State of Crypto: Gensler's Regulatory Clarity Sounds Familiar

How policy and regulation impact the crypto world – and the other way around

By Nikhilesh De

Managing Editor, Global Policy & Regulation

May 11, 2021

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Welcome to State of Crypto, a CoinDesk newsletter looking at the intersection of cryptocurrency and government. I’m your host, Nikhilesh De. You’re probably here because you signed up, but in case you're not a fan, you can unsubscribe here.

SEC Chair Gary Gensler’s been on the job for three weeks. He’s just revealed what increased regulatory clarity might look like for crypto.

—Nik

Regulating crypto?

SEC Chair Gary Gensler suggested Congress could grant a federal regulator oversight authority over crypto exchanges during a Congressional hearing last week. (Andrew Harrer/Bloomberg via Getty Images)

The narrative

Securities and Exchange Commission Chairman Gary Gensler, three weeks into the job, said the U.S. Congress could help protect cryptocurrency investors by drafting some laws around crypto exchange regulation, noting the current, limited jurisdiction of the SEC.

“I think that this market, which is close to $2 trillion, [this] crypto asset market is one that could benefit from greater investor protection,” he said.

“I think if [Congress were to take action] – because right now the exchanges trading in these crypto assets do not have a regulatory framework, either at the SEC, or our sister agency, the Commodity Futures Trading Commission – that could instill greater confidence. Right now there's not a market regulator around these crypto exchanges, and thus there’s really no protection against fraud or manipulation.”

Why it matters

Okay, some thoughts. First off, a (HUGE!) caveat that this is all speculation on my part.

With that out of the way, the entirety of the crypto industry’s support of Gensler comes from the idea that he understands crypto in a way his predecessor did not, and that this would lead to regulatory clarity. We now have a hint of how Gensler thinks he can provide this clarity. Any number of issues pertinent to the crypto industry will depend on how the U.S.’ regulatory framework develops, including whether a bitcoin exchange-traded fund (ETF) is approved and how retail investors can tap the crypto market. The question becomes: Will Congress act with Gensler’s backing?

Breaking it down

What we don’t know are the specifics. There’s no concrete SEC or CFTC framework from Gensler right now. What we do know is that he thinks one of these agencies should have clearer oversight authority to address possible fraud or manipulation around the cryptocurrency markets.

Of course, exchanges are regulated right now at the state level. There are problems with this, though. For one thing, an exchange must secure money transmitter licenses in every state where it wants to operate (except Montana, which doesn’t have a licensing regime), which takes money and time. I’m not sure whether Gensler’s proposed federal framework would supersede the state-by-state approach, but if it does that would be massive. It’s the same problem that former Comptroller of the Currency Brian Brooks (now Binance.US CEO) tried to address with a federal trust charter to crypto companies. (While a few crypto custodians now have trust charters, it remains to be seen whether any exchanges will receive one.)

Both the SEC and CFTC have also demonstrated their oversight of the crypto markets with enforcement actions, but it sounds like Gensler’s going for something bigger. Though the CFTC has also laid claim to a number of crypto spot markets, there’s questions as to whether it actually has the authority to do so. So, in essence, it appears that what Gensler wants is some form of codified confirmation that a federal agency has oversight jurisdiction over the crypto markets in the U.S.

Here’s the next thing: We’ve seen this type of proposal in Congress already. Rep. Michael Conaway (R-Texas) introduced the Digital Commodity Exchange Act in the House of Representatives last year before he retired. That bill outlined how digital currencies could be treated similarly to commodities under federal law and, more importantly, it would create a federal jurisdiction for crypto exchanges.

To the best of my knowledge, there are no immediate plans to reintroduce the DCEA but it does seem like Gensler’s first recommendation has a frame all ready to go if someone in Congress does want to act on it. It could also, if passed, have a somewhat more immediate impact than the Eliminate Barriers to Innovation Act, sponsored by Rep. Patrick McHenry (R-N.C.), who asked Gensler about digital asset regulation. McHenry’s bill, which has been passed by the entire House, would form a study group that sends Congress recommendations after a year, versus the DCEA, which would skip the study aspect.

This extends beyond just the possible impact on exchanges. If Gensler believes the crypto industry in the U.S. needs more oversight, and in particular is concerned about market manipulation on exchanges, that might mean regulated products dependent on trustworthy exchanges won’t be approved before that oversight is in place.

Market manipulation, after all, is an issue the SEC has brought up repeatedly in denying approval of bitcoin exchange-traded fund (ETF) applications. As Bloomberg senior ETF analyst Eric Balchunas tweeted, Gensler may want this oversight to be formalized into law before an ETF is approved.

The possible downside I see here is if a new federal regulatory framework comes on top of the existing state-by-state regime. That would just become an additional burden on exchanges. There’s also the risk a federal framework would benefit larger, more established exchanges and become too difficult for smaller competitors to match, which would lead to some consolidation. The DCEA, as envisioned last year, would offer exchanges a choice of federal or state regimes to follow, so theoretically it wouldn’t result in a greater burden or consolidation.

I don’t know whether Gensler’s first public comments on crypto as SEC chair are a positive or negative sign for the industry. My view on Gensler’s nomination and confirmation has always been that he is likely to provide regulatory clarity, but it may not necessarily be the type of regulatory clarity the industry wants. That being said, my impression so far is that if Congress gets together and acts on this recommendation, this will be a long-term positive, both by giving exchanges some of that clarity they want and by giving retail or institutional investors more comfort about how their assets are regulated.

Fed accounts

Last Wednesday, the Federal Reserve published a proposal to allow financial institutions with novel banking charters access to accounts and services offered by the Fed. In other words, non-traditional financial institutions – like, say, crypto exchanges with certain charters – would be able to tap the Fed directly for an account rather than have to go through an intermediary bank.

