Top US Regulator Says Cryptocurrencies Pose Risks to Financial Stability

Representation of cryptocurrency Bitcoin is seen in this illustration taken on Nov. 29, 2021. Dado Ruvic/Reuters

The Financial Stability Oversight Council (FSOC) issued a report on digital assets like cryptocurrencies, warning about the dangers posed by such instruments.

“Crypto-asset activities could pose risks to the stability of the U.S. financial system and emphasizes the importance of appropriate regulation, including enforcement of existing laws. It is vital that government stakeholders collectively work to make progress on these recommendations,” the Oct. 3 report states. Many cryptocurrencies do not have the necessary risk controls to protect against “run risk or to help ensure that leverage is not excessive.”

Despite the distributed nature of crypto asset systems, operational risks can arise due to the concentration of key services or from vulnerabilities linked to the distributed ledger technology on which these assets rely, warned the FSOC’s “Report on Digital Asset Financial Stability Risks and Regulation.”

Rather than fundamental economic use cases, the prices of crypto assets are “primarily driven” by speculation. The report also noted that many crypto asset firms and activities have “sizable interconnections” with crypto asset entities that have “risky business profiles.”

The report highlighted three gaps regarding the regulation of crypto assets in the country. First, the spot markets for such assets, which are not classified as securities, are subject to only limited direct federal regulation.

Second, crypto asset businesses do not have a comprehensive or consistent regulatory framework, so they are in a position to engage in “regulatory arbitrage.”

A single business might operate several entities under various regulatory frameworks due to which no single regulator might perceive the risks that might be present in the overall business.

Third, the act of crypto trading platforms offering retail customers direct access to markets might have “financial stability and investor protection implications,” the report stated.

Recommendations, Crypto Market Dangers

The FSOC recommended passing legislation that will provide federal financial regulators with rulemaking authority over spot markets for crypto assets that are not classified as securities. It asked for measures to combat regulatory arbitrage and legislation to deal with the risks posed by stablecoins.

The report comes in response to an executive order on digital assets passed by President Joe Biden in March. Last month, the White House released a fact sheet detailing the reports submitted by various agencies on developing a framework for crypto regulation.

The report had called for encouraging federal regulators such as the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) to “aggressively pursue investigations and enforcement actions against unlawful practices in the digital assets space.”

In July, an FBI report revealed that the agency had identified 244 victims of crypto frauds who had lost around $42.7 million. The same month, federal authorities charged two people in what was described as the U.S. government’s first case related to cryptocurrency insider trading.