The FSOC’s Long-awaited Report on Crypto Regulation is Here

Centuries Analytics
Centuries Analytics
5 min readOct 10, 2022

The Financial Stability Oversight Council (FSOC), whose members include the top financial regulators in the county, has released its report, requested in Biden’s executive order earlier this year, urging Congress to provide much needed clarity on multiple issues, including spot trading regulation.

FSOC met to discuss the report prior to its publication on Monday. (Anna Moneymaker/Getty Images)

Anticipated Risks

The report underscored significant financial stability risks associated with cryptocurrencies.

“Some characteristics of crypto-asset activities have acutely amplified instability within the crypto-asset ecosystem. Many crypto-asset activities lack basic risk controls to protect against run risk or to help ensure that leverage is not excessive. Crypto-asset prices appear to be primarily driven by speculation rather than grounded in current fundamental economic use cases, and prices have repeatedly recorded significant and broad declines,” the report said.

The report continued to emphasize the increasing interconnectivity of crypto-assets and traditional financial markets. It notes the growing adoption of stablecoins, leverage trading, and asset custody offerings at multiple traditional financial institutions. Crypto-asset activities have little safeguards against run risk to ensure leverage isn’t excessive. They are also susceptible to vulnerabilities in distributed ledger technology.

Existing Regulatory Structure

Many non-bank firms in the crypto-asset ecosystem have advertised themselves as ‘regulated’. The regulation these firms refer to is focused on anti-money laundering and consumer protection rather than financial stability risks arising from other digital asset activities. The report emphasizes that enforcing the existing regulatory structure is a critical step to addressing financial stability risks in the crypto ecosystem.

The report notes the series of enforcement actions taken by the Securities and Exchange Commission (SEC) on the sale of crypto-assets, in violation of state securities law, because the sales were unregistered and nonexempt. False reports concerning availability of Federal Deposit Insurance have, in violation of law, given the impression to consumers that their investments are protected by a government safety net, when in reality they are not. In August, the FDIC issued cease and desist orders to five cryptocurrency-related firms for misleadingly stating that they have federal deposit insurance.

Regulatory Gaps

The report identified three major regulatory gaps that need to be addressed:

Spot Market

The report clarifies that crypto-assets that are not deemed securities are subject to limited direct regulatory guidelines. The fact sheet continues that “as a result, those markets may not feature robust rules and regulations designed to ensure orderly and transparent trading, prevent conflicts of interest and market manipulation, and protect investors and the economy more broadly.”

Regulatory Arbitrage

Crypto-asset businesses lack a comprehensive regulatory framework which allows for regulatory arbitrage. Affiliates or subsidiaries of any given crypto-related business may fall under different regulatory measures, making it difficult for any single regulator to have full-access over the entire inner workings of a given business.

Vertical Integrations

Crypto-asset firms have begun offering vertical integrations of intermediary services, such as broker-dealers and futures commission merchants, to retail customers. In doing so, implications may arise from retail investor exposure to vertically integrated services that affect their financial stability and protection.

Recommendations

The Council provides five major recommendations to combat their findings.

Consideration of Regulatory Principles

As integration between the crypto-asset market and traditional financial systems increases, the FSOC requested that member agencies keep issues such as technology neutrality, transparency in technology and disclosures, as well as preempting financial stability risks before they impair the economy. Interagency cooperation in market data and enforcement was also noted.

Continued Enforcement

The council reiterated that they recommend continued enforcement of current regulations including, but not limited to, banking laws, anti-money laundering, sanctions, consumer protection, and participant registration requirements. Banks and credit unions that participate in crypto-related activities are urged to act in compliance with current laws and regulations

Addressing Regulatory Gaps

To address vulnerabilities in spot market trading, the FSOC urges Congress to pass regulation that provides “explicit rulemaking authority for federal financial regulators over the spot market for crypto-assets that are not securities.” The authority created to regulate this market should not interfere or undermine the current jurisdictions of other financial regulatory bodies and should focus on the following issues: conflict of interest, abusive trading, public trade reporting requirements, governance, cybersecurity, custody, transparency, and anti-fraud requirements, among others. The legislation should provide for enforcement and examination authority to ensure compliance.

In regards to regulatory arbitrage, the FSOC recommends stronger coordination between different regulatory agencies, especially if the entity is a stable-coin issuer or has different entities falling under different regulatory jurisdictions. The report also recommends that regulators work with law enforcement agencies, when necessary, if market participants are not readily identifiable, as the case may be with crypto-asset entities.

The report calls on Congress to create a sound regulatory framework for stablecoin issuers that addresses market integrity, consumer protection, and payment system risks. Legislation should focus on financial stability risks associated with stablecoins. Importantly, the Council notes that should Congress fail to enact legislation on stablecoins in a timely fashion, they are prepared to take steps to address the risks of stablecoins independently.

FSOC also called on Congress to develop legislation that grants regulators the authority to have visibility into all subsidiary and affiliate programs of crypto-asset entities. It clarifies that such authority would apply regardless of a projects ‘decentralized’ nature. The report argues that this legislation would allow regulators to combat arbitrage in a coordinated manner.

The Council calls on the FDIC, FRB, and OCC to use their existing authority to evaluate services provided by banks relating to crypto-assets. As they evaluate their powers over these existing entities, the FSOC recommends that they consider whether the powers they have are sufficient to address growing issues in the crypto-asset communities. They also recommend that Congress ensure that the FHFA and NCUA have proper authority to enforce and oversee these crypto-assets as well.

Finally, the Council recommends that member agencies assess the impact of vertical integration on the crypto ecosystem, specifically conflict of interest and market volatility.

Ensuring Regulation is Informed by Appropriate Data

FSOC believes that data must be shared in order to implement effective and proper regulation. This data should be used to facilitate the assessment of financial risks around crypto-assets in a coordinated study by member agencies. The council will work with its members to collect and coordinate data collection and analysis to avoid duplication and facilitate its improvement and use across the regulatory field.

Building Regulatory Capacity and Expertise

In short, the FSOC believes that the current understanding of cryptocurrency, digital assets, and decentralized ledger technology is still nascent. The council is urging member agencies to to build their understanding and ability to process crypto-asset activities. They will work closely with academics, industry experts, and government to build expertise related to rapidly developing technologies. This includes the ability to understand on-chain data and complaints received relating to crypto-asset activities.

About Centuries Analytics

Investing in cryptocurrency doesn’t have to be risky — not anymore. We let data speak; not investors, “experts”, pundits, or tv show commentators. Centuries uses social media, financial, and macro-economic data to determine and predict cryptocurrency markets.

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Centuries Analytics
Centuries Analytics

Centuries uses social media, financial, and macro-economic data to determine and predict cryptocurrency markets.