AG Letitia James Joins Call for Increased Crypto Regulation After FTX Collapse

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Following the collapse of FTX, the world’s third-largest digital cryptocurrency exchange that also operated as a sort of crypto hedge fund, a letter to Congress from the New York State Attorney General, Letitia James, is one of the latest to call for increased regulation on cryptocurrency investments.

James’ letter focuses on retirement funds and calls for measures to be taken to prevent IRAs and defined contribution plans from being invested in high-risk digital assets such as cryptocurrency and digital tokens.

Concerns mentioned include the high risks of fraud, theft, and loss associated with investing in cryptocurrencies, as well as the lack of ownership or debt securities and the non-transparent market forces at play.

For many Americans, the majority of their retirement savings will come from an IRA or 401(k) plan. AG James’ letter warns that allowing these types of funds to be invested in digital assets means that many Americans could find themselves at retirement age without enough savings for basic expenses.

Most cryptocurrency issuers are not scrutinized by any regulator, state or federal, James wrote. They do not operate within net capital requirements nor do they maintain minimum reserves to meet commitments and avoid a run.

The New York Attorney General is not the first to worry about the possibility of mixing cryptocurrency investments and retirement funds.

Earlier this year, the US Department of Labor released a statement warning plan trustees to exercise extreme caution when considering adding cryptocurrency options to 401(k) plans. The department cited a list of serious concerns about the use of crypto for retirement investments, in particular the high risks of fraud, theft and loss.

With this letter, AG James joins a growing list of names in recent weeks calling for increased scrutiny of the largely unregulated cryptocurrency industry in general. Janet Yellen, current US Treasury Secretary and former Federal Reserve Chair, also released a recent statement calling for tighter crypto regulations.

The recent failure of a major cryptocurrency exchange [FTX] and the resulting unfortunate impact for holders and investors of crypto assets demonstrate the need for more effective oversight of cryptocurrency markets, Yellen said, warning that new interconnections of the traditional financial system and Crypto markets could raise broader financial stability issues.

However, some urge caution when considering broad legislation at this early stage of the nascent crypto industry.

Omid Malekan, a professor at Columbia Business School and author of several crypto-related books, including Story of the Blockchain, told The Crime Report that he supports the introduction of new crypto regulations but says a law prohibiting the investment of any portion of citizens’ pension funds in crypto would be draconian.

Malekan, however, agrees that tighter regulation is needed around crypto, the controversies lie in the details of exactly how to regulate it. He says a modified version of James’ proposal, limiting the availability of crypto in pension funds to only the most established coins (e.g. Bitcoin), might make sense.

Everyone, even in the industry right now, agrees that there are aspects of crypto that need to be regulated, but there is very little agreement on how and by whom, Malekan said.

We have a landscape of many different regulators at the state and federal levels, and they are currently in the midst of a turf war over who can regulate crypto.

Malekan argued that in some ways the cryptocurrency industry may actually be easier to regulate than traditional financial institutions due to the technology involved.

There are aspects of blockchain technology that make it much easier to regulate crypto companies than it takes to regulate traditional financial services, he said.

Because everything is ultimately traced on this transparent global ledger, it is much easier to ensure that, if customers send their coins to an exchange, the exchange does not hijack them.

One way to introduce more oversight into the cryptocurrency industry then could come in the form of a law formally requiring proof of reserves.

There’s this idea called proof of reserves if done right what happens is that periodically the exchange releases information that can be used to prove that they have the assets that they are supposed to have, explained Malekan, [The FTX failure] happened because the industry, their customers, didn’t demand it.

Exchanges would post information verifying that they control a certain wallet and confirming the amount of cryptocurrency in the wallet.

Since this information would be available to everyone, in theory there would be no need for an external auditor to assure investors that the coins are not being hijacked or loaned out.

This concept of proof of reserves could potentially solve the problem mentioned in James’ letter regarding non-compliance with net capital requirements.

We all agree that crypto needs to be regulated, but you don’t want to regulate it the way Wall Street does. It’s a fundamentally different thing, Malekan said.

With regulations so early in the process, you want [use] as light as possible while preventing something like FTX from reproducing. You want to be forward-looking.

Kay Bontempo is a TCR contributor.

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