With The Pavlovic Today from the US Capitol: At the first crypto hearing of the year titled “Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets,” Democrats and Republicans agree on the urgency for crypto regulations. 

Hate it or love it, the crypto regulatory framework is happening. Following the FTX collapse, the Senate is moving the needle on crypto regulations. Tuesday’s hearing has gathered experts from academia to bring fresh ideas on building the regulatory framework around digital assets. At the first Senate hearing on the crypto crash this year, Chairman of the Banking Committee, Sherrod Brown (D-OH), expressed the need for “common sense principles” that will provide a good foundation for a “comprehensive framework to regulate crypto products to protect consumers and our financial system.” 

FTX was considered a “darling of the crypto industry,” said ranking member Tim Scott (R-SC), before Sam Bankman-Fried “stole millions of dollars” of customer funds and “used them to finance risky bets and to pay for luxury penthouses in the Bahamas.”

Senator Scott said the American people “deserve to know why no action was taken before the FTX collapse” and how millions of dollars “just vanished into nothing.” 

He called out the SEC for failing their responsibility to “conduct appropriate effective supervision” and take “preemptive action to ensure that this type of catastrophic failure does not happen again.”

From what could be heard in the Senate today, the legislators are more than eager to summon the SEC Chair Gary Gensler and fire questions at him at one of the future hearings. 

Witness Lee Reiners from the Duke Financial Economics Center expressed a skeptical view of the crypto industry at the Senate hearing. “Most people invested in crypto simply because they thought they could sell it to someone else at a higher price in the future. Sadly, these people were wrong,” said Lee Reiners. He added that Sam Bankman-Fried was not “just a bad apple” of the industry and the FTX collapse was in” no way an isolated incident.” He listed Terra LUNA and Celsius among others as the examples that the “entire barrel is rotten.”

Reiners urged Congress to carve out cryptocurrency from the definition of the commodity in the Commodity Exchange Act and instead classify it as “securities” under a special definition to the securities laws. According to Reiners, this would give the SEC “exclusive authority” to regulate all aspects of the crypto industry. He noted that the SEC has more expertise, resources, and appetite for enforcement in the crypto realm than the CFTC does.

Witness Linda Jeng from Georgetown Institute of International Economic Law characterized Sam Bankman-Fried’s actions that led to FTX collapse as “outright fraud.” She emphasized in her testimony an “urgent need to establish formal federal regulatory oversight.” 

Law professor Yesha Yadav proposed in her testimony the creation of a “self-regulatory regime” where cryptocurrency exchanges are tasked with oversight of the market as a whole. “This would bring cryptocurrency exchanges in line with traditional commodities and Securities Exchanges, where self-regulation by exchanges has been the norm for centuries,” she said. Her proposal, she explained, would establish rules and discipline around cryptocurrency exchanges. Yadav clarified that her proposal would not be a substitute for public regulations but a solution that would “complement” them. 

Once the floor was opened for questions, Chairman Brown noted that the collapse of FTX made the legislators focus on basic protections like safeguarding customer money so companies can’t use it for their own personal benefit. 

Witness Lee Reiners recommended that Congress focus on requiring crypto platforms to “segregate customer assets from firm’s assets.” In that way, Reiners maintained, “customers will still have access to their funds” in case these firms get in trouble. 

Linda Jeng spoke of the “urgent need for a regulatory framework that clearly states what are the consumer rights and also what are the responsibilities of crypto participants.” 

Witness Yesha Yadav stressed that exchanges need to play their part in making the crypto market much safer for consumers. 

Is the US lagging far behind the rest of the world in crypto regulations?

Senator Mendez wanted to know if the US is ahead or behind the curve regarding crypto regulations. Yadev said that the US is “way behind” the curve. While the US has been an incredibly powerful exporter of financial markets regulation abroad, “we do not have anything to export at present” regarding crypto, stressed Yadev.

“The important thing is we get it right,” Reiners contradicted Yadev against urgency for the US to move forward on crypto.

Linda Jeng warned that the UK, Australia, Hong Kong, and Singapore are moving ahead with a national strategy on crypto regulations. Even China, she said, is pursuing a multi-year crypto strategy.

One of the most interesting ideas that emerged at the crypto hearing was Senator Menendez’s recognition of crypto as a potential tool in America’s foreign policy and economic arsenal. 

Proof-of-reserves

“We have a divided government here and while I hope we can look at some big things, I’m really wanting to get down into some singles and doubles,” said Sen. Thom Tillis (R-NC) 

He spoke of the proof-of-reserves (PoR) requirement for crypto exchanges and other things Congress can act on in the context of the Proof of Reserves Bill he is working on.  

Lee Reiners said that “proof-of-reserves are not worth the paper they’re written on.” 

Yadav pointed out the importance of internal controls and said that proof-of-reserves needs to be done regularly. According to law expert, it’s not just about the proof-of-reserves but also about the proof of solvency. She insisted that it is important to make sure that crypto assets are “liquid” as well.

Senator Warren: Big-time financial criminals love crypto

Senator Warren, a harsh crypto critic, kept repeating her one-sided talking points on crypto from the previous hearings. She wanted to know why the drug lords and human traffickers in countries like North Korea, Russia, and Iran use crypto instead of banks and credit unions or even Western Union.

Witness Lee echoed Warren by saying, “crypto is the exclusive payment method of choice for ransom.”

Senator from Massachusetts is introducing an anti-money laundering bill she wanted input on concerning crypto. She said that bad actors want a “a giant loophole” to be written into the law so they can launder money easily. Warren’s negative stance on crypto is not likely to change.

A shared conclusion at the hearing was that Congress needs the proper legislation to protect consumers. “The SEC isn’t going to do its job. So it’s on us now more than ever to make sure that we have proper safeguards in place and to make certain that another FTX-like event never happens again,” said Senator Hagerty. 

Divided government or not, there is a shared bipartisan understanding that innovation in decentralized finance may happen elsewhere and that consumers need to be protected. There is no way to go around that. While today’s hearing did not provide a silver bullet for a nascent and fast-evolving crypto industry overshadowed by the FTX collapse, the policy conversation is moving forward. With it, legislation will eventually emerge.

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Ksenija Pavlovic is the Founder and Editor-in-Chief of the Pavlovic Today, The Chief White House Correspondent. Pavlovic was a Teaching Fellow and Doctoral Fellow in the Political Science department at...

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