Bitcoin fraud concerns draw scrutiny from regulators5 min read . Updated: 08 Jul 2021, 10:50 PM IST
- SEC’s Gary Gensler has told lawmakers that investor protection rules should apply to crypto exchanges
Regulators are signaling they want more control over an expanded cryptocurrency universe that has pushed further into Wall Street activities without the investor and consumer protections that apply to traditional securities and financial services.
The catch: no single regulator inspects crypto exchanges or brokers, unlike in the securities and derivatives markets. Regulators step in only when they believe U.S. law applies to a particular cryptocurrency or transaction, based on the way the asset was sold or traded.
Once a quirky asset that required navigating special exchanges to buy, cryptocurrencies can now be easily purchased on mobile apps from PayPal Holdings Inc., Square Inc.’s Cash app and Robinhood Markets Inc.
“A lot more money is being put into it, there is a lot of trading and the uses seem to be expanding," said Dan Berkovitz, a commissioner on the Commodity Futures Trading Commission. “I see a concern about whether we have a shadow financial system developing, and that should be a question for all of the regulators."
Securities and Exchange Commission Chairman Gary Gensler has told House lawmakers that investor protection rules should apply to crypto exchanges, similar to those that cover equities and derivatives. Regulated exchanges are required by law to have rules that prevent fraud and promote fairness. But crypto exchanges face no such standard, Mr. Gensler said at the Piper Sandler Global Exchange and FinTech conference last month.
“When you go into one of these exchanges, you don’t know whether the order book is accurately reporting the bids and the offers," Mr. Gensler said. “You don’t really know if there is front-running. You don’t know whether some of the trading that is reported is real or fake." Front-running involves the misuse of customer information to trade for one’s own gain.
Consumers reported losing nearly $82 million to crypto scams during the fourth quarter of 2020 and first quarter of 2021, more than 10 times the amount from the same six-month period a year earlier, according to the Federal Trade Commission. Many of the losses came from scammers targeting small investors on social media, the FTC said.
The House Financial Services Committee recently formed a working group of 12 Democratic lawmakers to consider potential legislative changes aimed at digital assets, such as an oversight regime as Mr. Gensler recommended.
Lawmakers are still learning about the industry, but many Democrats welcomed Mr. Gensler’s call, said Rep. Jim Himes (D., Conn.), a member of the working group. “There is not a single shred of evidence over many centuries that new financial systems or new systems of currency grow organically in an unregulated way and lead to good outcomes," he said.
Cryptocurrencies developed with virtually no regulation. In 2014, then-Federal Reserve Chairwoman Janet Yellen said the central bank didn’t have authority to regulate bitcoin or similar cryptocurrencies. At the time, bitcoin’s total market value was $4.3 billion. It is now valued at about $622 billion, with millions of individual investors and a handful of public companies, including Tesla Inc., holding bitcoin or similar cryptocurrencies.
The Treasury Department, now headed by Ms. Yellen, is in the early stages of reviewing whether its authority to regulate payment networks could apply to some crypto assets. One possible tool: using the Financial Stability Oversight Council, a panel of top regulators headed by Ms. Yellen, to target crypto assets such as cash-backed stablecoins, which some regulators have said could become a source of systemic risk, according to people familiar with the discussion. Such a move would allow regulators to write rules governing those activities and give authority to the Fed over stablecoins.
Some policy makers have said stablecoins could fuel financial panics if users come to doubt the value of the underlying collateral. “It will be practically impossible for Treasury and FSOC not to examine the financial stability risks of digital assets and how they can use their authorities to address those risks," said David Portilla, a former Obama-era Treasury staffer who is now a partner at Cravath, Swaine and Moore LLP.
Crypto’s varied forms and uses make it hard to assign the whole asset class to one regulator. Some coins facilitate payments, while stablecoins substitute for national currencies, making it easier to swap from one crypto asset to another. Others reward programmers who validate transactions on blockchain networks or develop new applications.
For now, the SEC is the industry’s de facto overseer. But its regulatory model frustrates crypto companies, which say investor protection rules don’t always fit how cryptocurrencies are used. One example: the SEC hasn’t made clear how brokerages can safely hold crypto assets that are deemed to be securities, since the method of custody differs significantly from how stocks are held.
The SEC’s enforcement actions have also jolted the market, creating uncertainty about whether assets were issued and traded legally. The SEC last year sued Ripple Labs Inc., the company behind cryptocurrency XRP, alleging the sale violated investor protection rules. At the time, XRP was the world’s third-largest cryptocurrency by market capitalization. Ripple disputes the SEC’s claims and is fighting the agency in federal court.
Crypto firms say regulators should write rules that fit their industry, rather than relying on enforcement actions to set precedents. In the absence of federal rules, some companies have committed to a code of conduct, modeled on one developed for the global foreign-exchange market, said Michelle Bond, the chief executive of the Association for Digital Asset Markets, which developed the framework.
“There needs to be a high level of regulatory engagement," Ms. Bond said. “Attempts to regulate digital assets are unlikely to succeed if you don’t have engineers, developers and programmers at the table, because the technology can be highly complicated."
Newer crypto innovations are likely to further challenge traditional regulation. Peer-to-peer networks for swapping digital tokens or allowing investors to earn interest on their deposits, for instance, are gaining market share. The networks work like exchanges but don’t hold investors’ assets.
These decentralized exchanges, or DEXes, lack traditional touch points for regulators, such as the involvement of brokers who earn fees by connecting people who want to trade.
Mr. Berkovitz, the CFTC commissioner, said in a speech last month that some activities on decentralized exchanges, such as trading derivatives, could be illegal. The sale of commodity futures in the U.S. generally must be done on regulated markets overseen by the CFTC.
“There are organizations out there to audit the code, but can you really trust any private entity to look out for the public interest?" Mr. Berkovitz said. “Traditionally that has been a government function to evaluate whether these things are in the public interest."
This story has been published from a wire agency feed without modifications to the text
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