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On November 21, the DOJ seized nearly $9 million in stablecoins from cryptocurrency scammers after the criminals exploited over 70 victims. The DOJ seized stablecoins, a certain crypto asset pegged to a central bank’s currency, tied to the U.S. dollar. The scammers employed a long-con technique called “pig butchering” which is a tactic to build and exploit a victim’s trust over time by creating fake romantic enticements meant to swindle victims into handing over money. The criminals targeted and convinced victims to “make cryptocurrency deposits by fraudulently representing that the victims were making investments with trusted firms and cryptocurrency exchanges.”
The DOJ was able to trace the stolen funds based on the funds’ cryptocurrency addresses as part of a money laundering technique known as “chain hopping… used to ‘layer’ the proceeds of criminal activity into new cryptocurrency ecosystems, all to obfuscate the… ownership of those proceeds.” The DOJ worked with the U.S. Secret Service to trace the victim’s deposits, and it was originally alerted from victim reports made on the FBI’s Internet Crime Complaint Center and the FTC’s Consumer Sentinel Network.
On November 6, the Bank of England and the Financial Conduct Authority (FCA) requested feedback on their proposal to regulate a form of cryptocurrency known as stablecoins. Stablecoins are a cryptoasset that “maintain a stable value relative to a fiat currency by holding assets as backing” and fall within the UK Government’s plan to regulate them for future retail payment use. In addition to retail use, the Bank of England and FCA’s wish to regulate stablecoins is meant to “prevent money laundering… and safeguard financial stability.”
The Bank of England published a handy road map with similar regulators on how to best navigate rolling out new technological payment innovations, such as the digital pound. Each of the financial regulators provided two white papers: (i) the FCA’s discussion paper outlines how the FCA can regulate cryptoassets under the Financial Services and Markets Act 2000, including providing information on backing assets, custody requirements, and allowing overseas stablecoins used as a form of tender in the UK; and (ii) the Bank of England’s discussion paper examines proposed regulations for sterling-dominated stablecoins in the hopes of becoming widespread for retail use. Furthermore, this paper details proposed regulations for everyday use, including money transfers and providing digital wallets.
Both regulators’ comment period is open until February 6, 2024.
On October 27, Fed Vice Chair for Supervision, Michael Barr, delivered a speech at the Economics of Payments XII Conference discussing the Fed’s place in the payments system and highlighting its role as a bank supervisor and operator of key payment infrastructure. Emphasizing the Fed’s introduction of its FedNow instant payment service (covered by InfoBytes here), which was designed to enable secure instant payments in response to the increasing demand for secure and convenient payment options, Barr encouraged banks to build upon the new payment infrastructure. He also noted that ongoing experimentation with new payment technologies, such as stablecoins, creates a need for regulation, particularly where an asset is “pegged to government-issued currencies.”
Regarding central bank digital currencies (CBDCs), the Fed is engaged in research and in discussions with various stakeholders; however, it has not decided on whether to issue a CBDC. The Vice Chair stressed that any move in this direction would require “clear support” from the Executive Branch and authorization from Congress.
Barr emphasized the Fed’s commitment to working with the international community to improve cross-border payment systems as well as the need for research into both traditional and emerging payment methods, noting that innovation should “promote broad access and financial inclusion.” Finally, the remarks touched on the Fed’s proposed revisions to the interchange fee cap for debit card issuers, with a call for public input on the matter (covered by InfoBytes here).
The House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion recently held a hearing to examine stablecoins’ role in the payment system and to discuss proposed legislation for creating a federal framework for issuing stablecoins. A subcommittee memorandum identified different types of stablecoins (the most popular being pegged to the U.S. dollar to diminish volatility) and presented an overview of the market, which currently consists of more than 200 different types of stablecoins, collectively worth more than $132 billion. The subcommittee referred to a 2021 report issued by the President’s Working Group on Financial Markets, along with the FDIC and OCC (covered by InfoBytes here), in which it was recommended that Congress pass legislation requiring stablecoins to be issued only by insured depository institutions to ensure that payment stablecoins are subject to a federal prudential regulatory framework. The subcommittee discussed draft legislation that would define a payment stablecoin issuer and establish a regulatory framework for payment stablecoin issuers, including enforcement requirements and interoperability standards.
