Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets (U.S. Senate Committee on Banking, Housing, and Urban Affairs)

Hearing	Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets
Committee	U.S. Senate Committee on Banking, Housing, and Urban Affairs
Date	February 14, 2023

 

Hearing Takeaways:

• Cryptocurrency Concerns: Committee Members and the hearing’s witnesses used the hearing to raise several concerns over the state of the cryptocurrency space and the policies that govern it. They raised concerns over how the current problems with cryptocurrencies could impact U.S. consumers, investors, the economy, and national security.
  • Recent Problems in the Cryptocurrency Market: Committee Members and the hearing’s witnesses highlighted how the cryptocurrency market had lost $1.46 trillion in value in 2022. They noted how this downturn had resulted in the collapse of several cryptocurrency businesses, including FTX, Terra Luna, Celcius, Voyager, BlockFi, Axie Infinity, Genesis, and Mango Markets. They also expressed concerns over how too much leverage, undercapitalization, the absence of risk controls, and fraud had contributed to these business failures and how these failures had harmed consumers and investors.
  • Impact of Cryptocurrency Problems on Minority and Vulnerable Communities: Committee Members and the hearing’s witnesses noted how people of color and newer investors are more likely than the general population to hold cryptocurrencies. They expressed concerns that downturns in the cryptocurrency market would thus disproportionally harm these groups. Mr. Reiners argued that cryptocurrencies are undermining financial inclusion and warned that minorities and low-income Americans are being targeted with very risky cryptocurrency products.
  • Inconsistent Regulation of Cryptocurrencies Across Levels of Government: Prof. Jeng raised concerns over how companies operating within the U.S. digital assets space are currently subject to a “patchwork” of state and federal regulatory requirements. She remarked that the absence of a transparent and consistent federal regulatory framework coupled with successful state regulatory regimes causes uncertainty for cryptocurrency businesses and innovators. She commented that this dynamic undermines protections for consumers and investors.
  • Interaction Between the Cryptocurrency Space and the Traditional Economy: Committee Democrats and Mr. Reiners expressed concerns over efforts to further integrate the cryptocurrency space into the traditional financial services system. They expressed concerns that this integration could lead problems within the cryptocurrency space to impact the broader economy. They noted how banks with significant ties to the cryptocurrency industry had recently required liquidity infusions due to the problems in the cryptocurrency market. Sen. Tina Smith (D-MN) and Mr. Reiners also expressed concerns with the recent decision of Fidelity Investments to offer Bitcoin as part of their 401(k) plans given the risky nature of cryptocurrencies. Mr. Reiners applauded the U.S. Department of Labor (DoL) for its recent letter asserting that the inclusion of cryptocurrencies in retirement plans would be a violation of a plan administrator’s fiduciary duty. Sen. Bill Hagerty (R-TN) and Prof. Jeng argued however that efforts to cut off the cryptocurrency sector from the traditional financial sector would either drive the cryptocurrency industry abroad or to make use of shadow banking services. They stated that both outcomes put the cryptocurrency industry outside of the purview of U.S. regulators.
  • Lack of Bankruptcy Protections within the Cryptocurrency Space: The hearing’s witnesses lamented how users of defunct cryptocurrency platforms (such as FTX) have recently found themselves as unsecured creditors in the bankruptcy process. Prof. Jeng and Prof. Yadav stated that Congress should make clear that digital asset holders have property rights that could be recognized in bankruptcy proceedings.
  • The U.S.’s Competitiveness within the Global Cryptocurrency Market: A key areas of interest during the hearing involved the U.S.’s competitiveness within the global cryptocurrency market. Committee Members, Prof. Jeng, and Prof. Yadav argued that the U.S.’s failure to establish a regulatory regime for cryptocurrencies has enabled other jurisdictions, such as the European Union (EU), China, United Kingdom (UK), Australia, Hong Kong, and Singapore, to dictate cryptocurrency standards. They raised concerns that the efforts of these foreign jurisdictions are undermining the U.S.’s ability to attract the innovation activity needed to compete within the cryptocurrency space. Mr. Reiners contended however that the U.S. should prioritize strong cryptocurrency regulation over global leadership given the various drawbacks associated with cryptocurrencies. He mentioned how the Bahamian government had embraced cryptocurrencies and highlighted how FTX’s collapse had harmed the Bahamas.
  • Use of Cryptocurrencies in Illicit Activities: Committee Democrats and Mr. Reiners expressed concerns over how cryptocurrencies are often used to facilitate illicit activities, including drug trafficking, ransomware payments, and sanctions evasion. Sen. Elizabeth Warren (D-MA) noted how the cryptocurrency market had taken in $20 billion in illicit transactions in 2022 and commented that this figure only accounts for known illicit transactions.
  • Enforcement Actions Against Cryptocurrency Businesses from Federal Agencies: Committee Republicans and Prof. Jeng criticized the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) for engaging in few rulemakings on cryptocurrency matters. They stated that these agencies had instead focused on enforcement actions and commented that this approach did not provide certainty to cryptocurrency businesses. Full Committee Chairman Sherrod Brown (D-OH) and Mr. Reiners argued however that regulatory agencies must pursue enforcement actions against investment products that run afoul of U.S. laws and rules. Mr. Reiners noted how the SEC has filed over 125 cryptocurrency-related enforcement actions and has yet to lose any of these cases.
