US Consumer Protection Watchdog has warned that cryptocurrencies could severely affect the financial system.
The Financial Stability Oversight Council on Monday made recommendations to close regulatory gaps in a bid to strengthen consumer protections and limit cryptocurrencies threat to the US financial markets.
According to the federal U.S. government organization, cryptocurrency markets pose a great threat to broader financial stability if they continue growing without more thoughtful oversight and enforcement with immediate effect.
The report listed four specific crypto-threats that could spill over and negatively impact legacy markets. They were:
- Lack of controls in preventing run risks or sufficient oversight on excessive leverage.
- The price of crypto assets appeared to be speculation driven, making them highly volatile.
- Some crypto firms “have risky business profiles and opaque capital and liquidity positions.”
- The centralization of “key services” or vulnerabilities related to distributed ledger technology can lead to operational risks.
The Dodd-Frank Act established council designed to assist in identifying financial stability issues in the United States, claims that if the industry is left unregulated, crypto assets like stablecoins may endanger the nation’s financial system.
“Crypto-asset activities could pose risks to the stability of the U.S. financial system if their connections to the traditional financial system or their overall scale were to grow without adhering to or being paired with appropriate regulation, including enforcement of the existing regulatory structure,” the report states.
Even if related to the established system is still comparatively insignificant, the FSOC warns that future dangers could arise from choke points like stablecoins and trading platforms.
“Although there are now only a few connections to the conventional banking system, this number has the potential to grow quickly. Participants in the traditional financial system and the ecosystem of crypto assets have investigated or developed a number of linkages. Traditional assets retained as part of stablecoin operations are notable sources of potential connections.
By offering a variety of services, such as leveraged trading and asset custody, to a variety of retail investors and traditional financial institutions, crypto-asset trading platforms may potentially have the potential for broader linkages. Customers can also access crypto-asset activities more frequently, even via some traditional money services.
According to the council, enforcing and adhering to current regulations is a “key step” in reducing these possible threats. In order to combat the risks, the sector can provide, it also suggests strengthening the regulatory authorities’ capacity in relation to data and knowledge about crypto-assets.
Regarding adhering to existing regulatory structures, the FOSC said some crypto firms avoided regulatory systems. In contrast, others had actively participated by obtaining crypto-specific charters or licenses.
Concerns were raised about misrepresentation, for example, false statements about federal deposit insurance and the degree to which some firms had advertised themselves as regulated — all of which give consumers a false sense of protection.
To address regulatory gaps, the FOSC recommended spot cryptocurrencies not deemed securities fall under “limited direct federal regulation.” Implementing a regulatory arbitrage process would give authorities insight, supervise activities, and research into vertical integrations that offer retail consumers direct market access, leaving them exposed to practices such as automated liquidation.
What is SEC saying about the FSOC report?
SEC Chair Gary Gensler released a statement in support of the FSOC’s findings and recommendations.
In addition, Gensler also picked up on several points raised by the FSOC, particularly the operational risks posed by centralized service providers and how that contradicts how the industry portrays itself.
“This market isn’t so decentralized. Now, we see this industry populated by large, concentrated intermediaries, which often are an amalgam of services that typically are separated from each other in the rest of the securities markets.”
Similarly, the SEC Chair believes most crypto tokens are securities and would fall under the SEC’s remit. Gensler said:
“Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these crypto security tokens are covered by the securities laws.”
He added that “this market” cannot undermine the broader financial system.