Subcommittee Chairman, French Hill (R-AR), delivered opening remarks, in which he commented that the proposed legislation would require stablecoin issuers to comply with redemption requirements, monthly attestation and disclosures, and risk management standards. Recognizing the significant amount of work yet to be done in this space, Hill said he believes that “innovation is fostered through choice and competition,” and that “one way to do that is through multiple pathways to become a stablecoin issuer, though with appropriate protections [to] prevent regulatory arbitrage and a race to the bottom.” He cited reports that digital asset developers are leaving the U.S. for countries that currently provide a more established regulatory framework for digital assets, and warned that this will stymie innovation, jobs, and consumer/investor protection. He also criticized ”the ongoing turf war between the SEC and CFTC” with respect to digital assets, and warned that “[w]hen you have two agencies contradicting each other in court about whether one of the most utilized stablecoins in the market is a security or a commodity, what you end up with is uncertainty.”
Witness NYDFS Superintendent Adrienne A. Harris discussed the framework that is currently in place in New York and highlighted requirements for payment stablecoin issuers operating in the state. In a prepared statement, Harris said many domestic and foreign regulators call the Department’s regulatory and supervisory oversight of virtual currency the “gold standard,” in which virtual currency entities are “subject to custody and capital requirements designed to industry-specific risks necessary for sound, prudential regulation.” Harris explained that NYDFS established “additional regulations, guidance, and company-specific supervisory agreements to tailor [its] oversight” over financial products, including stablecoins, and said the Department is the first agency to provide regulatory clarity for these types of products. She highlighted guidance released last June, which established criteria for regulated entities seeking to issue USD-backed stablecoins in the state (covered by InfoBytes here), and encouraged a collaborative framework that mirrors the regulatory system for more traditional financial institutions and takes advantage of the comparative strengths offered by federal and state regulators. Federal regulators will be able to comprehensively address “macroprudential considerations” and implement foundational consumer and market protections, while states can “leverage their more immediate understanding of consumer needs” and more quickly modernize regulations in response to industry developments and innovation, Harris said.
On January 6, the U.S. District Court for the Northern District of California granted a defendant cryptocurrency exchange’s motion to compel arbitration in a class action alleging the exchange, along with the issuer of a stablecoin cryptocurrency, misrepresented the stability of the coin when offering it on the exchange’s platform. The defendants filed separate motions to compel arbitration, however, the plaintiffs claimed, among other things, that since they opened their accounts, the exchange’s user agreement, which contains an arbitration agreement, “has been unilaterally modified more than 20 times.” They further maintained that the exchange’s motion to compel arbitration should be denied because the arbitration provision is “unconscionable and thus unenforceable” and “the delegation clause is inapplicable and unconscionable.”
On October 20, FDIC acting Chairman Martin J. Gruenberg spoke before the Brookings Institution on the prudential regulation of crypto-assets. In his remarks, Gruenberg first discussed banking, innovation, and crypto-assets, which he defined as “private sector digital assets that depend primarily on the use of cryptography and distributed ledger or similar technologies.” He stated that innovation “can be a double-edged sword,” before noting that subprime mortgages, subprime mortgage-backed securities, collateralized debt obligations and credit default swaps were considered financial innovations before they were “at the center of the Global Financial Crisis of 2008.” Gruenberg further discussed that such innovations resulted in catastrophic failure because, among other things, consumers and industry participants did not fully understand their risks, which were downplayed and intentionally ignored. He then provided an overview of the FDIC’s approach to engaging with banks as they consider crypto-asset related activities, and the potential benefits, risks, and policy questions related to the possibility that a stablecoin could be developed that would allow for reliable, real-time consumer and business payments. He stated that “[f]rom the perspective of a banking regulator, before banks engage in crypto-asset related activities, it is important to ensure that: (a) the specific activity is permissible under applicable law and regulation; (b) the activity can be engaged in a safe and sound manner; (c) the bank has put in place appropriate measures and controls to identify and manage the novel risks associated with those activities; and (d) the bank can ensure compliance with all relevant laws, including those related to anti-money laundering/countering the financing of terrorism, and consumer protection.”
