The $2 Trillion Cryptocurrency Market Is Drawing Interest From Investors, Scrutiny From U.S. Regulators

WASHINGTON — With the proliferation of cryptocurrencies, prices of bitcoin and other digital tokens are often displayed on cable news tickers and financial apps as if they were common stocks, bonds or oil futures.

They are not. This makes them a challenge to US financial lawmakers.

Cryptocurrency censorship, which appeared in 2009, is sporadic. Regulators in the Biden administration are working to clarify the rules for a market that nearly tripled in value in 2021 to more than $2 trillion, attracting millions of American investors and raising concerns about financial stability.

Although the SEC has not announced major actions against large cryptocurrency exchanges, the commission has threatened to sue companies that provide crypto lending. WSJ’s Dion Rabouin explains why this part of the cryptocurrency market has reacted so strongly. Photo: Mark Linehan/Associated Press

Here are some key questions about establishing those regulations:

What is the difference between cryptocurrencies and other assets?

The traditional financial system is built around intermediaries – banks, brokerages, stock or commodity exchanges and asset managers. Government and industry regulators monitor such companies to protect investors, promote fair and orderly markets, guard against financial bubbles and prevent crimes such as money laundering or tax evasion.

This omission comes with tradeoffs. Banks and brokerages are required to set aside money to meet potential losses and are supposed to know who their customers are; In return, their account holders are protected by government-backed insurance. Public companies must follow standard accounting practices and disclose information about their financial resources and operations; In return, they can access tens of trillions of dollars of liquidity in the stock and bond markets.

A major belief among cryptocurrency advocates is that technology can replace such brokers and remove the need for trust.

Here’s how to implement this kind of arrangement: Bitcoin allows any two people, anywhere in the world connected to the Internet, to transfer value in a few minutes without an intermediary. Transactions are recorded on a database called the blockchain. It is visible to the public on networks of computers running separate copies of the same software. This should ensure that no one on the network is faking the cryptocurrency or double spending the same bitcoins.

Do cryptocurrencies need regulation?

As advocates of cryptocurrency argue that the assets are diminishing the role of traditional intermediaries, some argue that they do not need to be regulated like banks, securities or investment funds.

But below the surface, regulators and experts say, there are always humans at work.

Most of the new cryptocurrency investors access the market through trading platforms such as Coinbase Global company

or Gemini Trust Co. LLC. These companies take investor dollars and convert them into bitcoin, ether, or dozens of other digital tokens. They charge fees, custody assets, and roll out products that sometimes offer a return to investors.

A fast-growing group of cryptocurrency applications known as “decentralized finance,” usually allows some users to vote on how they operate. They are often supported by software developers and charge transaction fees.

And while networks like Bitcoin can carry out transactions without an intermediary, there is still a small group of programmers, known as moderators, who have the ability to change the underlying code if errors arise.

Policy makers say that the presence of people in all of these systems creates the potential for conflicts of interest and requires oversight.

The irreversibility and concealment of many cryptocurrency transactions makes them popular with fraudsters and criminals, and the assets have led to an increase in ransomware attacks like the one that hit Colonial Pipeline Ltd. 2021. The rapid growth of the cryptocurrency market, governance and its murky ties to the broader financial system have also raised concerns about stability. While the hiccups have largely been contained in the cryptocurrency market, the potential for the effects to spread in the real world could increase as more people invest their savings in the asset class.

“Few technologies in history, since ancient times, can persist for long periods of time outside of public policy frameworks,” Gary Gensler, chairman of the Securities and Exchange Commission, told the Wall Street Journal in December.

“Few technologies in history, since ancient times, can persist for long periods of time outside of public policy frameworks,” said Gary Gensler, Chairman of the Securities and Exchange Commission.


Photo:

Evelyn Hochstein/Paul Press

Who will be responsible?

In the United States, an alphabetical set of federal and state agencies oversee financial institutions and markets.

