Even though there’s no policy consensus for cryptocurrency regulation as 2022 kicks off, the cryptocurrency community’s engagement with policymakers in 2021 had a positive effect in Washington – that’s Patomak Global Partners’ takeaway from recent hearings in the House Financial Services Committee and the Senate Banking Committee. In the absence of an emerging Congressional consensus on cryptocurrency regulation—be it related to trading platforms, stablecoins, or other issues—regulatory agencies will likely continue to drive policy changes in this area for the foreseeable future.

Below we include a summary of the notable takeaways from each hearing and a look ahead of what to expect in 2022.

House Financial Services Committee Hearing Key Takeaways

• A productive dialogue: FTX CEO Sam Bankman-Fried captured the feeling of many cryptocurrency advocates in a tweet, writing, “I came in expecting some hostility and grandstanding, but instead found the discussion to be by and large productive and helpful.”
• Members of Congress are better informed: On both sides of the aisle, Members seemed more informed about digital assets than in past hearings. Some of this may be due to the hard work of many crypto advocates engaging with policymakers in the past year, which was evident during debates about cryptocurrency tax issues in the infrastructure bill.
• No policy consensus: The hearing covered a broad range of topics, including stablecoins, which regulatory agency should have authority over digital assets, the applicability of securities regulation to digital asset markets, digital identity standards, and climate change. While Republicans were generally more enthusiastic about the potential benefits of digital assets, Democrats were less stridently opposed to digital assets than in past hearings. However, several Democratic Members expressed concerns about the impacts of cryptocurrency on climate change, systemic risk, cybercrime, and consumer protection. While there are several industry policy proposals for regulating digital asset trading platforms, none appeared to garner traction with the committee.

Patomak Take: While many Members on the House Financial Services Committee are still learning and developing opinions about the industry and its technologies, there are clear trends emerging. For many Democrats, stablecoin regulation is a pressing item on their agenda. Meanwhile, several Republicans are seeking more regulatory clarity on issues impeding the adoption of digital assets.

Senate Banking Committee Key Takeaways

• Pronounced partisan divide on stablecoins: Chairman Sherrod Brown (D-OH) opened the hearing saying, “Stablecoins and crypto markets aren’t actually an alternative to our banking system. They’re a mirror of the same broken system – with even less accountability, and no rules at all.” On the other side, Ranking Member Pat Toomey (R-PA) emphasized the benefits of stablecoins and advanced a regulatory proposal that recognized stablecoins as a “very important innovation.” Democrats did not advance their own regulatory policy proposal, but the hearing suggested that Senate Democrats and Republicans remain far from consensus on the role stablecoins can play in the U.S. economy, let alone how to regulate them.
• Skepticism about financial inclusion and decentralization: Chairman Brown and crypto-skeptic witnesses questioned stablecoin issuers’ claims of financial inclusion. They noted that unless stablecoins can be more widely used as a payments instrument, digital assets have limited value to the underbanked and unbanked since users need to convert stablecoins to fiat currency to make purchases—a process which incurs several fees. Chairman Brown and other Democrats also questioned the use of the term “decentralized” to refer to stablecoins. Chairman Brown argued that stablecoin issuers claiming to be decentralized “rely on a single, centralized company to manage the reserve assets and their supply of coins. That sounds a lot like what traditional financial institutions do.”
• Systemic risk concerns: Banking Committee Democrats, including Sen. Jon Tester (D-MT), likened digital assets to pre-2008 synthetic financial products. Chairman Brown called the roughly $3 trillion digital-asset market cap the “definition of a systemic issue in our economy” and Sen. Elizabeth Warren (D-MA) warned that an ill-timed stablecoin run could “crash our whole economy.” Concerns from Democratic senators will likely help propel the Financial Stability Oversight Council’s (FSOC) work on stablecoins.
• Toomey stablecoin proposal: Ranking Member Toomey unveiled a proposal for regulating stablecoins. He argued that stablecoin providers should be able to choose to operate under a conventional bank charter; comply with or acquire a special-purpose banking charter designed for stablecoin providers; or register as a money transmitter under the existing state regime and as a money services business with FinCEN at the federal level. He also suggested that a regulatory framework for stablecoins should include disclosures about which assets back the stablecoin, redemption policies for token holders, periodic audits of reserves, and potential reserve requirements.

Patomak Take: The partisan divide on the benefits of stablecoins and the lack of bipartisan agreement on an approach to regulation for stablecoins, indicates that it will be difficult to reach consensus on any legislation that could pass the Senate. In the absence of legislation, federal regulators are likely to feel pressure from Congress to act on stablecoin policy, which could take several forms.

Look Ahead: Legislative Consensus Unlikely in 2022, Regulators Will Drive the Action

With midterm elections around the corner in 2022 and Republicans likely to make gains in both the Senate and House, if not taking control of one or both, bipartisan agreement on any legislation on cryptocurrency regulation is unlikely in the near-term. Instead, committees are likely to hold additional hearings on discrete topics and Members will continue to roll-out new proposals. Potential hearing topics include regulating cryptocurrency trading platforms, addressing Know Your Customer (KYC)/Anti-Money Laundering (AML) and ransomware risks, and understanding cryptocurrency’s environmental impact.