• Cryptocurrency Policy Proposals: The hearing also considered several policy proposals for regulating cryptocurrencies. There was broad agreement amongst Committee Members and the hearing’s witnesses that the U.S. needs to adopt clear policies for overseeing cryptocurrencies.
  • Proposal to Put Cryptocurrencies Entirely Under the Purview of the SEC: Mr. Reiners stated that while most cryptocurrencies should be considered securities and thus be subject to SEC regulation, he noted that certain cryptocurrencies (such as Bitcoin) meet the definition of a commodity and would thus be subject to CFTC regulation. He noted that the CFTC does not regulate commodity spot markets and commented that this dynamic meant that cryptocurrency exchanges in the U.S. are not being regulated at the federal level. He called on Congress to carve out cryptocurrencies from the definition of commodity in the Commodity Exchange Act and recognize cryptocurrencies as securities. He commented that this approach would provide the SEC with exclusive authority to regulate all aspects of the cryptocurrency industry. He stated that the SEC has more expertise, more resources, and more appetite to pursue enforcement actions within the cryptocurrency realm as compared to the CFTC. Prof. Jeng stated however that cryptocurrencies are intended for use in payments. She remarked that putting digital currencies under an SEC regulatory framework would be problematic because securities could not be used as a form of payment.
  • Establishment of a Self-Regulatory Regime for Cryptocurrency Exchanges: Prof. Yadav recommended that the U.S. create a self-regulatory regime for cryptocurrency exchanges that would task the exchanges with overseeing the cryptocurrency market. She commented that this approach would bring cryptocurrency exchanges in line with traditional commodity and security exchanges where exchange self-regulation has long been the norm. She remarked that her self-regulatory regime proposal for cryptocurrency exchanges is meant to serve as a complement (rather than a substitute) for public regulation. She stated that this proposal is meant to be deployed quickly and provide enhanced oversight as compared to the status quo. She also indicated that this self-regulatory regime would still be subject to federal oversight.
  • Requirement for Cryptocurrency Businesses to Segregate Customer Funds from Firm Assets: Full Committee Chairman Brown, Sen. Thom Tillis (R-NC), Mr. Reiners, and Prof. Yadav called for the adoption of requirements to ensure that cryptocurrency platforms would segregate customer assets from firm assets. They stated that these requirements would protect customer access to their funds in the event of a platform failure.
  • Increased Disclosures for Cryptocurrencies and Stablecoins: Committee Members and the hearing’s witnesses expressed interest in ensuring that the U.S. require disclosures for cryptocurrencies and stablecoins. These disclosures could involve information on governance structures and reserve assets. Mr. Reiners remarked however that proof of reserves statements are often mere attestations whose veracity could not be ensured. He called for robust auditing requirements for cryptocurrency-related businesses. Prof. Yadav also suggested that cryptocurrency businesses demonstrate proof of solvency to demonstrate that their assets are liquid and traceable. Full Committee Ranking Member Tim Scott (R-SC) and Prof. Yadav further asserted that disclosures to be made in a fashion that are easily comprehensible for most consumers. Prof. Jeng also noted how the code underlying blockchain systems is often not comprehensible to regulators. She stated that cryptocurrency product disclosures should involve white papers provide information about a product’s design, risks, governance, and holdings.
  • Application of Anti-Money Laundering (AML) Rules to Cryptocurrencies: Sen. Elizabeth Warren (D-MA) and Mr. Reiners raised concerns that current AML requirements did not cover large parts of the cryptocurrency industry. They stated that this situation enables the continuation of illicit activities (including money laundering) and asserted that the application of AML requirements to the cryptocurrency space would not cause undue burdens. Sen. Warren mentioned how she would be reintroducing bipartisan AML legislation to combat cryptocurrency-related crimes with Sen. Roger Marshall (R-KS).
  • Adoption of Interoperability Standards for Digital Assets: Prof. Yeng remarked that the U.S. should promote open and interoperable standards for blockchain technology to guard against future monopolies. She discussed how companies are currently digitizing driver’s licenses in closed wallet solutions. She warned that these companies would have advantages within the digital wallets space and have greater levels of access to consumer data.
  • Requirements for Banks that Do Business with Cryptocurrency Businesses: Mr. Reiners noted how the U.S. Federal Deposit Insurance Corporation (FDIC), the U.S. Office of the Comptroller of the Currency (OCC), and the U.S. Federal Reserve all maintain guidance that calls on banks wishing to engage in cryptocurrency-related activities to first notify their regulators. He indicated that while he supported this guidance, he asserted that more protections are needed in this space. He stated that U.S. banking regulators could be more prescriptive around what specific cryptocurrency-related activities could be done in a safe and sound manner. He specifically asserted that banks should not be permitted to hold cryptocurrencies as principal on their balance sheets.