Gruenberg pointed to an April financial institution letter from the FDIC (covered by InfoBytes here), which requested banks to notify the agency if they engage in crypto asset-related activities. He added that as the FDIC and other federal banking agencies develop a better understanding of the risks associated with crypto-asset activities, “we expect to provide broader industry guidance on an interagency basis.” Regarding crypto-assets and the current role of stablecoins, Gruenberg noted that payment stablecoins could be significantly safer than available stablecoins if they were subject to prudential regulation, including issuing payment stablecoins through a bank subsidiary. He cautioned that disclosure and consumer protection issues should be “carefully” considered, especially if custodial wallets are allowed outside of the banking system as a means for holding and conducting transactions. Specifically, he said that “payment stablecoin and any associated hosted or custodial wallets should be designed in a manner that eliminates—not creates—barriers for low- and moderate-income households to benefit from a real-time payment system.” Gruenberg added that if a payment stablecoin system is developed, it should complement the Federal Reserve's forthcoming FedNow service—a faster payments network that is on track to launch between May and July of next year—and the potential future development of a U.S. central bank digital currency. In conclusion, Gruenberg stated that although federal banking agencies have significant authority to address the safety, soundness and financial stability risks associated with crypto assets, there are “clear limits to our authority, especially in certain areas of consumer protection as well as the provision of wallets and other related services by non-bank entities.”
On October 12, Federal Reserve Vice Chair for Supervision Michael S. Barr delivered remarks at D.C. Fintech Week in a speech titled Managing the Promise and Risk of Financial Innovation. Barr’s remarks focused on financial innovation supported by new technologies, or fintech. Among other things, Barr discussed supporting innovation with appropriate regulation, striking the right balance for crypto-asset activity, regulating stablecoins, recognizing the risks of tokenizing bank liabilities, advancing customer autonomy, and providing public sector support for payment innovation. Barr noted that cryptoassets’ rapid growth, in market capitalization and activity outside and inside supervised banks requires oversight, including safeguards to ensure that crypto service providers are subject to similar regulations as other financial services providers. Barr stated that “[t]he same type of activity should be regulated in the same way,” and this remains the case “even when the activity may look different from the typical activities we regulate, or when it involves an exciting new technology or a new way to provide traditional financial services.” He also disclosed that there are additional types of crypto asset-related activities where the Fed may need to provide guidance to the banking sector in the future. Barr noted that since “crypto assets have proved to be so volatile, they are unlikely to grow into money substitutes and become a viable means to pay for transactions.” He also warned banks seeking to experiment with these new technologies that they should only do so "in a controlled and limited manner.” Regarding the risks of tokenizing bank liabilities, Barr expressed concerns, stating that banks’ crypto-asset-related activities pose “novel risks,” and said that stablecoins could eventually pose a risk to financial stability and that regulators need to put in guardrails before their adoption is more widespread. Barr also acknowledged that not all tokenization arrangements are the same. He stated that potential designs “range from issuance of tokens on private, controlled networks to facilitate payments within or among banks, to proposals that explore issuance of freely circulating tokens on open, permissionless networks.”
Recently, Financial Stability Board (FSB) Chair Klaas Knot sent a letter to the G20 Finance Ministers and Central Bank Governors concerning global financial stability, followed by the release of two FSB reports. The letter stated that “turmoil in crypto-asset markets has validated many of the FSB’s concerns about crypto assets,” and noted that the “‘crypto winter’ has reinforced [its] assessment of existing structural vulnerabilities.” The letter expressed concerns that the risks crypto assets pose to financial stability are "likely to come back to the fore sooner rather than later.” Knot stated that the FSB’s report on stablecoins expanded recommendations for the regulation of stablecoins, which are digital tokens that aim to maintain a one-on-one value with less volatile assets such as the euro or dollar. In the stablecoin report, the FSB stated that most existing stablecoins would not meet its recommendations at present, and would require “significant improvements” to their governance, risk management, stabilization mechanisms and disclosures. Knot also discussed the FSB's report on crypto-asset activities and markets, which focuses on regulatory, supervisory, and oversight issues relating to crypto-assets to help ensure safe innovation. The report noted that “[c]orrelations between crypto-asset prices and mainstream equity indices have been steadily increasing since year-end 2021 and peaked in May 2022, when the market stress began.” The letter further described that in 2020, G20 Leaders endorsed the Roadmap for Enhancing Cross-border Payments to address the frictions that payments currently face, and thereby achieve faster, cheaper, more transparent and more inclusive cross-border payment services. As previously covered by InfoBytes, Knot stated that the recent FSB report on the roadmap presents “priorities for this new phase of the work, and proposes an intensified public-private sector collaboration to take this forward.” In regard to cyber risks, he stated that cyber-risk safeguards are important due to rapidly growing cyber incidents. He further stated that the FSB “is working to promote a resilient global financial system in the near term and over the longer run, supporting policymakers in the G20 to foster stronger, equitable and inclusive growth.”
