What to expect after the Senate banking hearing on the crypto crash

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Senate Banking Committee

CQ-Roll Call, Inc via Getty Images

The stakes have never been higher for the crypto industry as the Senate Banking Committee met on crypto on Tuesday, calling the Valentine’s Day hearing Crypto Crash: Why Financial System Backups are needed for digital assets. This hearing covered the hot topics of the week, including stablecoin regulation, consumer protection, the banking of the crypto industry, the need for a self-regulatory body, and how the Securities and Exchange Commission (SEC) should work with the Commodity Futures Trading Commission (CFTC) to regulate digital assets.

In testimony from Lee Reiners, director of policy at Duke Universitys Financial Economics Center, the law professor offered a comprehensive new approach to regulation. Overall, the committee, chaired by Sherod Brown (D-Ohio) and Tim Scott (RS.C.), aims to begin work on a bipartisan regulatory framework for cryptocurrency. They heard testimony from Georgetown University law professor Linda Jeng, JD, who is also director of global regulation at the Crypto Council for Innovation, and Vanderbilt Law School law professor Yesha Yadav.

Regarding Reiners’ testimony, he argued that Congress should clarify that the SEC has the authority to write rules governing DeFi applications, in addition to formal crypto businesses. Jeng and Yadav advocated for innovation, financial inclusion, diverse user base and other countries taking the lead like China. Reiners argued for consumer protection, financial stability and whether this is really an asset class or just gambling. The committee clearly noted Gary Gensler’s absence and said he had to appear before September, which is simply too late.

The stakes have never been higher for the crypto industry, as lawmakers grapple with how, or whether, to allow innovation to thrive in established economic hubs like New York and San. Francisco. The future of the dollar’s global dominance could also be affected by the decisions being discussed today on Capitol Hill.

SEC against. CFTC

Reiners argued for the SEC to have control, noting that the CFTC regulates commodity derivatives but does not regulate commodity spot markets. The practical effect of this structure is that cryptocurrency exchanges in the United States are currently not federally regulated. This is precisely because lawmakers want to solidify how crypto exchanges are federally regulated. This would improve clarity and reduce the likelihood of crypto firms being penalized for deals they didn’t know how to handle, as was recently the case with Kraken and Ethereum staking.

According to his statement, released ahead of the hearing, Reiners argued that the best and most feasible way forward is for Congress to exclude cryptocurrency from the definition of a commodity in the Commodities Exchange Act and to recognize crypto-currencies as securities according to a special definition in the securities laws. In short, Reiners believes the SEC should be the primary regulator focused on crypto exchanges.

He went on to say that if a crypto exchange offers custodial services for client assets instead of requiring the use of a qualified custodian, that exchange may be subject to a special resolution administered by the Securities Investor Protection Corporation. (SIPC) so that clients are insured against losses up to $500,000 if the exchange company goes bankrupt. This could have helped protect some of the victims of FTX’s bankruptcy, for example. As important as these decisions are, they may pale in comparison to how lawmakers might pivot on decentralized crypto services and tools.

Regulate DeFi

The inclusion of DeFI as a topic in today’s hearing is subtle, but important. Reiners notes that several companies have developed online user interfaces that allow users to access DeFi protocols. These companies should be required to register as brokers. This would impact many companies and projects such as AaveAAVE and CompoundCOMP.

Reiners added that DeFi projects run exclusively on blockchain-based smart contracts, which do not depend on the efforts of others, present less potential risk because very few people have the technological means to access them directly. Additionally, these projects are still so experimental that they have little connection to real-world assets. Given that the most salient risks associated with DeFi today are code vulnerabilities that could attract illicit hackers, Reiners argued that the SEC could start by requiring independent code audits and computer security testing of DeFi protocols. It would be a huge step forward for a traditional regulator like the SEC to consider code audits as part of the standardized compliance process.

Stable Coins

Reiners’ proposal would also grant the SEC oversight of stablecoins. Elizabeth Warren and Roger Marshall are likely to agree with him. If lawmakers follow the advice of law professors, regulators will impose strict requirements that all stablecoin reserves must be held in cash or US Treasury securities. This was not the case, for example, with the crypto exchange Paxos, which was recently ordered to stop issuing the stablecoin BUSDBUSD.

The idea would also be to subject stablecoin issuers to routine audits and disclosures, and even banking regulations. Rather than deciding whether stablecoins are commodities or securities, Congress could simply ask the CFTC and SEC to engage in joint rulemaking and sharing authority in the case of stablecoins. There is precedent for this, as the two agencies engaged in joint regulation to implement Title VII in 2010, which governed derivatives regulation, of the Dodd-Frank Act. Rather than forcing stablecoins into the banking system, Congress can grant the SEC the power to regulate them like money market mutual funds, with strict requirements that stablecoin reserves must be held in cash. and Treasury securities.

All things considered, this hearing is different from previous hearings because there is now more pressure from the Biden administration for Congress to finally take definitive action. If Congress responds to this pressure, the most likely first step lawmakers will take is to pass stablecoin regulations first. It would be the most similar action to what lawmakers have done before. Regardless of what happens next, these decisions are sure to impact the economic growth of nations for decades to come. The future of digital assets in North America is determined on days like today.

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