US Risk Watchdog Asks Congress to Name Crypto Spot Market Regulator

The top U.S. financial regulators are warning of dangerous holes in the oversight of crypto and are asking Congress for more powers, including settling which agency will oversee the bulk of trading in bitcoin and other non-security tokens, according to a report unanimously approved at a meeting of the Financial Stability Oversight Council (FSOC) on Monday.

The council's report flags several of the unregulated hazards in the digital assets industry, including the spot market for bitcoin (BTC). These latest recommendations from the group, which is led by Treasury Secretary Janet Yellen, effectively bolster the two leading efforts in crypto legislation: a bill that would put the Commodity Futures Trading Commission (CFTC) in charge of overseeing that spot market, and another that would establish rules for stablecoin issuers.

“Innovation without adequate regulation could result in significant disruptions,” Yellen said during the council’s Monday meeting. She said the report "identifies a number of current gaps in regulation" and finds that crypto assets "could pose a risk to financial stability."

Read more: Biden’s Executive Order Produces Few Answers in Crypto Reports From US Treasury

The 125-page FSOC document concluded that potential fraud and manipulation in crypto trading begs for a spot market watchdog, according to a staff presentation at the meeting. Legislation in both the Senate and House would place the CFTC in that role, though the bills leave the Securities and Exchange Commission (SEC) with authority to decide which tokens are "securities" over which it will have jurisdiction.

The FSOC – whose members include the heads of financial agencies, including the Federal Reserve and both the SEC and CFTC – is also preparing to recommend that U.S. regulators need to be able to reach into all corners of digital businesses. They not only need to be able to supervise a crypto firm, but also all of its affiliates and key service providers – as the Fed can do when it oversees Wall Street banks, the report will argue, asking Congress to grant that power.

This is the latest document – and one of the most anticipated – set to emerge from President Joe Biden’s executive order calling on federal regulators to come up with plans for overseeing crypto. While the FSOC will once again note that U.S. financial regulators do have powers that reach into much of the industry, the report’s recommendations rely heavily on Congress to step in and solve many of the government’s shortcomings. However, the current congressional session is nearing its end and lawmakers will be directing their attention to the midterm elections next month that will remake Congress. Thus, any reliance on the legislative branch could represent a long-term project.

"Crypto cannot exist outside of our public policy frameworks, regardless of what the crypto industry initially expected or what certain market participants might say today," SEC Chairman Gary Gensler said on Monday, adding that the policies need to protect consumers and financial stability, while also shielding against illegal activity. "Whether you call something a crypto token, stablecoin or decentralized finance platform (DeFi), those public policy goals remain the same," he added.

As expected, the report calls for Congress to “create a comprehensive federal prudential framework for stablecoin issuers” that will let regulators set up guardrails around the tokens that are so vital to current crypto trading and future payments ideas. A high-profile bill in the House Financial Services Committee is seeking to do that.

The FSOC contends the crypto industry has been picking and choosing regulators – or often ignoring them completely.

“Crypto-asset entities do not have a consistent or comprehensive regulatory framework and can take advantage of gaps in the regulatory system and engage in regulatory arbitrage,” according to the report. It added that agencies should use their existing authority and coordinate with each other to block the industry’s ability to pick and choose the rules they want to follow and the regulators they want to deal with.

The FSOC’s recommendations also targeted the kind of proposal made by crypto broker FTX to directly clear its customers’ crypto derivatives trading rather than using traditional go-betweens.

“A number of firms have proposed to offer vertically integrated services so that retail customers can directly access markets,” the report noted, without mentioning FTX’s very public proposal being considered now at the CFTC. The FSOC is wary of the idea that customers’ under-margined positions could automatically be closed out at all hours, which the council argued “creates the potential for cascading liquidations and reduced capacity for human intervention during periods of stress.”

The council said its agency members need to more closely study such “vertical integration” and whether the structure “can or should be accommodated under existing laws and regulations.”

UPDATE (Oct. 3, 2022, 19:27 UTC): Adds council's approval and comment from SEC's Gary Gensler.

UPDATE (Oct. 3, 2022, 19:41 UTC): Adds recommendation affecting FTX proposal.