Hearing Witnesses:

1. Mr. Lee Reiners, Policy Director, Duke Financial Economics Center
2. Prof. Linda Jeng, Visiting Scholar on Financial Technology, Adjunct Professor of Law, Georgetown Institute of International Economic Law
3. Prof. Yesha Yadav, Vanderbilt University Law School

Member Opening Statements:

Full Committee Chairman Sherrod Brown (D-OH):

• He mentioned how the cryptocurrency industry had spent $54 million on advertisements during the 2022 Super Bowl.
  • He commented that these advertisements had neglected to mention how cryptocurrency products often contain high fees and risk of loss, as well as the “outright theft” that plagues the cryptocurrency industry.
• He noted how the 2023 Super Bowl by contrast had no cryptocurrency advertisements and stated that the cryptocurrency industry had “imploded” in 2022.
  • He indicated that the cryptocurrency market had lost $1.46 trillion in value in 2022.
• He also discussed how hackers and fraudsters tied to Russia and North Korea have stolen over $3 billion in cryptocurrencies.
  • He also mentioned how cryptocurrency firms have eliminated over 1,600 jobs in response to the recent downturn int the cryptocurrency market.
• He further noted how declines in cryptocurrency values in 2022 had led to the collapse of several cryptocurrency platforms to collapse, which created more losses across the broader cryptocurrency ecosystem.
  • He highlighted how the remaining cryptocurrency firms have needed to halt customer withdrawals.
• He stated that while these issues within the cryptocurrency space had not spread to the broader financial system, he asserted that these issues could have posed significant problems for the broader financial system.
  • He mentioned how the few banks with ties to the cryptocurrency industry had required “liquidity lifelines” after they had experienced large withdrawals.
• He remarked that the cryptocurrency industry’s problems remained ongoing and noted how details about the collapses of FTX and other cryptocurrency businesses are still being uncovered.
  • He commented that these businesses had been overleveraged and undercapitalized and had lacked internal risk controls.
• He also highlighted how the cryptocurrency had not publicized the fact that cryptocurrency markets lack basic investor protections and oversight.
  • He commented that retail investors tend to be most harmed by crashes in the cryptocurrency market.
• He remarked that the U.S. must work to protect consumers from unregulated digital assets and mentioned how the Committee had held numerous hearings during the previous 117th Congress to examine the potential perils of cryptocurrencies.
  • He noted how the Committee had looked into the mechanics of stablecoin companies, the use of cryptocurrencies in illicit activities (such as drug running and human trafficking), and fraud and speculation within the cryptocurrency market.
• He stated that recent problems within the cryptocurrency space have demonstrated the need for the adoption of a comprehensive framework to regulate cryptocurrency products.
• He specifically expressed interest in considering several basic principles of regulation as they apply to cryptocurrencies.
  • He indicated that these principles include disclosures, prohibitions on conflicts of interest and self-dealing, segregation of customer funds, internal governance and risk management standards, consumer and investor rights and protections, AML and fraud prevention measures, and oversight and supervision.
• He discussed how the U.S. had experienced numerous financial crises throughout its history and commented that these crises are the result of speculative bubbles.
• He remarked that the Committee must address the risks associated with cryptocurrencies to protect against future financial crises.
  • He expressed hope that the Committee could work in a bipartisan fashion to protect investors from cryptocurrency-related risks.

