One Small Step for President Biden. One Giant Leap for Crypto?br>
The U.S. Executive Order on Ensuring Responsible Development of Digital Assets (the “EO”), issued in March 2022, describes the first comprehensive digital assets strategy for the U.S. signaling that crypto is a part of the financial system that is here to stay. The EO is a government call to action rather than a specific roadmap for the future of crypto regulation. Policymakers and industry participants alike understand that there is no turning back from cryptocurrencies and that moving forward requires an integrated domestic and international approach.
The pace of regulatory and enforcement actions regarding digital assets has been accelerating as U.S. regulators and legislators seek to address the risks arising from the explosive growth of the digital assets industry. The six priorities reflected in the EO align with the central issues around digital assets that have coalesced to form the points of debate about how to accomplish these priorities: (1) protecting consumers, investors, and businesses; (2) protecting the U.S. and global financial stability and mitigating systemic risk; (3) mitigating illicit finance and national security risks posed by the criminal use of digital assets; (4) promoting and reinforcing U.S. leadership in the global financial system; (5) promoting equitable access to safe and affordable financial services; and (6) supporting technological advances and ensuring responsible development and use of digital assets.
Through all of the discussions about whether and how digital assets should be regulated and overseen, most federal agencies look favorably on the technology and the U.S. to take a leading role as advanced in the EO. But, just as the agencies see great promise, they also see some danger lurking. The U.S. Comptroller of the Currency, the regulator of national banks, has expressed concern about having a large and less regulated “shadow system” of digital assets. The Chair of the Securities and Exchange Commission (“SEC”) has announced that crypto trading and lending platforms, whether centralized or decentralized, need to be registered with the SEC similar to traditional securities exchanges. He has also indicated that most tokens are securities that need to be registered. The SEC’s Chair noted that stablecoins are so integral to the crypto ecosystem that the loss of a peg or failure of an issuer could imperil a trading platform and could have negative consequences across the wider crypto environment. Several agencies, such as the Commodity Futures Trading Commission, have pointed to the need for legislation to decide and clarify which regulators should oversee what aspects of the crypto market.
The EO addresses the overarching regulatory framework for crypto by instructing the Financial Stability Oversight Council (“FSOC”) at the Department of the Treasury to produce a report that describes specific financial stability risks and regulatory gaps posed by digital assets and makes regulatory and legislative recommendations to address these risks. The brevity of this part of the EO does not reflect its influence on the future regulatory and legislative direction for digital assets. The FSOC report will combine the collective thinking of all of the federal financial institution regulators and will consider the views of state and insurance regulators and other stakeholders. The FSOC recommendations may very well be the closest to a digital assets roadmap of all of the individual reports required by the EO. The President’s Working Group on Financial Markets has requested that the FSOC analyze systemic risks of stablecoins, and the FSOC may use that same lens of operational risk, risk of runs, and risk of concentrations of power in the broader review of digital assets. In any event, in recent remarks, the U.S. Secretary of the Treasury called for the functional regulation of digital assets – same business, same risks, same rules – and this portends the regulatory roadmap to come.
The U.S. Treasury is not the lone voice in respect of the risks to financial stability that it believes digital assets bring. The Bank of England issued a detailed explanation in March 2022 of how it believes digital assets and decentralized finance pose risks to systemic financial institutions, particularly in respect of the risk of financial loss and operational disruption by U.K. banks were their involvement in the cryptoasset and associated markets to grow.
The U.K. Financial Stability Board also voiced concerns earlier this year with a particular fear of the threats posed by “global stablecoins”.
Executing the EO priorities will be both challenging and worthwhile. Let’s take a look at why using the U.S. Central Bank Digital Currency (“CBDC”) priority as an example. The EO places the highest urgency on research and development efforts into potential design and deployment options of U.S. CBDC. Prior to the issuance of the EO, the Board of Governors of the Federal Reserve System was already engaged in experiments related to digital currencies and a hypothetical CBDC, the results of which will likely make their way into the EO research and next steps.
Many see the future of money and inclusion in the financial system at stake in the effort to develop a digital dollar. Adoption of U.S. CBDC could fundamentally alter the role of central and commercial banking and, weighing all of the factors in play, is a policy and practical balancing act. This centerpiece of the EO evinces the desire to showcase U.S. leadership in international pilot CBDC projects. A U.S. CBDC would have international consequences making it imperative that the private sector, foreign central banks and other stakeholders have a seat at the table. The EO recognizes the importance of developing a U.S. CBDC that is interoperable with CBDCs issued by other sovereign monetary authorities.