Banks are regulated by the Federal Reserve, the Office of the Comptroller of the Currency, and state bank committees. Brokerages, asset managers, and exchanges are overseen by the Securities and Exchange Commission, which also sets disclosure requirements for publicly traded companies. Trading venues for futures and other derivatives are regulated by the Commodity Futures Trading Commission.

Money transfer services, such as Western UnionAnd

Licensed by state governments.

These agencies write rules and regulations, monitor financial markets, and send inspectors to examine companies’ compliance with the law and take enforcement action against companies or executives they suspect of violating them.

Determining which ones should regulate cryptocurrencies and what their powers are is a work in progress. Some senior policymakers said there were loopholes in existing laws and urged Congress to close them. Meanwhile, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have taken the lead in cracking down on cryptocurrency projects or trading platforms that they consider to be illegal or defrauding investors.

What is the agency that regulates bitcoins?

So far, no agency has confirmed full jurisdiction to oversee the two largest cryptocurrencies, bitcoin and ether, which together account for more than 60% of the entire market.

That’s because the CFTC has no legal authority to regulate cash markets for commodities, the asset class that some regulators and courts have proposed over bitcoin and ether. Money markets, or the market in which goods or securities are paid for and received at the point of sale, do not have an overall financial regulator.

Congress will likely have to pass a CFTC law to obtain such powers.

The Treasury considers the platforms many investors use to buy and sell bitcoin as a money transfer business. These companies generally need to obtain licenses from state governments to operate, know their customers and take certain steps to prevent money laundering. But they face much lower requirements and less supervision than traditional stock and commodity exchanges.

However, the CFTC has the authority to monitor fraud in the bitcoin markets. It also supervises exchanges, such as the Chicago Mercantile Exchange company ,

That lists bitcoin and ether futures contracts.

How do regulators view other types of cryptocurrency?

It depends on their features.

For example, the Biden administration plans to regulate issuers of stablecoins — a rapidly growing subset of cryptocurrencies that peg their value to a national currency like the dollar — similar to banks, although the regulator has asked Congress to introduce comprehensive legislation first.

But the biggest question facing the cryptocurrency industry is whether an asset meets the legal definition of security, or “investment of funds in a common enterprise with a reasonable expectation of profit that can be reaped from the efforts of others.” If the definition is met, the issuer must register with the Securities and Exchange Commission, along with any trading platforms offering such assets and the brokers selling them.

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How clear is this SEC test?

Gensler, the chairman of the Securities and Exchange Commission, says the law is already clear. The legal test used to identify securities was established by the Supreme Court in 1946, and the SEC gave guidance on its application to cryptocurrencies in 2019. The agency has also won dozens of lawsuits against defendants who sold unregistered securities in so-called Initial coin offerings.

Gensler declined to specify that cryptocurrencies, if any, are not securities and therefore fall outside the agency’s jurisdiction. But he has repeatedly urged major cryptocurrency exchanges to register with the agency, saying that it is highly likely that they offer securities on their platforms.

Have crypto platforms acquired it?

Registering as a stock exchange with the Securities and Exchange Commission is slow, expensive, and bureaucratic. No major cryptocurrency exchanges have done so.

Instead, some have tried to stop serving American customers. Others are taking a different approach. Coinbase, for example, says that it only allows trading of assets “for which we determine that there are reasonably strong arguments for concluding that a crypto-asset is not a security.”

This situation leaves major cryptocurrency exchanges open to the possibility of SEC enforcement action that could force them to pay fines, write off popular tokens, or compensate clients for losses. It was a risk they were willing to take for a chance to make quick profits in a hot market.

Douglas Borthwick, chief business officer at INX Ltd. , a cryptocurrency firm that says it has worked to create a trading platform that is registered with the Securities and Exchange Commission: “It is very profitable to list things that might be securities but not call them securities.”

write to Paul Kiernan at paul.kiernan@wsj.com

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