This grace period may not last long. Policymakers should act now to impose some much-needed rules on this market.
The problem areas are clear. #1 are stablecoins, or digital tokens that pretend to be worth a dollar and are used by speculators to gain leverage or park funds between bets. At their peak, such coins had attracted more than $160 billion, which their issuers invested in assets ranging from corporate debt to Bitcoin to nothing at all. The danger is that a sudden loss of confidence could trigger an exodus, as happened with stablecoin Terra in May. The more regular assets issuers hold, the greater the chances of broader disruption — for example, in markets that real-world companies rely on to make payroll and raise working capital.
Another threat arises when commercial banks become exposed to crypto, either directly or through lending to corporations and hedge funds. For example, if major banks had been among the creditors of now-bankrupt companies Celsius or Three Arrows Capital, which at their peak had tens of billions of dollars in combined liabilities, the crypto meltdown could have done much more damage. Fortunately, regulators appear to have averted such an outcome and remain vigilant, although they have yet to issue formal rules.
Additionally, myriad digital tokens and trading venues — including major exchanges powered by Coinbase and Crypto.com — are largely not subject to the same consumer protection, disclosure, governance, security, and soundness standards as traditional assets and financial intermediaries. The market is therefore awash with hacks, manipulation, self-dealing, and outright fraud as regulators like the Securities and Exchange Commission and the Commodity Futures Trading Commission struggle to figure out how to respond and who should be in charge of what.
Ideally, Congress would set things right. There are many legislative proposals, some of them good. A bipartisan bill would (reasonably) require stablecoins to be backed by regularly disclosed high-quality assets and create oversight of crypto tokens and exchanges. However, it would also complicate things by creating a new category of “secondary stocks” for certain digital tokens and involving dubious measures like tax breaks for the “miners” who process blockchain transactions. With midterm elections approaching, lawmakers are unlikely to make any headway any time soon.
Officials don’t have to wait for Congress. For their part, banking regulators have the power to create a limited charter for stablecoin issuers: those who meet the required standards, including for assets and governance, could be granted privileges such as access to accounts with the Federal Reserve; others would face severe scrutiny and possible sanctions. Authorities can also impose strict capital requirements to ensure all crypto exposures are funded with equity that banks can afford to lose.
For tokens and exchanges, the SEC and CFTC should work together. It matters little whether an item is labeled as a security or a commodity as long as some semblance of transparency and accountability is established. To that end, former CFTC chairman Timothy Massad and Harvard Law School professor Howell Jackson have a promising proposal: the agencies should create an industry-funded organization (similar to the Financial Industry Regulatory Authority) that would set appropriate standards for all relevant crypto -Instruments would establish and institutions. As with stablecoin issuers, companies that do not comply would risk legal consequences.
The technology underlying crypto can still bring benefits, but the speculation frenzy that surrounds it still has the potential to do a lot of damage. Rarely has history given authorities a second chance to fend off such an obvious threat to the financial system. Don’t waste it.
More from the Bloomberg Opinion:
• Crypto wants some SEC rules: Matt Levine
• Crypto Fails Where Digital Yuan Could Succeed: Lionel Laurent
• No, crypto exchanges aren’t like exchanges: Aaron Brown
The editors are members of the Editorial Board of Bloomberg Opinion.
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