These abuses should not occur, especially as the law already exists to put a stop to most of them. Simply bringing digital asset securities under the jurisdiction of the securities laws to the greatest extent possible would allow the SEC to address abuses related to, among other things, asset valuation, through information disclosure requirements, accounting rules, government-regulated data sources, and rules to prevent fraud and manipulation, so that investors can know what their assets are worth; custody, through capital requirements, information technology mandates, and Securities Investor Protection Corporation insurance for up to $500,000, so investors can know their assets are safe; and market access, through requirements to maintain business continuity plans and rules around systems compliance. These latter plans and rules would mean that brokerages and exchanges have minimal errors and outages and that investors have continuous market access. No new regulations would be required; the SEC would only have to enforce the law.
Instilling confidence in the system is what will help the cryptocurrency sector grow and achieve its full potential. One of the roles that FinCEN plays in this space is that we are a regulator, with a focus on combating illicit finance. We draft rules and regulations to implement the Bank Secrecy Act, our basic law. And, we work to foster and ensure compliance.
Addressing the illicit finance and national security risks related to Travel Rule compliance and unhosted wallets remains top of mind for us. But, as we think through next steps, and in line with the broader U.S. Government approach, we try to approach rules and regulations in a way that recognizes not only the risks that innovations pose, but the opportunities that they present. And we do recognize that the cryptocurrency industry and its underlying technologies present opportunity.
What does this mean? Responsible innovation means that financial institutions that operate in the cryptocurrency space have the same obligations as all other financial institutions to ensure that their new offerings can leverage innovations while still protecting consumers, reducing cybercrime, combating illicit financial activity, and ensuring their platforms are not used to harm our national security interests.
The industry can only achieve its full potential if VASPs proactively adopt and uphold high standards for compliance. What does this mean? That you implement a rigorous risk-based approach to compliance and to your customer relationships and transactional activity. To do so, one of the first steps is to develop a deep understanding of the risks that you face, the customers you serve, and the parties with which you transact.
One area that is unique to the cryptocurrency sector is the amount of information available to you, by virtue of the public nature of many blockchain ledgers. This means that you have a lot of information at your fingertips that can be used to inform your understanding of risk and shape your compliance programs. This information can provide companies in the cryptocurrency space with valuable insight into risk, fueling the more effective implementation of a risk-based approach to compliance.
Before we start delving into the Q&A portion of this session, I just want to emphasize that we believe that the cryptocurrency and digital assets industry has an immense opportunity to raise the bar for the next generation of financial services.
In July, the OCC stated that banks and savings associations could provide crypto custody services for customers, including holding unique cryptographic keys associated with accessing private wallets. This means that the OCC believes that banks could safely and effectively hold either the cryptocurrency itself, or the key to access crypto on a personal digital wallet for its customers.
New proposed rules from the SEC related to alternative trading systems (ATSs) have raised speculation in the crypto industry that the regulatory expansion could include blockchain and cryptocurrency platforms.
Lawmakers in Chile are working to develop a regulatory and oversight framework for cryptocurrencies and to potentially recognize bitcoin as legal form of payment. The government is also working on a CBDC. With a growing number of cryptocurrency exchanges in the country, and in the absence of a legal framework, the Central Bank and the Financial Market Commission has said that existing regulations are applicable to cryptocurrencies.
The Thailand Central Bank has said repeatedly that it does not support use of crypto as payments. In January 2022, the central bank and market regulator announced plans to ban digital asset operators from facilitating use of crypto as a means of payment for goods and services.
But there are lots of other reasons to create cryptocurrencies. If you set up some sort of app that does a thing on the Ethereum system and you want to charge people money for doing that thing, what sort of money should you charge them? Or if you set up a two-sided marketplace that connects people who do a thing with people who want the thing done, what sort of money should the people who want the thing use to pay the people who do the thing?