If finalized (there’s currently a 60-day comment period on the proposal), the rule would mean entities like Wyoming-licensed Special Purpose Depository Institutions would be one step closer to acting as a full bank native to the crypto industry.

“The payments landscape is evolving rapidly as technological progress and other factors are leading to both the introduction of new financial products and services and to different ways of providing traditional banking services (i.e., payments, deposit-taking, and lending). Relatedly, there has been a recent uptick in novel charter types being authorized or considered across the country and, as a result, the Reserve Banks are receiving an increasing number of inquiries and requests for access to accounts and services from novel institutions,” according to the 20-page proposal.

David Kinitsky, the CEO of Kraken Bank, one such Wyoming-chartered bank, told CoinDesk his company had already applied for an account with the Fed, meaning this proposal is “of vital importance to us.”

The fact the Fed has taken the step of publishing this proposal is a good sign in and of itself, he said.

“We’re stoked about how they’re approaching it, with a risk-based approach,” he said. “There's nothing novel in terms of the factors that they're including here. It's exactly the type of things that the Federal Reserve is looking at, in terms of risk to the reserve itself, risk to the payment system [and] risk to the economy.”

In other words, fintech or crypto platforms won’t have to jump through extra hoops simply because they’re within the fintech or crypto industries.

Kraken Bank intends to maintain full reserves for the assets it holds rather than operate any fractional lending services or otherwise engage in fractional banking, Kinitsky said.

This means the liquidity and solvency risks that other banks might face aren’t an issue for Kraken Bank, he said. Kraken Bank does not intend to apply for Federal Deposit Insurance Corporation insurance at this time for that reason.

That’s not to say the Fed is comparing these alternate-charter institutions to banks. In Kinitsky’s view, the U.S. central bank is trying to determine how best to evaluate novel financial institutions in their own right.

“I think it's a really positive acknowledgement of the validity of some of these alternative charters that are eligible,” Kinitsky said. “... We don't want big banks to be gatekeepers, in effect, for them through banking as a service platform. It’s super, super important. It keeps us up to speed with other kinds of global regions like the U.K. faster payments initiative.”

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The Biden Bunch

Changing of the guard

Key: (nom.) = nominee, (rum.) = rumored, (act.) = acting, (inc.) = incumbent (no replacement anticipated)

On Friday, Treasury Secretary Janet Yellen announced Michael Hsu would be taking over as the Acting Comptroller at the Office of the Comptroller of the Currency, effective Monday. Hsu comes from the Federal Reserve, where he was a part of the bank supervision division, so he’s got experience overseeing major financial institutions. I’m not sure if he has any crypto background or where he’ll take former Comptroller Brian Brooks’ work from the past year. I’m also not sure if Hsu will eventually be nominated to become the full comptroller.

Has anyone heard anything about the CFTC?

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Elsewhere

Consensus 2021: CoinDesk’s annual shindig is back, albeit still virtual because COVID-19 remains a thing in much of the world and we shouldn’t encourage a bunch of you to fly to New York and congregate in a conference room. That is a bad idea. Anyways, I’m moderating a pair of chats with Ripple CEO Brad Garlinghouse and Binance.US CEO Brian Brooks. If you have questions you’d like me to ask, email nik@coindesk.com, subject line “Consensus question.” I’ll ask the best ones.

Republic of Georgia’s Central Bank Is Researching a Digital Currency: The National Bank of Georgia is exploring whether a digital lari will improve its domestic payment system and financial services.

Turkish Crypto Exchanges Must Report Transactions Over $1,200, Finance Minister Says: Turkey continues to bring the regulatory hammer down on its crypto industry. Finance and Treasury Minister Lütfi Elvan said exchanges must report transactions exceeding 10,000 lira ($1,200) under anti-money laundering rules.

Crypto Is Booming in Brazil, but Regulations Lag Behind: Crypto trading volumes in Brazil have skyrocketed in the first half of 2021 compared to all of 2020, reflecting a trend seen in the broader South American region. Regulators are now taking a look at this market.

Unlocked 101 at Consensus by CoinDesk 2021

The countdown is on to Consensus by CoinDesk, our virtual big-tent event this May.

For those who need a primer or to brush up on the fundamentals, we're hosting Unlocked 101, a free educational series designed to give you the tools you need to navigate crypto.

Sessions run May 4–20, covering the basics of Bitcoin, DeFi, scams and hacks and the NFT boom.

Register for Unlocked 101.

Outside CoinDesk

(The Washington Post) The U.S. Department of Justice sought and acquired subpoenas to obtain the phone records of three Washington Post reporters last year. The DOJ said it was looking for anything related to classified information that the reporters covered, and specifically for the reporters’ sources. It sure looks like it was just going after these reporters for publishing information that was less than great for then-Attorney General Jeff Sessions. I have to say, as a reporter who occasionally talks to sources about sensitive information, this is really concerning. I can’t see this doing anything other than furthering a move to encrypted chat applications (P.S.: I’m on Signal).

(Yahoo Finance) U.S. Sen. Elizabeth Warren (D-Mass.) said that “there’s a real issue about the environmental impact” of cryptocurrencies, in an interview with Yahoo Finance’s Andy Serwer. Warren is fairly influential, and her statements reflect a growing trend among policymakers.

Today's Tweet

If you’ve got thoughts or questions on what I should discuss next week, or any other feedback you’d like to share, feel free to email me at nik@coindesk.com or find me on Twitter @nikhileshde.

You can also join the group conversation on Telegram.

See ya’ll next week!

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