Many central banks are considering their own CBDCs with one of the key legal questions being whether their CBDC should be subject to their existing legal and regulatory regime applicable to currencies. Sweden was a first mover in this space but its plan to issue an e-krona has slowed down since it started its own CBDC project in 2017. It is now looking more like the U.K. will become the frontrunner here within the E.U. following close behind. It is no surprise that data privacy concerns play an important part in the consideration as to the viability of a CBDC in Europe.
Since the EO proclaimed U.S. CBDC as a top priority, the U.S. Secretary of the Treasury has confirmed that Treasury will address CBDC with urgency while making clear “that issuing a CBDC would likely present a major design and engineering challenge that would require years of development, not months.” The guiding lesson advanced by the U.S. Secretary of the Treasury is that sovereign money is the core of a well-functioning financial system and the U.S. benefits from the central role that the dollar and U.S. financial institutions play in global finance.
By setting the national priority of mitigating illicit finance and national security risks posed by the criminal use of digital assets, the EO reflects the government’s enduring intense scrutiny of financial system activities in the fight against terrorism, criminal activity and fraud. As cryptocurrency has become a more mainstream part of the global financial system, there have been calls for greater analysis of risk exposure to illicit activity. The most recent threat has been from the use of cryptoassets to circumvent economic sanctions or to carry out money laundering, with the U.K. Financial Conduct Authority recently writing to all of its registered cryptoassets firms to highlight the current application of sanctions on various entities and individuals.
Before and after the issuance of the EO, the government has been escalating its enforcement efforts against bad actors in the cryptocurrency space. Last fall, the U.S. Department of Justice (“DOJ”) sought to turbocharge its enforcement in the cryptocurrency markets through the creation of a National Cryptocurrency Enforcement Team. The team’s mission is to handle complex investigations and prosecutions of criminal misuses of cryptocurrency, focused on crimes committed by virtual currency exchanges, mixing and tumbling services and money laundering infrastructure actors. Following issuance of the EO, the DOJ also created an interagency Task Force KleptoCapture devoted to enforcing the sweeping sanctions, export restrictions, and economic countermeasures the U.S. has imposed, together with its allies, in response to Russia’s military invasion of Ukraine. These and other steps are underway while at the same time there are many reports that the vast majority of crypto transactions are legitimate and companies that process transactions using digital currency are responsible for ensuring they do not engage in unauthorized transactions prohibited by government sanctions under current law.
Further, the EO prioritizes consumer protection and inclusion as a policy imperative in the digital assets market. Some observers have pointed to consumer issues that can arise principally from misunderstandings as reasons for consumer protection rules, for example, misunderstanding the price volatility that can affect the value of crypto or misunderstanding a feature of digital wallets. An unfair or deceptive act or practice can result from a consumer’s misunderstanding, so there has been some thought that the U.S. Consumer Financial Protection Bureau or Federal Trade Commission could seek to curb unfair acts and practices through regulation or enforcement. However, without legislation, there is a question about just how far the existing jurisdiction of the consumer protection agencies extends and whether it extends only to consumer products and services that are neither a security nor a commodity.
So, what happens next? In the coming months, U.S. government agencies will explore the risks and benefits of cryptocurrency, further integrating crypto initiatives into their regulatory agendas. Additional rules are on the horizon.
Through the FSOC report and separately, the U.S. Department of the Treasury and the federal financial institution regulators will likely make new recommendations for federal legislation. Some U.S. legislators have already taken an interest in crypto as advocates and others as opponents. Advocates have supported legislation providing regulatory certainty and protecting innovation. Opponents have characterized digital assets as the Wild West, bad investments, an unwieldy method of buying and selling, and an environmental disaster due to crypto mining energy consumption.
The EO is the first U.S. whole-of-government approach to digital assets. The EO seeks to encourage innovation while protecting against risks and seeks to promote U.S. leadership while working together with the international community in the digital asset space. This is an approach shared by the U.K. government. In order to encourage responsible innovation, the U.K. is considering allowing unregulated tokens that are used for speculative investment purposes, such as Bitcoin, to remain initially outside the financial regulatory perimeter for conduct and prudential purposes but to be subject to stringent regulation in relation to consumer communications and rules to combat anti-money laundering and the financing of terrorism.
Altogether, the issuance of the EO signals that crypto is here to stay.