Regulators Warn Crypto Could Threaten Financial System

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Cryptocurrency risks could grow rapidly and eventually threaten the broader financial system, a panel of senior US officials warned on Oct. 3, calling for stricter oversight of digital assets.

The Financial Stability Oversight Board, chaired by Treasury Secretary Janet Yellen, said the crypto industry remains small relative to the broader financial system, but that could change quickly and exacerbate systemic risks. potentials.

“Crypto-asset financial stability risks would be substantial if these vulnerabilities were to remain in place as the scale of crypto-asset activity and interconnectedness with the mainstream financial system were to grow rapidly,” the risk panel said. in a 120-page report.

The Oct. 3 report is the latest response to a March executive order from President Biden, which called on a number of federal agencies to assess the risks and opportunities posed by cryptocurrencies.

The industry initially hoped regulators would see promise in the asset class, but officials have recently warned of the potential for disruption posed by financial innovation without sufficient regulation.

“As we have painfully learned from history, innovation without proper regulation can lead to significant disruption and harm to the financial system and to individuals,” Yellen said ahead of a unanimous FSOC vote to release the report on March 3. october.

The FSOC said large parts of the cryptocurrency industry fall under the jurisdiction of existing financial regulatory laws. He called on Congress to consider legislation to close any loopholes, such as in the “spot” market for cryptocurrencies that do not meet the definition of a security overseen by the Securities and Exchange Commission.

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Cryptocurrencies remain largely unregulated by the federal government, leaving investors unprotected from the fraud and market manipulation that accompanies many other types of investments.

The report highlighted several market vulnerabilities. These include interconnection which can quickly spread losses through the crypto ecosystem, and the likely presence of “very high and excessive levels of leverage” or borrowed money which could exacerbate the shocks experienced by industry. A lack of fundamental economic uses for crypto has contributed to wild price swings that might otherwise be entrenched, according to the report.

“Furthermore, prices may be affected by the prevalence of fraud and market manipulation,” the report said.

Biden’s directive asking government agencies to improve their understanding of crypto came at a turbulent time for the industry. Two months after the decree, the implosion of a so-called algorithmic stablecoin, TerraUSD, and a related token destroyed a combined value of $40 billion. Then, over the summer, crypto-focused hedge fund Three Arrows Capital collapsed, bankrupting a number of platforms that held assets for individual investors.

Still, cryptocurrency advocates say the assets have the potential to make payments faster and cheaper than in the traditional banking system. Proponents of bitcoin, the largest cryptocurrency, see an advantage over government-issued money in the fact that its supply is capped by software code rather than adjusted by policymakers.

“Similar to other reports and executive order summaries, the FSOC report overstates the risks — and understates the opportunities — of present cryptonets,” said Kristin Smith, head of the Blockchain Association.

The reports stemming from the executive order come as Washington wrestles with how to regulate the cryptocurrency industry and federal agencies argue over who will be responsible. Competition has intensified in recent months as a crash in crypto markets underscored the need for guardrails in the eyes of many policymakers.

A Treasury Department report released in September highlighted the risks to consumers, financial stability, and the rule of law arising from cryptocurrencies, while assessing that the practical uses of digital tokens are limited. He called on agencies like the SEC to rigorously enforce existing regulations in the cryptocurrency market, dealing a blow to the industry’s hopes for a more tailored set of rules.

Legislators also decided to assign jurisdiction. In the House, a bipartisan pair of lawmakers are negotiating legislation that would subject stablecoin issuers to federal scrutiny. The pair face long odds of securing a deal this year.

An independent Senate plan aims to hand oversight of the two biggest tokens, bitcoin and ether, to the Commodity Futures Trading Commission. A separate pair of senators have proposed a proposal that would create special exemptions from federal law for certain cryptocurrencies.

Write to Andrew Ackerman at andrew.ackerman@wsj.com and Paul Kiernan at paul.kiernan@wsj.com

This article was published by Dow Jones Newswires, another service of the Dow Jones group

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Don F. Davis