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Don’t let the crypto winter go to waste

Regulators should not miss this once-in-a-lifetime opportunity to avert an obvious threat to the financial system.

The cryptocurrency market has given US policymakers the opportunity of a lifetime. Less than a year ago, it was about to become a systemic threat, gathering disciples, influence and political clout faster than regulators could come to grips with. Then the danger miraculously disappeared: the market imploded before reaching critical mass and entered the “crypto winter” that continues to this day.

This delay may not last long. Policy makers should act now to impose some much needed regulation on this market.

The problem areas are clear. Number 1 are stablecoins, or digital tokens that claim to be worth a dollar and are used by speculators to gain leverage or to park money between bets. At their peak, such coins had attracted more than $160 billion, which their issuers had invested in assets ranging from corporate debt to Bitcoin to nothing at all. The danger is that a sudden loss of trust could lead to an exodus, as happened with the Terra stablecoin in May. The more fixed assets issuers hold, the greater the potential for wider disruption, for example in markets that real companies rely on to make payroll and raise working capital.

Another threat arises when commercial banks are exposed to crypto, either directly or through loans to corporations and hedge funds. For example, if major banks were among the creditors of the now-bankrupt entities Celsius or Three Arrows Capital, which at their peak had tens of billions of dollars in combined liabilities, the crypto meltdown could have done much greater damage. Fortunately, regulators seem to have averted such an outcome and remain vigilant, although they haven’t adopted any formal rules yet.

In addition, numerous digital tokens and trading platforms – including major exchanges operated by Coinbase and Crypto.com – for the most part do not have the same standards of consumer protection, disclosure, governance, security and soundness as traditional assets and financial intermediaries. . So the market is rife with hacks, manipulation, self-dealing and outright fraud, while regulators like the Securities and Exchange Commission and the Commodity Futures Trading Commission struggle to figure out how to respond and who should be in charge of what.

Ideally, Congress would impose some order. There are plenty of proposed legislation, some good. One bipartisan bill would (sensibly) require stablecoins to be backed with regularly disclosed high-quality assets and oversee crypto tokens and exchanges. That said, it would also complicate things by creating a new category of “side assets” for certain digital tokens, and introducing questionable measures such as tax breaks for the “miners” who process blockchain transactions. And with the midterm elections approaching, lawmakers are unlikely to make any progress any time soon.

Officials don’t have to wait for Congress. Banking regulators, for their part, have the power to issue a limited charter for stable coin issuers: those who met the necessary standards, including for assets and governance, could be granted privileges such as access to accounts with the Federal Reserve; others would be subject to strict controls and possible sanctions. Authorities can also set strict capital requirements so that any crypto exposures are funded with equity that banks can afford to lose.

When it comes to tokens and exchanges, the SEC and CFTC must work together. It hardly matters whether something is called a security or a commodity, as long as there is some semblance of transparency and accountability. To that end, former CFTC chairman Timothy Massad and Harvard Law School professor Howell Jackson have a promising proposal: The agencies should set up an industry-funded organization (similar to the Financial Industry Regulatory Authority) that would set reasonable standards for all relevant crypto-currencies. instruments and institutions. As with stablecoin issuers, non-compliant entities risk legal repercussions.

The technology underlying crypto may still bring benefits, but the speculative frenzy surrounding it still has the potential to wreak havoc. Rarely has history given authorities a second chance to avert such a clear threat to the financial system. Don’t let it get lost.

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