Full Committee Ranking Member Tim Scott (R-SC):

• He first remarked that SEC Chairman Gary Gensler ought to testify before the Committee if he is going to take enforcement actions within the cryptocurrency space.
• He then discussed how financial innovation could increase access to traditional financial services and foster new technologies that promote financial independence, access to credit, and capital formation.
• He asserted however that financial innovation must be pursued in a safe and sound manner and commented that many actors within the digital assets space had not pursued financial innovation in this manner.
  • He highlighted how cryptocurrency exchange FTX had failed to protect customer interests and funds and had instead stolen customer funds to finance risky bets and the lifestyles of their executives.
• He questioned whether U.S. regulators had used their existing authorities to provide adequate oversight of cryptocurrency firms.
  • He asserted that the U.S. public deserves to know why the SEC had taken no action prior to FTX’s collapse and how the funds held at FTX had vanished.
• He also questioned whether the provision of SEC guidance would have protected investor losses associated with the recent collapses of Terra Luna, Celsius, Voyager, and BlockFi.
• He stated that these recent collapses of cryptocurrency firms have been particularly alarming considering that 44 percent of U.S. digital assets holders are new investors or people of color.
  • He commented that this situation makes vulnerable Americans particularly susceptible to downturns in the cryptocurrency market.
• He remarked that the U.S. must hold companies that harm consumers accountable and empower consumers through financial education.
• He accused U.S. regulators of having misplaced their focus on progressive social issues and criticized the SEC for failing to take meaningful preemptive action to protect against future cryptocurrency-related business collapses.
  • He questioned whether the SEC’s failure to prevent FTX’s collapse had been due to a lack of will or a lack of resources and reiterated his call for SEC Chairman Gensler to testify before the Committee.

Witness Opening Statements:

Mr. Lee Reiners (Duke Financial Economics Center):

• He remarked that cryptocurrency “scarcely” resembles the purely peer-to-peer version of electronic cash first envisioned by Satoshi Nakamoto when he introduced Bitcoin in October 2008.
  • He asserted that cryptocurrency is not new by technology standards and noted how smartphones and open artificial intelligence (AI) have experienced much faster consumer adoption.
• He stated that a popular use case for cryptocurrencies has not emerged, despite 14 years of promises.
  • He noted how only 16 percent of U.S. adults have invested in, traded, or used cryptocurrencies.
  • He asserted that most people have only invested in cryptocurrencies because they had believed that they could sell it for a profit to someone else.
• He remarked however the 14-year existence of cryptocurrencies have demonstrated that these assets are prone to fraud, hacks, and scams.
  • He asserted that cryptocurrencies undermine the U.S.’s national security through facilitating terrorist financing and sanctions evasion.
  • He also asserted that cryptocurrencies undermine the U.S.’s economic security through enabling ransomware attacks on U.S. businesses, health care systems, and municipal governments.
  • He further asserted that cryptocurrencies undermine the U.S.’s climate goals through needlessly consuming massive amounts of energy.
• He stated that the cryptocurrency industry is now pedaling new false narratives to deflect and obfuscate the damage wrought by digital assets.
  • He contended that FTX’s malfeasance had not been an isolated incident and mentioned how other cryptocurrency businesses, including Terra Luna, Celcius, Voyager, BlockFi, Axie Infinity, Genesis, and Mango Markets, have all failed.
• He also discussed how the cryptocurrency industry has argued that policymakers must embrace innovation or cryptocurrency companies will migrate abroad to more favorable jurisdictions.
  • He noted that argument is premised on the notion that innovation is an unmitigated good and commented that innovation could be used for both good and bad things.
  • He asserted that the costs of cryptocurrencies outweigh the benefits of cryptocurrencies and questioned the wisdom of embracing this technology.
• He lamented how the U.S. has not applied the same safeguards from the traditional financial system to the cryptocurrency space and called on Congress to take action to regulate cryptocurrencies.
• He contended that while most cryptocurrencies are securities and should therefore be subject to SEC registration and disclosure requirements, he stated that some cryptocurrencies (such as Bitcoin) constitute commodities.
  • He noted that the CFTC does not regulate commodity spot markets and commented that this dynamic meant that cryptocurrency exchanges in the U.S. are not being regulated at the federal level.
• He called on Congress to carve out cryptocurrencies from the definition of commodity in the Commodity Exchange Act and recognize cryptocurrencies as securities.
  • He commented that this approach would provide the SEC with exclusive authority to regulate all aspects of the cryptocurrency industry.
• He stated that the SEC has more expertise, more resources, and more appetite to pursue enforcement actions within the cryptocurrency realm as compared to the CFTC.
  • He highlighted how the SEC possesses a statutory mandate to protect investors (unlike the CFTC).

