The Treasury Department is reportedly considering using the Financial Stability Oversight Council to regulate cryptocurrencies. This would be an appropriate role for the council that could result in an effective regulatory regime for these controversial assets.
Currently, there is no single U.S. regulator with authority to comprehensively regulate cryptocurrencies and large portions of the crypto industry are outside the jurisdiction of any regulator.
Cryptocurrencies are complicated. They share attributes applicable to securities, commodities and currency. Their issuers and intermediaries can resemble banks or non bank payment systems. If a cryptocurrency is a “security,” the Securities and Exchange Commission has anti-fraud and disclosure regulatory authority. Bitcoin, the largest cryptocurrency in terms of value, however, has been determined not to be a security. Similarly, the Commodities Futures Trading Commission has authority to regulate other limited aspects of crypto. States may also regulate crypto entities in their jurisdictions and law enforcement agencies may regulate crypto-related criminal conduct.
The lack of a regulatory framework for cryptocurrencies has caused the House to form a working group of Democratic members to consider legislation to regulate these assets, but Republicans have also called for stringent regulation of crypto. This is a bipartisan issue and congressional action is needed.
In designing a regulatory system for cryptocurrencies, Congress could move in either of two directions. It could establish a new agency to regulate cryptocurrency as an entirety, but this would require it to replicate skill sets that already exist in agencies such as the CFTC, the SEC, Treasury and the banking agencies. Alternatively, it could grant additional powers to existing agencies. If it adopts the latter approach, it must solve the problem of how to coordinate the activities of these agencies in the crypto space. The United States has a fractured system of financial regulation. Three different federal agencies exist to regulate banks, and the regulation of securities-like instruments is divided between the SEC and the CFTC. These agencies have often marched to the beat of their own drummers, creating regulatory inconsistencies. To avoid these problems, a structure to establish interagency coordination is needed. The Financial Stability Oversight Council is the perfect vehicle to accomplish this task.
The council is chaired by the secretary of the Treasury and comprised of the heads of the principal U.S. financial regulatory agencies, as well as representative state regulators. Established in 2010 by the Dodd-Frank Act, FSOC is tasked with identifying and responding to threats to U.S. financial stability. In determining whether an activity poses a threat, the council focuses on the scale of the risk and its transmissibility to financial markets and the non-financial sector of the U.S. economy.
Cryptocurrencies can be viewed as a threat to U.S. financial stability for at least two reasons. First, they are the payment system of choice for criminals, including those who conduct ransomware attacks. The recent proliferation of these attacks against entities that are essential to the U.S. economy, such as Colonial Pipeline, certainly constitute the type of threat that the council was established to avoid.
Second, stablecoins, a type of cryptocurrency backed by cash or other assets, also pose a threat to U.S. financial stability, because they potentially threaten the position of the U.S. dollar as the world’s principal reserve currency. This threat became apparent in 2019, when Facebook proposed a stablecoin that potentially could be used in lieu of the dollar by its several billion subscribers worldwide. The dollar is the dominant currency used today in international transactions and in the first quarter of 2021, non-U.S. central banks held 59.5 percent of their reserves in dollar-denominated assets, according to the International Monetary Fund. These assets are typically U.S. Treasury securities. The demand by central banks for Treasury securities helps keep Treasury interest rates low, supporting the U.S. economy, and is of crucial importance to the Biden administration’s plans to fund their proposed $4.1 trillion budget.
Perhaps even more important than its role as a financial stability policeman is FSOC’s role in coordinating the policies and activities of U.S. financial regulators. Both Democratic and Republican secretaries of the Treasury have used the council as a vehicle to harmonize financial policies across agencies. A particularly good example of this was Secretary Mnuchin’s use of FSOC to coordinate member agencies’ responses to the COVID-19 pandemic.
FSOC has a relatively small, but highly professional staff, but can also draw on the staff and resources of its member agencies. The council works principally through committees. Since 2017, the council has had a digital asset and distributed ledger technology working group, that has met periodically and developed expertise in cryptocurrencies.
In FSOC, the U.S. government has an already-existing entity to coordinate the efforts of the financial regulatory agencies to meet threats to financial stability. The council could easily establish a committee, comprised of senior representatives of each of the regulatory agencies with an interest in cryptocurrencies, to coordinate an interagency regulatory regime for the crypto world and to ensure that the government speaks with one voice in containing the threats that cryptocurrencies pose to the U.S. economy.
Howard B. Adler was formerly deputy assistant secretary of the Treasury for the Financial Stability Oversight Council. He is currently working on a book on U.S. financial stability during and emerging from the COVID-19 pandemic.