With Banking Regulators Sidelined, Congress Considers Crypto Legislation After FTX Implosion

House Financial Services Committee Chair Maxine Waters joined her Republican counterpart on the panel in saying that FTX’s unraveling is accelerating the need for legislation that outlines crypto regulation.

The stunning fall from grace of crypto firm FTX has policymakers in Washington thinking about how regulation of the broader cryptocurrency world might affect the financial system, including the safety and soundness of banks.

Several lawmakers, including Rep. Maxine Waters (D-California), chair of the House Financial Services Committee, and Sen. Sherrod Brown (D-Ohio), chair of the Senate Banking Committee, have joined Rep. Pat McHenry (RN.C.), ranking member of the House panel and its probable future chaircalling for a closer look at crypto markets.

House Financial Services Committee Chair Maxine Waters, D-California, and Ranking Member Patrick McHenry, RN.C., agree that the apparent collapse of cryptocurrency exchange FTX reinforces the need for legislation concerning digital assets.

Andrew Harrer/Bloomberg

The calls come after crypto exchange FTX loaned billions of dollars in client assets to fund risky bets by its affiliate trading firm, Alameda Research, according to The Wall Street Journal. This would have exacerbated a liquidity crisis within the company, which continues to unravel after rival Binance reneged on a tentative bailout offer.

Waters, who worked on a stable bill with McHenry, called the FTX spiral “the latest example in a series of incidents involving the collapse of cryptocurrency businesses and the impacts of those failures on consumers and Investors”. She echoed McHenry’s previous statements that the event increases the urgency for lawmakers to pass legislation.

“I have been working around the clock with Ranking Member Patrick McHenry to craft bipartisan legislation that establishes a federal framework for stablecoins to begin putting in place the necessary safeguards to protect customer assets and insulate our markets. financiers of the contagion,” she said. “This week’s news further underscores the urgent need for legislation.”

Brown called on U.S. regulators to investigate FTX’s demise and pointed to potential implications for the banking system, though he notably did not join the chorus of lawmakers calling on Congress to come up with some sort of regulatory framework.

“The recent collapse of FTX is a strong warning that cryptocurrencies can fail, and just as we saw with OTC derivatives that led to a financial crisis, these failures can have a ripple effect. on consumers and other parts of our financial system,” Brown said. “The continued turmoil in the cryptocurrency market is why we need to think carefully about how to regulate cryptocurrencies and their role in our economy. It is crucial that our financial watchdogs examine what led to FTX’s collapse so that we can fully understand the misconduct and abuse that took place. . I will continue to work with them to hold bad actors in the crypto markets accountable. I am committed to finding the best way forward to protect consumers and the stability of US markets and the banking system.

While FTX has reportedly been under investigation by the Securities and Exchange Commission and the Department of Justice, banking regulators have largely been silent on the crypto-melee. The Federal Deposit Insurance Corp. previously issued a cease and desist letter to FTX for misrepresenting deposit insurance, but issued no further statements or directives regarding the exchange’s collapse.

The FDIC declined to say whether it is currently investigating FTX or its banks.

But that doesn’t mean banks and their supervisors are entirely out of the fray. Regulators have repeatedly warned that banks need to control the risk of their partnerships with fintechs and crypto companies, and they will likely be part of the upcoming discussion on how to reduce some of those risks.

“It gives regulators an opportunity to say I think we got it right,” said John Popeo, director of the Gallatin Group who previously worked at the FDIC where he led deals to unwind troubled banks during the crisis. financial. “And that certainly lights a fire under lawmakers on the Hill. I think they’re going to be watching a lot more carefully in the future.”

Banks have repeatedly noted that they have remained largely insulated from the turmoil in the crypto market, and for the most part, industry groups say they don’t want risk in their business models.

“There is one way this event could have generated financial instability: if the companies involved had been integrated into the country’s payment system through primary accounts at Federal Reserve banks,” the Bank Policy Institute said Thursday. on a Twitter thread. “The lesson: don’t bail out a failing industry by giving it access to Fed accounts and providing it with a new business model, thereby tying it into the regulated financial system and increasing the risk that the next cryptoverse crisis could actually harm the economy. financial stability. ”

Anthony Tu-Sekine, head of Seward & Kissel’s blockchain and cryptocurrency group, said he expects to see a lot more “regulation by enforcement” across various financial agencies, including agencies. banks that oversee banks that partner with crypto firms, following news from FTX. . While this likely won’t change the business models of crypto-focused banks, it will likely prevent other banks from trying to break into the business, he said.

The outcome of FTX could have bigger implications, depending on how the company’s contracts were drafted, said Todd Phillips, a progressive political advocate who has worked in banking policy. If FTX was basically providing a custodial service for clients’ assets, meaning they held the assets but didn’t technically own them, and then transferred the assets to Alameda, that’s still a big deal, but that’s not probably not something that banking regulators would get involved in.

But if FTX took customer assets as if they were loans, becoming the property of FTX, then FTX would have owed a debt to customers, and the company could be more vulnerable to claims for illegal banking activities, and the banking regulators might have more authority to intervene. Ultimately for FTX it doesn’t really matter, but it is an opening for banking regulators to further define the parameters of what is and isn’t banking.

“One is the illegal bank and the other is stealing from customers,” Phillips said. “So at the end of the day, FTX is still really fucked up.”

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