$2tn crypto market is attracting interest from investors, scrutiny from US regulators

they are not. And that makes them a challenge to US financial regulators.

Monitoring of cryptocurrencies, which came into existence in 2009, is spotty. Regulators in the Biden administration are working to clarify rules for a market whose value has nearly tripled to more than $2 trillion in 2021, attracting millions of US investors and concerns about financial stability. I am getting worried.

Here are some key questions related to setting those regulations:

What is the difference between cryptocurrency and other assets?

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

This inspection comes with trade-offs. Banks and brokerages are required to set aside money for potential losses and must know who their clients are; In return, their account holders are protected by government-backed insurance. Public companies must follow standardized accounting practices and disclose information about their finances and operations; In return, they receive tens of trillions of dollars of liquidity in the stock and bond markets.

A key belief among cryptocurrency advocates is that technology can substitute for such intermediaries and eliminate the need for trust.

Here’s how such a system works: Bitcoin enables any two people, anywhere in the world with an internet connection, to transfer value in a matter of minutes without any middlemen. Transactions are recorded on a database, called a blockchain. It is publicly visible across a network of computers running different copies of the same program. This should ensure that no one on the network is counterfeiting cryptocurrency or double spending the same bitcoin.

Do cryptocurrencies need to be regulated?

Because crypto advocates argue that assets dilute the role of traditional intermediaries, some argue that they do not need to be regulated like banks, securities or investment funds.

But beneath the surface, regulators and experts say, there is almost always a human being at work.

Most new cryptocurrency investors access the market through trading platforms such as Coinbase Global Inc. or Gemini Trust Company LLC. These companies take investors’ dollars and convert them into bitcoin, ether or dozens of other digital tokens. They roll out fees, custodial assets and products that sometimes offer investors a return.

A rapidly growing set of cryptocurrency applications known as “decentralized finance” typically allow a few users to vote on how they work. They are often supported by software developers and charge a transaction fee.

And even though networks like bitcoin can carry out transactions without a middleman, there is a small group of programmers, known as maintainers, who have the ability to alter the underlying code in case a bug emerges.

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

The immutability and anonymity of many cryptocurrency transactions make them popular with scammers and criminals, and the asset has fueled a surge in ransomware attacks such as the one that struck Colonial Pipeline Ltd in 2021. The rapid growth of the cryptocurrency market, its self-governance and its ambiguous relationship with the broader financial system have also raised concerns about stability. While the hiccups within the cryptocurrency market have been largely controlled, the potential for spillover effects in the real world may increase as more people invest their savings in the asset class.

“Certain technologies in history, since antiquity, can persist for long periods outside of public policy frameworks,” Securities and Exchange Commission Chairman Gary Genslers said at the Wall Street Journal CEO Council in December.

Who will be responsible?

In the US, an alphabet soup of federal and state agencies oversee financial institutions and markets.

Banks are controlled by the Federal Reserve, the Office of the Comptroller of the Currency, and state banking commissions. Brokerages, asset managers and stock exchanges are overseen by the SEC, 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-transmission services such as Western Union are licensed by state governments.

These agencies write rules and regulations, monitor financial markets, send out inspectors to check compliance with the law, and take enforcement action against companies or officials suspected of violating them. Is.

Deciding which cryptocurrencies should be regulated and what their authorities will be is a work in progress. Some top policy makers have said there are loopholes in the existing laws and urged Congress to fill them. Meanwhile, the SEC and CFTC have taken the lead in cracking down on cryptocurrency projects or trading platforms they believe to be breaking the law or defrauding investors.

Which agency controls bitcoin?

So far, no agency has claimed full jurisdiction to oversee the two largest cryptocurrencies, bitcoin and ether, which together represent over 60% of the entire market.

This is because the CFTC does not have the legal authority to regulate cash markets for commodities, which are the asset classes some regulators and courts have suggested fall within bitcoin and ether. The cash market, or a market where goods or securities are paid for and received at the point of sale, does not have a comprehensive financial regulator.

Congress would likely pass a law for the CFTC to gain such powers.

The Treasury Department considers the platforms that many investors use to buy and sell bitcoins to be money-transmission businesses. These firms generally need to be licensed from state governments to operate, to know who their clients are and to take certain steps to prevent money laundering. But they also face far fewer requirements and less oversight than traditional stock or commodity exchanges.

However, the CFTC has the authority to police fraud in the bitcoin markets. It also oversees exchanges such as the Chicago Mercantile Exchange Inc., which lists futures contracts for bitcoin and ether.

How are other types of cryptocurrencies viewed by regulators?

It depends on their qualities.

For example, the Biden administration plans to regulate issuers of stablecoins – a rapidly growing subset of cryptocurrencies that determine their value to a national currency such as the dollar – in a similar manner to banks, although regulators told Congress First to provide comprehensive legislation.

But the biggest question facing the cryptocurrency industry is whether an asset meets the legal definition of a security, or “an investment of money in a common enterprise with a reasonable expectation of profit from the efforts of others.” If the definition is met, its issuer is required to register with the SEC, along with any trading platforms that sell such assets and the brokers who sell them.

How straightforward is the SEC test?

Gensler, the head of the SEC, says the law is already clear. The legal test used to identify a security was established by the Supreme Court in 1946, and the SEC provided guidance on applying it to cryptocurrencies in 2019. The agency also won dozens of lawsuits against defendants who sold unregistered securities in the so-called initial. Coin offering.

Mr Gensler declined to specify which cryptocurrencies, if any, are not securities and are therefore excluded from the agency’s remittances. But he has repeatedly urged major cryptocurrency exchanges to register with the agency, saying it is highly likely that they will be offering securities on their platform.

Has the crypto platform got him on it?

Registering as an exchange with the SEC is slow, expensive, and bureaucratic. No major cryptocurrency-trading platform has done this.

Instead, some have attempted to stop serving US customers. Others take a different approach. For example, Coinbase says it only allows trading of assets “for which we determine there are reasonably strong arguments to conclude that crypto assets are not a security.”

The situation leaves major cryptocurrency-trading platforms open to the possibility of SEC enforcement actions that could force them to pay fines, remove the popular token, or reimburse customers for losses. This is a risk they are willing to run for an opportunity to make rapid gains in a hot market.

“It is very profitable to list things that can be securities, but cannot call them securities,” says Douglas Borthwick, chief business officer at cryptocurrency firm INX Ltd.