Don't let the crypto winter go to waste

Don’t let the crypto winter go to waste

Regulators should not miss this once-in-a-lifetime opportunity to stave off a clear threat to the financial system.

The cryptocurrency market has given US policy makers the opportunity of a lifetime. Less than a year ago, it was on the verge of becoming a systemic threat, amassing disciples, influence and political influence faster than the regulators could control. Then the danger miraculously dissipated: the market exploded before reaching critical mass, entering the “crypto winter” that continues to this day.

This delay may not last long. Policy makers must act now to enforce some much needed rules in this market.

Problem areas are clear. Number 1 is stablecoins, or digital tokens that claim to be worth a dollar and are used by speculators to get leverage or stop money between bets. At its peak, these coins attracted more than $160 billion, which their issuers invested in assets ranging from corporate debt to bitcoin to nothing at all. The risk is that a sudden loss of confidence could lead to a mass exodus, as happened with the stablecoin Terra in May. The more regular assets that issuers hold, the greater the chances of a broader disruption—for example, in the markets that real-world companies rely on to prepare payroll and raise working capital.

Another threat arises if commercial banks are exposed to cryptocurrency, either directly or by lending to companies and hedge funds. For example, if major banks were among the creditors of now insolvent entities Celsius or Three Arrows Capital, which at its peak had tens of billions of dollars in combined liabilities, the cryptocurrency crash could have caused much greater damage. Fortunately, it seems that regulators have avoided such an outcome and have remained vigilant, although they have not yet adopted any formal rules.

Moreover, countless cryptocurrencies and trading venues – including the large exchanges operated by Coinbase and Crypto.com – do not often face the same standards of consumer protection, disclosure, governance, safety, and integrity that traditional assets and financial intermediaries do. Thus, the market is riddled with hacking, manipulation, self-dealing and outright fraud, with regulators such as the Securities and Exchange Commission and the Commodity Futures Trading Commission struggling to determine how to respond and who should be responsible for what.

Ideally, Congress might impose some order. There is a lot of proposed legislation, some of which are good. A bipartisan bill would (logically) require stablecoins to be backed with high-quality, regularly disclosed assets and to establish oversight over cryptocurrencies and exchanges. However, it will also complicate matters by creating a new category of “additional assets” for some digital tokens, and include questionable measures such as tax breaks for “miners” who process blockchain transactions. Also, with the midterm elections looming, lawmakers aren’t likely to act anytime soon.

Officials do not need to wait for Congress. Banking regulators, for their part, have the ability to create a limited charter for stablecoin issuers: those who meet the necessary criteria, including assets and governance, can gain privileges such as access to accounts at the Federal Reserve; Others will face strict scrutiny and potential penalties. The authorities can also adopt strict capital requirements, ensuring that any cryptocurrency exposure is funded with shares that banks can afford to lose.

For tokens and exchanges, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) must cooperate. It hardly matters whether something is called a security or a commodity, as long as some semblance of transparency and accountability is established. To this end, former CFTC President Timothy Massad and Harvard Law School professor Howell Jackson have made a promising proposal: agencies should create an industry-funded organization (similar to the Financial Industry Regulatory Authority) that sets reasonable standards for all crypto-related tools and institutions. As with stablecoin issuers, entities that fail to comply will risk legal consequences.

The underlying technology of cryptocurrencies may bring benefits, but the speculative frenzy surrounding it still has the potential to do a lot of damage. History has rarely given the authorities a second chance to avert such an obvious threat to the financial system. Don’t let it go to waste.

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