Bates Research | 06-11-21
Regulating Cryptocurrency: New Players, New Urgencies
In an op-ed in the Wall Street Journal on June 6, 2021, former SEC Chair Jay Clayton and former Undersecretary of the Treasury Brent McIntosh warned against the “serious risk of both overregulation and underregulation” of cryptocurrencies. They were responding to a rapidly changing financial marketplace in which innovative and complex digital products and services have become mainstream. They were also responding to recent statements by legislators, administrators and regulators advocating for a more comprehensive framework of government intervention to protect consumers and investors from price volatility and the fraud and money laundering that has proliferated across digital platforms. In this article, we review some of the recent pronouncements concerning cryptocurrency regulation, including the latest considerations on the development of a U.S. central bank digital currency.
FinCEN has yet to act on a December 2020 proposed rule (“Transactions Involving Convertible Virtual Currency or Digital Assets”) that would require banks and money servicing businesses to submit reports, keep records and verify the identity of customers in relation to transactions involving convertible virtual currency or digital assets held in private digital wallets. The proposed rule also requires the filing of currency transaction reports for transactions over $10,000. (See also previous Bates posts here and here.) The comment period on the proposal was extended early this year, but no action has been taken.
At a recent conference, the acting head of FinCEN, Michael Mosier, stated that “nothing has been decided” on the proposed rule which has reportedly drawn significant criticism from throughout the industry. The main issue is the concern that the requirements on private digital wallets would—as a practical matter—slow or shut down the use of cryptocurrency for most transactions. FinCEN, meanwhile, remains concerned about bad actors exploiting crypto exchanges, money laundering and cyber scams, (See FinCEN alerts addressed here). The non-action reflects the fine line between promoting innovation and stifling the market. These concerns are at the heart of the broader debate on where crypto regulation is headed next.
Adding to that, the Biden administration has been vocal about addressing the tax challenges on the use of virtual currencies. In its recently published American Families Plan Tax Compliance Agenda (at pp.20-21) the Treasury Department is already anticipating a new cryptocurrency compliance regime and calling the prevention of “business income from being shielded from reporting requirements” an imperative. Assuming the establishment of a “broad-based financial account reporting regime,” Treasury said that “cryptocurrencies and cryptoasset exchange accounts and payment service accounts that accept cryptocurrencies would be covered,” and that “businesses that receive cryptoassets with a fair market value of more than $10,000” (a key provision of the FinCEN proposal) would be required to report.
The Treasury Secretary also addressed the Department’s own constraints in tackling crypto regulatory issues. At a recent congressional budget hearing, she testified that the department needs additional resources to respond to, among other priorities, crypto and tax challenges as well as the added burden of developing a FinCEN database for collecting and storing beneficial ownership information. She argued that as much as seven trillion dollars could "fall through the cracks of our tax system" because the IRS does not have enough auditors.
The Securities and Exchange Commission
In several settings over the past month, SEC Chair Gary Gensler expressed the need for clarity in regulating cryptocurrency, greater cooperation with the CFTC, and a broader legislative approach by Congress. At a recent FINRA conference, he called for more investor protection for cryptoassets—a “highly volatile asset class.” He argued that currently “there is no authority to register and write rules to protect the investing public” and oversee crypto exchanges. That said, he referred to ramped-up SEC examination and enforcement over those crypto investment tokens (that can be defined as securities) within the jurisdiction of the SEC. Chair Gensler also expressed the need to update SEC rules on marketing for these cryptocurrency assets, including with respect to gamification.
In testimony before the House Subcommittee on Financial Services, Chair Gensler was more specific. He noted the recent volatility of crypto tokens (current market valuation $1.6 trillion after a one-third drop over 12 days) and expressed concern that important data—on valuations, market concentration, trading volume—are not audited or reported to regulators. He called these regulatory gaps which have “led to substantially less investor protection than in our traditional securities markets, and to correspondingly greater opportunities for fraud and manipulation.”
Chair Gensler reiterated that the SEC has been prioritizing token-related cases involving fraud or other significant harm to investors in order to enforce the securities laws over those crypto products (which are considered investment contracts and thus within the jurisdiction of the SEC). He warned firms that “the SEC has been consistent in its communication to market participants: that those who use initial coin offerings to raise capital or to engage in securities transactions must comply with the federal securities laws. Asset managers that invest in these assets may come under securities laws, too.”
The Chair also reported that the SEC is looking into crypto lending platforms and so-called decentralized finance (“DeFi”) platforms. Further, the SEC is currently in the process of seeking comment on crypto custody arrangements by broker-dealers.
On May 20, 2021, Federal Reserve Board (“Fed”) Chair Jerome Powell announced that the central bank is “exploring ways that it might refine its role as a core payment services provider and as the issuing authority for U.S. currency.” Powell reported that the bank has been “carefully monitoring and adapting to the technological innovations now transforming the world of payments, finance, and banking," and that the bank is considering the implications of the development and issuance of a central bank digital currency (“CBDC”), a digital form of bank liability that “could be designed for use by the general public.” As a complement to—not a replacement for—cash, the digital dollar raises “important monetary policy, financial stability, consumer protection, legal, and privacy considerations and will require careful thought and analysis—including input from the public and elected officials," he said. An important Fed-drafted discussion paper is due in summer 2021, which should give a strong indication of where the Fed is heading on CBDCs.
There remains a lack of consensus around a unified approach to regulation of cryptocurrency. One prescription offered by former SEC Chair Jay Clayton to regulators in his op-ed is to “ground their efforts in the principal objectives underpinning existing financial regulations: financial stability, deep and efficient funding markets across the spectrum of debt and equity, and the prevention of fraud and illicit activity,” is prudent, and, by default, could be an operating model under the various divided regulatory jurisdictions going forward. But the major players seem to be seeking something more. Given the recent volatility in the market and the recent considerations and urgencies expressed by the Fed Chair, the Treasury Secretary and the new SEC Chair—particularly around crypto exchanges—a larger. more comprehensive framework may emerge. Bates will keep you informed.
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