory framework in place to define who does what, or what activity counts as what,” said Andrew Park, senior policy analyst for Americans for Financial Reform.
“It would be best if the FSOC commences a review of this, and that's where I'm hoping the President's Working Group report lands,” said Timothy Massad, former chairperson of the Commodity Futures Trading Commission.
“They have rights to get information and would look at what a disruption in this activity might do, in terms of ripple effects. We just don't have very much information right now,” said Massad.
The industry has found itself on the defensive on other fronts. Despite a vigorous lobbying campaign over the summer, it failed to strike a provision in the infrastructure bill, now pending before Congress, that would impose tax reporting obligations on crypto brokers.
And this month, the Treasury Department announced sanctions against Suex, a crypto exchange that allows people to buy and sell digital assets with credit cards, as part of a push to disrupt the channels that criminal hackers use to collect pay-offs for ransomware attacks. National security officials suggested other exchanges could be next. This year alone, federal regulators have meted out more than $729 million in penalties, to companies in the crypto sector, for violating existing market regulations and other infractions, according to Elliptic, a crypto research firm.
Some major crypto firms also have run afoul of state regulators. Hong Kong-based Tether, which issues the most widely used stablecoin in the world, settled with the New York attorney general this year, following that office's two-year fraud probe into the company. Letitia James, the attorney general, said her office found the company misled investors about the stablecoin's reserves.
“Tether's claims that its virtual currency was fully backed by US dollars, at all times, was a lie,” she said in a February statement announcing the settlement. Tether admitted no wrongdoing, but agreed to stop doing business with New York customers and start producing quarterly reports on its reserves.
Meanwhile, BlockFi, a company that offers traditional banking services, such as loans and interest-bearing accounts, but transacts in cryptocurrency, this summer was targeted by regulators in five states, that accused it of selling unregistered securities. In a blog post, BlockFi chief executive Zac Prince wrote that the company was complying with the law and viewed the actions “as an opportunity for BlockFi to help define the regulatory environment for our ecosystem”.
In response to the threat in Washington, some in the industry are trying to get ahead of a crackdown. Circle, which issues USD Coin, the second-largest dollar-pegged stablecoin, says it is embracing potential federal regulation. The company is seeking a bank charter and announced that, as of this month, it will hold all reserves for its stablecoin among the most liquid assets.
Coinbase, the largest US crypto exchange, likewise, is working to position itself as a friend to regulators. Company executives said they sought to work with the SEC to make sure that Lend, a proposed product that would allow investors to earn interest on their stablecoin holdings, would pass muster with the agency. When the SEC threatened to sue if Coinbase went forward with the launch, it shelved the project.
The company is preparing to roll out its own proposal for regulating the sector. And, like many other crypto players, it has been on a lobbyist hiring spree in Washington. Just last month, it added to its roster of hired guns – Andrew Olmem, deputy director of the National Economic Council in the Trump administration; a team from the firm Rich Feuer Anderson, including two former Senate aides and a former Treasury staffer; and Tiger Hill's Milan Dalal, a former top Senate Banking Committee aide
Kristin Smith, executive director of the Blockchain Association, said her group is cautiously optimistic about the stablecoin report.
“There's certainly a risk they could misunderstand how stablecoins work,” she said.
“We're nervous about that, but we've also had positive conversations, and I'd like to be optimistic that this is a vehicle for progress,” said Smith.