Prof. Linda Jeng (Georgetown Institute of International Economic Law):

• She remarked that technological innovation could improve people’s lives and stated that the U.S.’s financial policy should focus on empowering consumers, ensuring open markets, increasing efficiency, and lowering costs for consumers.
  • She asserted that technologic innovation should be harnessed to improve access, efficiency, and equity for digital consumers.
  • She specifically stated that policymakers must address consumer and investor protection, digital money, digital identity, decentralized finance (DeFi), private and commercial law, bankruptcy, accounting, tax, technology standards, energy, illicit finance, and national security.
• She discussed how companies operating within the U.S. digital assets space are currently subject to a “patchwork” of state and federal regulatory requirements.
  • She noted how cryptocurrency exchanges must typically secure a state money transmitter license or obtain a license through a tailored regime (such as a BitLicense from the New York Department of Financial Service).
  • She also noted how cryptocurrency businesses must register at the federal level as money service businesses with the U.S. Financial Crimes Enforcement Network (FinCEN) and comply with AML and Combating the Financing of Terrorism (CFT) rules.
• She remarked that the absence of a transparent and consistent federal regulatory framework coupled with successful state regulatory regimes causes uncertainty for cryptocurrency businesses and innovators.
  • She added that this dynamic often fails often fails to protect consumers and investors.
• She highlgihted how legitimate cryptocurrency projects had failed and outright fraud had been committed against digital assets customers within the past year.
  • She asserted that these losses have underscored the “urgent” need to establish formal federal regulatory oversight and have demonstrated the inadequacy of only using enforcement measures to regulate cryptocurrencies.
• She noted how the SEC has not initiated any formal rulemaking process to update the U.S.’s securities laws to account for the unique attributes of digital assets that are deemed to be securities.
• She called on Congress to pass comprehensive and thoughtful legislation that establishes a federal regulatory framework for digital assets.
  • She commented that this legislation must address both securities and non-securities.
• She warned that the U.S.’s failure to enact rules for digital assets could lead innovation to be offshored and put American consumers, businesses, and the economy at a competitive disadvantage with its global peers.
  • She added that this failure to enact rules for digital assets could jeopardize the preeminence of the U.S.’s financial system.

Prof. Yesha Yadav (Vanderbilt University Law School):

• She remarked that the digital assets market is growing in terms of size and popularity and is becoming increasingly sophisticated and financialized.
  • She asserted that there are costs associated with failing to promptly regulate this market.
• She discussed FTX’s current bankruptcy process and noted how this process involves an estimated 9 million creditors and 134 entities.
  • She commented that the legal process associated with this bankruptcy is very expensive and lengthy.
  • She stated that FTX’s customers are likely to become unsecured creditors and will likely have low priority status to recover funds if and when recoveries do occur.
• She remarked that FTX’s recent collapse undermines trust and confidence in cryptocurrency exchanges and the broader cryptocurrency industry.
  • She further commented that these collapses have undermined trust and confidence within the U.S.’s financial regulatory system.
• She stated that the U.S.’s failure to provide a regulatory framework for cryptocurrencies has resulted in bankruptcy courts making determinations over cryptocurrency custody arrangements.
• She recommended that the U.S. create a self-regulatory regime for cryptocurrency exchanges that would task the exchanges with overseeing the cryptocurrency market.
  • She commented that this approach would bring cryptocurrency exchanges in line with traditional commodity and security exchanges where exchange self-regulation has long been the norm.
• She stated that her proposal would task cryptocurrency exchanges with writing rules, monitoring the market, and exercising discipline and commented that her proposal has three main goals.
  • She indicated that the first goal is to bring cryptocurrency exchanges within a framework for federal oversight.
  • She indicated that the second goal is to make cryptocurrency exchanges accountable through subjecting the exchanges to financial penalties for failing to fulfill their oversight obligations.
  • She indicated that the third goal is to ensure that cryptocurrency exchanges are making expenditures to look after their marketplaces.
• She remarked that her self-regulatory regime proposal for cryptocurrency exchanges is meant to serve as a complement (rather than a substitute) for public regulation.
• She also acknowledged that her self-regulatory regime proposal for cryptocurrency exchanges is not perfect and noted how there have occurred conflicts of interest involving self-regulatory regimes in more traditional markets.
  • She stated that this proposal is meant to be deployed quickly and provide enhanced oversight as compared to the status quo.