On October 3, the Financial Stability Oversight Council (FSOC) released its Report on Digital Asset Financial Stability Risks and Regulation. As called for by Executive Order 14067, “Ensuring Responsible Development of Digital Assets” (covered by InfoBytes here), the report reviewed financial stability risks and regulatory gaps posed by various types of digital assets and provided recommendations to address such risks. Among other things, the report noted three gaps in the existing cryptocurrency regulatory framework: (i) limited direct federal oversight of the spot market for crypto-assets that are not securities; (ii) opportunities for regulatory arbitrage; and (iii) whether vertically integrated market structures can or should be accommodated under existing laws and regulations. The report stated that FSOC recommended that Congress pass legislation that would create “a comprehensive prudential framework for stablecoin issuers that also addresses the associated market integrity, investor and consumer protection and payments system risks, including for entities that perform services critical to the functioning of the stablecoin arrangement.” FSOC further recommended that the member agencies should follow several guiding principles, including “same activity, same risk, same regulatory outcome,” and “technology neutrality.” The report also requested that agencies consider whether “vertical integration” or other business models where retail customers can directly access markets instead of going through a broker-dealer “can or should be accommodated.” The report noted that if banks “scale up their participation in the crypto-asset ecosystem, such activity could potentially entail much greater access to the crypto-asset market by a broad range of institutional investors, corporations, and retail customers than currently exists.” The U.S. Treasury Department released a Fact Sheet summarizing the report’s key findings and recommendations.
Treasury Secretary Janet Yellen noted in a statement that the “report adds to analysis of digital asset issues that have been covered in other recent reports, including on the future of money and payments; consumers and investor protection; illicit finance; and a framework for international engagement.” Acting Comptroller of the Currency Michael J. Hsu released a statement supporting the report, emphasizing that “it is critical for the Council and Congress to prioritize Recommendation 4 regarding interagency coordination, Recommendation 5 regarding a federal prudential framework for stablecoin issuers, and Recommendation 6 regarding regulatory visibility and authorities over all of the activities of crypto-asset entities.” SEC Chair Gary Gensler also expressed his support in a statement, noting that he looks “forward to working with Congress to achieve our public policy goals, consistent with maintaining the regulation of crypto security tokens and related intermediaries at the SEC.” Texas Banking Commissioner and FSOC state banking representative Charles G. Cooper released a statement of support through the Conference of State Bank Supervisors saying that the report should “inform the work that we do as individual agencies and on an interagency basis to balance responsible innovation with safeguarding our financial markets and consumers.”CFPB Director Rohit Chopra released a statement, noting that “agencies have already taken steps to address discrete issues related to deposit insurance misrepresentation and to lay groundwork to address concerns related to fraud, hacks, and scams,” and emphasized the need “to tackle broader risks to the financial system.”
On September 8, SEC Chair Gary Gensler issued remarks before the Practising Law Institute to discuss cryptocurrency tokens and corresponding SEC regulation. During his remarks, Gensler stated his view that the “vast majority” of cryptocurrency tokens on the market are securities that are subject to SEC regulation. As a result, investors in cryptocurrencies “deserve disclosure to help them sort between the investments that they think will flourish and those that they think will flounder,” and that the law requires such protections. Gensler, also addressed stablecoins, which he also concluded raised significant policy issues. Gensler pointed out that depending on their attributes, stablecoins “may be shares of a money market fund or another kind of security,” and therefore require registration and deserve investor protections. Finally, addressing crypto intermediaries, Gensler noted that they are either engaging “in the business of effecting transactions in crypto security tokens for the account of others, which makes them brokers, or engage in the business of buying and selling crypto security tokens for their own account, which makes them dealers.” He warned that because crypto intermediaries often commingle other functions with a market, investors are inherently exposed to conflicts of interest and risks. To address this, Gensler noted that he encouraged SEC staff to collaborate “with intermediaries to ensure they register each of their functions—exchange, broker-dealer, custodial functions, and the like—which could result in disaggregating their functions into separate legal entities to mitigate conflicts of interest and enhance investor protection.” Gensler noted that legislation should be crafted in a way that maintains the SEC’s oversight of crypto security tokens, and added that these kind of assets make up most of the digital assets that are currently traded.
The same week, the SEC announced it is establishing an Office of Crypto Assets and an Office of Industrial Applications and Services to the Division of Corporation Finance’s Disclosure Review Program (DRP), which “has long had offices to review company filings by issuers.” According to the SEC, the offices will join the seven existing offices that provide focused review of issuer filings to continue the SEC’s efforts in promoting capital formation and protecting investors. The Office of Crypto Assets will permit “the DRP to better focus its resources and expertise to address the unique and evolving filing review issues related to crypto assets.”