But what does it mean to say that the NFT is a piece of digital art? The art does not live on the blockchain. As the well-known software engineer and hacker who goes by the name Moxie Marlinspike wrote in a blog post:
Experts in academia, crypto exchanges, the research community and the legal industry are speaking out, in the face of increasingly massive losses, to say that hacking does not present an existential risk to crypto as a concept.
Today's monetary system has come some way towards these high-level goals, but there is still some way to go. Changes in users' needs and the concomitant shifts in technology have pointed to areas for improvement (Table 1, second column). Current payment services can sometimes be cumbersome and costly to use, in part reflecting a lack of competition. Cross-border payments are particularly expensive, opaque and slow: they usually involve one or more correspondent banks to settle a transaction, using ledgers built on different technologies.3 In addition, a large share of adults, especially in emerging market and developing economies, still have no access to digital payment options. But a globalised world that features an ever-growing digital economy requires a monetary system that allows everyone to make financial transactions domestically and globally in a safe, sound and efficient way. Catering to these changes in the demands that society places in the monetary system calls for advances in technology and institutional arrangements.
While the DeFi ecosystem is evolving rapidly, the main types of financial activity continue to be those already available in traditional finance, such as lending, trading and insurance.7 Lending platforms let users lend out their stablecoins with interest to borrowers that post other cryptocurrencies as collateral. Decentralised exchanges (DEXs) represent marketplaces where transactions occur directly between cryptocurrency or stablecoin traders, with prices determined via algorithms. On DeFi insurance platforms, users can insure themselves against eg the mishandling of private keys, exchange hacks or smart contract failures. As activities almost exclusively involve exchanging one stablecoin or cryptocurrency for another, and do not finance productive investments in the real economy, the system is mostly self-referential.
Finally, central banks and regulators need to mitigate risks to financial stability that arise from the exposure of banks and non-bank financial intermediaries to the crypto space. Fast-growing investments in cryptocurrencies by traditional financial institutions mean that shocks to the crypto system could have spillovers. Non-bank investors, family offices and hedge funds have reportedly been the most active institutional investors in cryptocurrencies (Graph 6.A). So far, the exposures of large traditional banks have been limited and direct investments in firms active in crypto markets are still small relative to bank capital (Graph 6.B).21 That said, bank funding from stablecoin issuers has increased, as bank liabilities such as certificates of deposit form a key part of stablecoins' asset backing.22 Addressing these risks implies a sound implementation of standards for bank exposures to cryptocurrencies, which should seek to ensure adequate resilience to large and sudden changes in prices or large losses through direct and indirect channels.23 This may also require prudential regulation of crypto exchanges, stablecoin issuers and other key entities in the crypto system. This does not preclude an innovative approach; for example, supervision could be embedded in these markets, so that it is conducted "on-chain".
Programmable CBDCs could also support machine-to-machine payments in autonomous ecosystems.31 Autonomous machines and devices increasingly communicate and execute processes without human intervention through the Internet of Things, a network of connected devices. Looking ahead, machines may directly purchase goods and services from each other, and manage their own budget. Their interconnection will increase the need for smart contracts and programmable money. For example, they may be equipped with wallets, charged with a certain budget of digital money. Smart contracts may automatically trigger payments as soon as certain conditions are met, eg the arrival of the goods. This could lead to significant efficiency gains, for example in the goods logistics sector, where transactions often take several days and are still predominantly paper-based. The full potential of these technological developments can be realised only if machine-to-machine transactions are settled instantly, so that any settlement risk is removed. Existing private sector cryptocurrency projects for the Internet of Things are still exploratory and suffer from limits to scalability.32 They also raise concerns about the stability and convertibility of cryptocurrencies used for payments and would require on- and off-ramp bridges to connect with traditional payment rails. In this respect, the industry could benefit from CBDCs, which could underpin a decentralised system, eg by enabling regulated financial institutions to issue programmable money.33 2b1af7f3a8