For those Members who have already formed thoughts about how the space should be regulated, future hearings will be an opportunity to pressure regulators, promote their legislative priorities,[1] and persuade colleagues. One thing that could disrupt this dynamic is that a significant cryptocurrency market incident or downturn that might propel Members to act.

With near-term Congressional agreement seemingly unlikely, financial regulators will continue to drive action on digital assets. Members of Congress will continue to push regulators to prioritize their concerns on issues related to stablecoins, tax, decentralized finance (DeFi), marketplace fraud, KYC/AML, ransomware, and other issues.

On stablecoins, FSOC is likely to soon begin taking steps towards assessing systemic risks of stablecoins in line with the President’s Working Group (PWG) on Financial Markets[2] report on stablecoins released in November. That report called on Congress to pass stablecoin-specific legislation and recommended that in the absence of Congressional action, FSOC should determine whether certain stablecoin payment, clearing, or settlement activities are or may become, systemically important. If FSOC were to designate any one or all of these activities as “systemically important,” then FSOC may direct a regulatory agency, likely the Federal Reserve, to establish a system of prudential oversight.

FSOC action, however, will take time. In the interim, other federal agencies may act. Acting Comptroller of the Office of the Comptroller of Currency (OCC), Michael Hsu, announced in a speech that he has concluded a review of several actions by the previous OCC comptroller related to banks seeking to provide digital asset services and determinations and feedback for bank charter applicants will be communicated in the near future. Hsu also noted that the results from the joint OCC, Federal Deposit Insurance Corporation, and Federal Reserve “policy sprints” focused on cryptocurrency custody, stablecoin issuance, and loan collateralization are completed and should be announced shortly.

The U.S. Department of the Treasury will continue to work on implementing the tax provisions of the Infrastructure Investment and Jobs Act (H.R. 3684), which are not scheduled to go into effect until 2023 at the earliest. Some market participants have criticized the legislation for including a broad definition of “broker” that could be interpreted to impose tax reporting obligations on stakers, miners, or digital asset wallet providers. A bipartisan groups of Senators has sent a letter to Treasury Secretary Janet Yellen urging Treasury to clarify that the infrastructure bill’s definition of a “broker” does not include for tax purposes individuals who are involved in digital asset mining or staking, providing digital asset hardware or software wallets, or developing digital asset protocols. While an anonymous Treasury official told Bloomberg News in August that digital asset developers, miners, and certain software providers will not be subject to new requirements, Treasury has yet to release official guidance on the topic. The Internal Revenue Service included “broker” reporting regulations as part of its 2021-2022 Priority Guidance Plan. Senators Cynthia Lummis (R-WY) and Ron Wyden (D-OR) have also introduced legislation that would narrow H.R. 3684’s definition of “broker.”

The SEC and Commodity Futures Trading Commission (CFTC) are likely to continue their focus on bringing enforcement actions in the digital asset space, while also potentially testing the bounds of their regulatory authorities. SEC Chair Gary Gensler has argued that many cryptocurrencies and stablecoins are likely securities and that cryptocurrency trading platforms should be registered with the SEC. Chair Gensler has also expressed a preference for bringing “high-impact” cases that can change market participant behavior. CFTC Chair Rostin Benham has also indicated in Congressional testimony that recent enforcement actions against cryptocurrency companies that settled for over $140 million are the “tip of the iceberg.” Meanwhile, both SEC and CFTC heads argue that there is a need for Congress to act to fill a “regulatory gap” over cryptocurrency spot market trading platforms.

Relatedly, regulators are more closely scrutinizing DeFi activity. SEC Chair Gensler, for instance, has argued that DeFi is “a bit of a misnomer” because  “platforms facilitate something that might be decentralized in some aspects but highly centralized in other aspects.” His fellow SEC Commissioner Caroline Crenshaw has made similar arguments. In August, the SEC issued its first enforcement action against a DeFi token offering.

Other potential areas of focus for regulators include KYC/AML standards and ransomware, among other items.

Put Patomak’s Crypto Expertise to Work

Patomak has deep experience in helping digital asset trading platforms, venture capital funds, fintechs, and other financial firms assess emerging risks related to public policy developments in the digital assets space. If you’d like to learn more on how Patomak can partner with you, contact Paul Watkins, (pwatkins@patomak.com), Jamila Piracci (jpiracci@patomak.com), Ted Serafini (tserafini@patomak.com), or Robert Greene (rgreene@patomak.com).

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[1] For example, House Agriculture Committee Republicans have released a discussion draft of a bill to regulate digital commodities. Sen. Cynthia Lummis (R-WY)  also will introduce  legislation addressing digital-asset trading platforms and tax treatment. Rep. Patrick McHenry (R-NC) has said that “stablecoins are the soft entry point here by which we can build consensus on a bipartisan way [to] create law.”

[2] The PWG consists of agency heads from the Treasury Department, Federal Reserve, SEC, and CFTC. The PWG report on stablecoins was produced with the OCC and FDIC as well.