Financial Stability Board Issues Statement on Regulation of “Crypto-Asset Activity”
On Monday, the Financial Stability Board (FSB), an international regulatory coordinating body that monitors the global financial system, issued a statement announcing its plans to release a robust framework for regulating and supervising what it calls “crypto-asset activities.” According to the statement, the FSB will make its policy recommendations to G20 nations in October.
You can read the full text of the FSB’s statement here. But there are a couple of things we think are especially important in how the FSB has framed its impending policy recommendations.
In its statement, the FSB highlighted what it considers to be crypto’s “intrinsic volatility, structural vulnerabilities, and … increasing interconnectedness with the traditional financial system.” According to the FSB, these features of the crypto markets are the key reasons why they think regulators and central banks must begin exploring how to regulate them more effectively.
This represents a shift in focus for the FSB. In the past, they had shown relatively little interest in regulating digital asset activity (ignoring Libra/Diem here) — citing crypto’s small size and relatively marginal impact on the larger financial system as justification. But things have changed, and the FSB now wants to “ensure that crypto-asset activities posing risks similar to traditional financial activities are subject to the same regulatory outcomes, while taking account of novel features of crypto-assets and harnessing the potential benefits of the technology behind them.”
What does this mean?
For now, DeFi still seems to be on the FSB’s “explore further” list. That fits with the broader trend we’re seeing: as regulatory agencies around the world are increasingly motivated to act in the crypto markets, they’re starting with centralized businesses like reserve-backed stablecoin issuers and centralized crypto exchanges.
But we think it is encouraging to see the FSB recognize the nuanced difference between the different activities in crypto. We can only agree with the FSB that regulations must reflect the actual risks and be tailored to the actual functionality of a particular activity, technology, or asset.
Fed’s Brainard Calls for Sound Crypto Regulation
In a speech delivered in London last week, Federal Reserve Vice Chairwoman Lael Brainard advocated for a sound regulatory approach to be established before the crypto ecosystem becomes large or interconnected enough to pose risks to the stability of the broader financial system. “Recent volatility has exposed serious vulnerabilities in the crypto financial system” that Brainard believes are the result of unregulated market vulnerabilities. She stated that the Federal Reserve is “closely monitoring recent events where risks in the system have crystallized and many crypto investors have suffered losses.”
In response to this market turmoil and alleged vulnerabilities, Vice Chairwoman Brainard advocated for a comprehensive framework with “strong regulatory guardrails will help enable investors and developers to build a resilient digital native financial infrastructure.”
What does this mean?
The Fed has still yet to decide on a unified strategy for handling crypto assets. That includes deciding on a preferred regulatory approach for crypto markets, as well as other things like deciding whether or not a CBDC would be an appropriate and beneficial innovation.
But for now, regulators like the Fed seem primarily focused on implementing a framework for stablecoin issuers and centralized crypto entities rather than regulating on-chain activities. And frankly, this piecemeal approach makes sense for a variety of reasons:
Stablecoins and crypto service providers are centralized and do not require any novel regulatory frameworks to capture the risks they pose and the functions they perform
Centralized crypto entities like exchanges function as the bridge between the traditional financial ecosystem and the digital asset ecosystem; they are an accessible point of centralization to which regulators can direct their attention..
Stablecoins have a large market and are already becoming increasingly intertwined with the traditional financial system.
That said, we will ultimately need a broader, better and more flexible regulatory approach that can address novel technology and asset classes — especially DeFi. And while it is unclear what regulations lie in store for DeFi, it is encouraging to continue to see regulators recognize the fundamental differences between centralized crypto entities and decentralized, distributed protocols.
US Treasury Announces Framework for International Engagement on Digital Assets
Last week, the Department of Treasury released a fact sheet that outlines a framework for interagency engagement with foreign jurisdictions on digital assets. The framework was delivered in response to President Biden’s Executive Order on Digital Assets.
A key aspect of the report was its focus on utilizing private sector innovation and international engagement to eliminate the potential for regulatory arbitrage. Regulators seem to have come to the understanding that if they are able to enforce their KYC/AML regime comprehensively across multiple jurisdictions, they can eliminate the risk of illicit activity.
The report specified the important role international organizations and watchdogs like G7, G20, FSB, FATF, etc. will play in organizing these collaborative relationships between jurisdictions.
What does this mean?
The report is rather encouraging for a variety of reasons.
First, it is positive to see central banks and treasury departments acknowledging the potential benefits that digital assets and blockchain technology can offer users, as well as the importance of a collaborative and conscientious approach to crafting regulations for them.
It is also positive to see central bankers, treasury departments, and watchdogs in both the United States and abroad engage with the private sector and international organizations to meet their AML/CFT policy objectives — and to do so without compromising the privacy of crypto users.
The crypto community has long feared that policymakers and regulators would not accept the pseudonymous, peer-to-peer nature of blockchain technology. But by engaging with blockchain analytics companies to use appropriate technological tools for pursuing AML/CFT objectives, regulators are showing their willingness to adapt their enforcement mechanisms to meet the challenges of novel technology.