How the U.S. Government Could Crack Down on Crypto Without New Laws

The crypto industry is facing a regulatory uncertainty in the U.S., as lawmakers debate how to regulate stablecoins and other digital assets. While some legislators have proposed bills to create a clear framework for crypto, others have expressed concerns about the potential risks of unregulated crypto activities.

However, there is another way that the U.S. government could impose stricter rules on crypto without passing new laws: by using the Financial Stability Oversight Council (FSOC), a powerful body of regulators that can designate companies as systemically important and subject them to Federal Reserve oversight.

The FSOC was created after the 2008 global financial crisis to identify and mitigate threats to the financial system. It is chaired by the Treasury Secretary and includes the heads of the Federal Reserve, the Securities and Exchange Commission, and other agencies. The FSOC has the authority to label nonbank financial companies as systemically important financial institutions (SIFIs), which means they pose a significant risk to the stability of the U.S. economy if they fail or experience distress.

The FSOC has not used this power since 2013, when it designated four nonbank firms as SIFIs: AIG, Prudential, MetLife, and GE Capital. However, in November 2021, the FSOC reversed some changes made by the Trump administration that had weakened its ability to designate companies as SIFIs. It also issued a report warning that stablecoins could pose a threat to financial stability if they are not properly regulated.

Stablecoins are digital tokens that are pegged to fiat currencies or other assets, such as gold or commodities. They are designed to provide stability and liquidity for crypto transactions, especially for decentralized finance (DeFi) applications that offer lending, borrowing, trading, and other services without intermediaries. According to CoinGecko, there are over 300 stablecoins in existence, with a total market capitalization of over $130 billion as of January 2024.

The FSOC report stated that stablecoins could pose risks to financial stability due to their potential for large-scale adoption, lack of transparency, operational vulnerabilities, market concentration, and regulatory gaps. It recommended that Congress enact legislation to establish a comprehensive framework for stablecoins, including requiring stablecoin issuers to obtain a federal banking charter, comply with prudential standards and consumer protection rules, and maintain adequate reserves.

However, if Congress fails to act on stablecoins or other crypto issues, the FSOC could use its backdoor regulatory option to designate some crypto companies as SIFIs and subject them to Fed supervision. This could have significant implications for the crypto industry, as SIFIs face higher capital requirements, liquidity standards, stress tests, resolution plans, and other restrictions.

Some lawmakers have expressed their concern about this possibility during a House Financial Services Committee hearing in January 2024. Rep. Patrick McHenry (R-N.C.), the ranking member of the committee, asked Treasury Secretary Janet Yellen whether she would use the FSOC to designate any crypto company as a SIFI. Yellen replied that she would not rule out any option, but that she preferred a legislative solution.

The crypto industry has also been wary of the FSOC's potential intervention. Jeremy Allaire, the CEO of Circle, one of the largest stablecoin issuers in the world, said in a blog post that he welcomed a clear regulatory framework for stablecoins, but that he opposed any attempt to use the FSOC to designate Circle or other crypto firms as SIFIs. He argued that such a move would stifle innovation and competition in the crypto space.

The FSOC has not indicated when or whether it will use its SIFI designation power on any crypto company. However, it has said that it will continue to monitor the developments and risks of stablecoins and other digital assets. The crypto industry should be prepared for any scenario and engage with regulators and lawmakers to shape the future of crypto regulation in the U.S.

Sources:

- A Backdoor Regulatory Option Haunts U.S. Crypto - CoinDesk

- The Ultimate Cryptocurrency to Buy With $1,000 Today - Yahoo Finance

- Cryptocurrency Regulation and Enforcement at the US Federal and State Levels - Skadden