U.S. Crypto Sector Under Threat from Possible Backdoor Regulation

• Regulatory Attention on Crypto Sector by FSOC
• The Emerging Threat of Stablecoins
• Calls for Legislative Effort Support
• A Potential Leverage with Risk Designations
• The Track Record of FSOC
• Shortcomings of FSOC

Regulatory Attention on Crypto Sector by FSOC

In light of the financial upheaval in 2008, a group of regulatory authorities was established. This collective is known as the Financial Stability Oversight Council (FSOC). It is capable of marking companies with labels indicating systemic risk, subsequently placing them under heavy new regulations. The crypto sector has recently been under the watchful eye of the council.

Following the reversal of some key changes in the Trump era that limited the council's capability to flag companies as threats, FSOC can now perform this function in its entirety. However, it has largely remained inactive.

At any given moment, the council could deem a significant player in the digital asset domain, like a stablecoin issuer, as a potential risk to the broader financial system in case of failure. This scenario could resemble the role of American International Group Inc. during the 2008 mortgage collapse. When the FSOC applies this label to a company, it comes under the regulatory supervision of the Fed and has to meet multiple compliance demands.

The Emerging Threat of Stablecoins

Although there isn't any immediate sign of such a move, the council has expressed concern over the potential dangers posed by stablecoins to financial stability. This topic was recently brought into the public spotlight during a subcommittee hearing. As most of the digital asset industry was engrossed in the news of the spot Bitcoin$42,260 -0.64% exchange-traded funds (ETFs), lawmakers from the House Financial Services Committee questioned the ambitious plans of the regulator for crypto.

Representative French Hill cautioned that FSOC should be cautious about bypassing congressional intent. He underscored the legislative work being done to guide crypto bills to the House floor.

Calls for Legislative Effort Support

Hill stated, We've constructed a regulatory framework for digital assets, and a similar regime for stablecoins. FSOC's involvement isn't required. What they should be doing is supporting our legislative effort.

The mention of virtual assets in the annual report of the systemic-risk watchdog sounded an alarm about the potential emerging hazard to the health of U.S. finance. While the council's call for crypto legislation seems to support the aims of lawmakers, it also came with a warning. It prepared to consider steps to address risks related to stablecoins if no comprehensive legislation is enacted.

A Potential Leverage with Risk Designations

Testifying at the hearing, Ji Kim, the general counsel and head of global policy for the Crypto Council for Innovation, suggested it's still improbable that FSOC might use this tool. Bill Hulse, senior vice president of the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness, implied that the council may be utilizing potential risk designations as leverage for the formulation of the bills. He made the case that the crypto sector doesn't have the capacity to significantly affect the rest of the U.S. financial system.

The Track Record of FSOC

The FSOC has a history of varied successes and is notoriously slow in action due to a long list of agency heads with divergent interests. In its early days, it included several large insurers, but all four of the initially designated companies have since exited. In the following years, it has predominantly focused on its annual report that points out ongoing concerns.

Shortcomings of FSOC

Paul Kupiec, a senior fellow at the American Enterprise Institute, pointed out at the hearing that the regulators recently failed to prevent one of the most severe financial crises since the mortgage meltdown. He noted the federal banking agencies, whose chiefs are on the FSOC, fell short on their efforts to supervise banks that had significant business relationships with the digital asset industry.

To bring a crypto firm under the Fed's supervision, the council would have to go through a lengthy process that it's never employed on any companies other than those involved in the 2008 crisis. For the time being, Republican lawmakers have hinted that they will raise concerns if the FSOC attempts to follow this route.

Edited by Jonathan Stoker