The Biden administration is reportedly considering the issuance of an executive order that would create a governmentwide approach to the oversight and regulation of cryptocurrencies. Such an order would likely have significant implications for how cryptocurrencies are offered and traded, used for purchasing goods and services, and stored. More broadly, the recommendations and conclusions developed as part of this process could have a significant impact on the value of these assets (including cryptocurrencies, non-fungible tokens (NFTs), and smart contracts) and on the quality and pace of deployment of blockchain technology for other applications.
Executive orders are generally nonbinding on independent agencies, like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). An executive order can, however, direct the Treasury Secretary, as head of the Financial Stability Oversight Council (FSOC), to coordinate regulations among financial regulators, including the independent agencies, and provide a new policy framework for doing so. (The Biden administration used this approach in May 2021 with respect to climate-related financial risk.) An executive order on cryptocurrency would likely direct FSOC to use its convening authority in furtherance of key priorities including protecting investors and consumers, mitigating systemic risk, addressing bad actors, and dealing with preemption of existing state laws. Below, we consider these key issue areas.
Protecting Investors and Consumers
With billions of dollars traded worldwide each day in cryptocurrencies like Bitcoin, Tether and Ethereum, and made available to retail investors, a key focus of any executive order is likely to be on whether investors are adequately protected in the context of their purchase, custody and trading of digital assets. Generally, for financial assets sold to retail investors, this means some level of initial disclosure of the risks, safeguards around broker recommendations, regulation of the security of the custody of those assets, and measures to reduce fraud and require fairness in the marketplace in which assets are sold. In the cryptocurrency landscape, however, jurisdiction over these investor protections is shared between the SEC, which regulates securities, and the CFTC, which regulates commodity futures using a limited mandate to police for fraud and manipulation in commodity prices. To date, Bitcoin has been treated as a commodity under the sole jurisdiction of the CFTC; the classification of other cryptocurrencies remains murky.
As we previously highlighted, the SEC now believes it has ample authority under existing legal frameworks to regulate at least some digital assets, though its conclusion that some assets are “securities” has not yet been thoroughly tested in the federal judiciary. The SEC has sent at least one Wells Notice with respect to a stablecoin-backed lending project but has not publicly disclosed its legal argument for why the arrangement meets the definition of a security. Unlike traditional equity or debt instruments, many cryptoassets derive significant value from their utility function, not from the promise of a return on investment.
Members of Congress have their own divergent views on how digital assets should (or should not) be regulated. House Financial Services Committee Ranking Member Patrick McHenry (R-NC) recently introduced the Clarity for Digital Tokens Act of 2021, which would provide a statutory safe harbor from the registration requirement of the Securities Act of 1933 for tokens with certain characteristics. Rep. Rashida Tlaib (D-Mich.) introduced a bill in the last Congress to restrict issuance of stablecoins to insured depository institutions with the permission of the Federal Reserve System. Bipartisan legislation that passed the House this year would instruct the SEC to work with the CFTC in a joint working group to explore a coordinated approach.
Identifying and Mitigating Systemic Risk
In addition to facilitating regulatory cooperation in the investor protection landscape, the FSOC has broad statutory authority to identify and address nonbank financial companies and/or activities that could pose risks to the financial stability of the United States. This statutory authority could enable the FSOC to craft new regulations of cryptocurrencies—even if not authorized under existing laws governing securities or commodities—if the FSOC determines that cryptocurrencies “create or increase the risk of significant liquidity, credit, or other problems spreading among . . . financial markets of the United States.” Dodd-Frank Act § 120(b),(c) (emphasis added). FSOC’s broad authorities under the Dodd-Frank Act may prove to be the battleground for the future of regulation of digital assets because of its broad “super-regulatory” powers.
The power of the FSOC to regulate digital assets in the name of mitigating systemic risk has caught the attention of key lawmakers on Capitol Hill. For example, in a July 26, 2021, letter, Sen. Elizabeth Warren (D-Mass.) called on FSOC to implement a “coordinated and cohesive regulatory strategy to mitigate the growing risk that cryptocurrencies pose to the financial system.” More recently, Senate Banking Committee Ranking Member Pat Toomey (R-PA) fired back, warning that FSOC regulation of stablecoins would “cause tremendous damage to an emerging technology” and “violate the statutory standard for designation” under section 120 of the Dodd-Frank Act. Regardless of the political divide in Congress, any cryptocurrency executive order would likely require Secretary Janet Yellen to examine and, where appropriate, utilize its broad authorities to regulate and oversee cryptocurrencies that, in the FSOC’s collective judgment, could pose a systemic risk.
Policing Bad Actors
An executive order would also likely ask regulators to increase their oversight and enforcement activities regarding the use of cryptocurrencies for illegal purposes. Over the past few years, bad actors (often not based in the U.S.) have demanded ransom for the release of hostages or for the removal of malware from enterprise systems in the form of cryptocurrency because of the anonymity and immediate settlement digital transactions can afford. An executive order would likely ask the Financial Crimes Enforcement Network (FinCEN) at the Treasury Department to enhance its focus on this trend, including the finalization of its 2020 proposed rule concerning the application of the Bank Secrecy Act’s recordkeeping requirements and “travel rule” to convertible virtual currencies. Complementing FinCEN’s work, the Department of Justice recently established a new National Cryptocurrency Enforcement Team to focus on the prosecution of the criminal misuse of digital currency. Given the globalized market for cryptoassets and the increasingly sophisticated use of electronic tools by criminal enterprises, we would anticipate these items to be included in any executive order on this subject.
Preemption of State Law
A number of states have already enacted legislation affecting the cryptocurrency landscape. Wyoming and Nebraska, for example, have authorized state-licensed banks to obtain charters to accept cryptocurrency; Wyoming has established a state Chancery Court to adjudicate any issues arising from cryptocurrency or digital asset disputes. The State of Ohio had a program in 2018 that permitted business owners to pay their tax bills in cryptocurrency. A number of other jurisdictions are considering legislation to attract the crypto industry to their states—especially now that China has effectively banned the production and circulation of cryptocurrencies, further opening the door to U.S. dominance in the industry. An executive order would likely encourage the FSOC to explore whether and how federal regulatory policy should either defer to existing state laws, leaving the states as “laboratories of democracy,” or should effectively preempt it with uniform federal policy. In the latter case, we envision a long future of jurisdictional clashes between state and federal laws and agencies with key federal policymakers (e.g., Sen. Cynthia Lummis (R-WY)) heavily involved.
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It remains unclear whether President Biden will in fact issue an executive order on cryptocurrency, but even in the absence of one, the federal government is already busy considering whether and how to regulate this relatively new marketplace to protect investors and customers and the integrity of the marketplaces in which they trade or spend their cryptoassets. But even without an executive order, Secretary Yellen is convening the FSOC this week to discuss a report on stablecoins being developed by the President’s Working Group on Financial Markets. Given the breadth of financial regulators concerned, and the increasing attention digital assets are getting from Capitol Hill, crypto market participants are well-advised to engage early and often with policymakers to ensure their respective points of view are considered as government develops a regulatory framework.