Congressional Question Period:

Full Committee Chairman Sherrod Brown (D-OH):

• Chairman Brown mentioned how some cryptocurrency industry stakeholders have recently complained about SEC enforcement actions against cryptocurrency firms for offering unregistered investment products. He noted that these unregistered investment products often advertised double digit returns to consumers. He asked Mr. Reiners to indicate whether financial products that take in retail consumer funds should operate with basic consumer protections.
  • Mr. Reiners answered affirmatively. He stated that the cryptocurrency industry often accuses the SEC of regulation by enforcement to deflect attention from the fact that the industry will choose to operate outside of existing regulatory perimeters. He remarked that the SEC has been consistent and clear in asserting that most cryptocurrencies are securities that need to be registered with the SEC. He noted how the SEC has filed over 125 cryptocurrency-related enforcement actions and has yet to lose any of these cases.
• Chairman Brown then noted how Prof. Yadav’s testimony had discussed how the U.S. could extend the safeguards used by stock exchanges to cryptocurrency exchanges. He asked Prof. Yadav to identify potential safeguards that could benefit consumers, increase market transparency, and prohibit conflicts within the cryptocurrency space
  • Prof. Yadav noted how stock exchanges have long engaged in self-regulation and commented that this self-regulation leverages the private self-interest of exchanges to provide a public good. She stated that exchanges possess surveillance expertise and capabilities. She noted how exchanges are responsible for enforcing standards for preventing fraud and manipulation under Section 6 of the Securities and Exchange Act of 1934. She commented that while this oversight is not perfect, she asserted that this oversight is still beneficial. She then discussed how various steps have been taken to prevent conflicts of interest associated with exchange self-regulation. She noted how these steps have included entity separations within the exchange and the establishment of self-regulatory organizations (SROs), such as the Financial Industry Regulatory Authority (FINRA). She concluded that self-regulation would complement (rather than substitute for) the public oversight of exchanges.
• Chairman Brown then discussed how FTX’s collapse has brought renewed attention to the importance of safeguarding customer funds so that companies could not use the funds for their own personal benefit. He asked Mr. Reiners to discuss the importance of developing better standards for the custody of consumer assets.
  • Mr. Reiners lamented how millions of cryptocurrency exchange users have recently learned that the failures of their exchanges made them unsecured creditors in the bankruptcy process. He indicated that these users do not have control or access to their assets. He noted how banks by contrast have deposit insurance from the FDIC to protect customers in the event of a bank failure. He also noted how broker-dealers have insurance from the Securities Investor Protection Corporation (SIPIC) to protect customers in the event of a broker-dealer failure. He recommended that Congress require cryptocurrency platforms to segregate customer assets from firm assets to ensure that customers would maintain access to their funds in the event of a platform failure.
• Chairman Brown then asked the witnesses to explain how the U.S. could apply existing disclosures or principles to cryptocurrencies.
  • Prof. Yadav remarked that there need to exist disclosures around the governance of the cryptocurrency issuer and the technologies underlying the cryptocurrencies. She also noted how younger people and minorities are increasingly using cryptocurrencies and called it important for policymakers to ensure that users can understand cryptocurrency products. She stated that this would entail ensuring that cryptocurrency disclosures are readable and comprehensible. She commented that cryptocurrency disclosures would be useless if retail customers could not make sense of them.
  • Prof. Jeng noted that while blockchain codes are transparent, she stated that most regulators did not know how to read code. She remarked that the developers of these blockchain codes would therefore need to explain their codes in a comprehensible manner. She stated that cryptocurrency product disclosures should involve white papers that explain how the product is designed, the risks associated with the product, the holders of the product’s private keys, the product’s governance structure, and the location where the product’s funds will be held.
  • Mr. Reiners remarked that companies seeking to raise money from U.S. public markets are required to make disclosures to potential investors. He asserted that this principle ought to also apply to cryptocurrencies. He stated that Congress should provide the SEC with the authority to draft customized disclosure requirements for certain decentralized cryptocurrency products.

Full Committee Ranking Member Tim Scott (R-SC):

• Ranking Member Scott first stated that it would be important for any potential cryptocurrency disclosures to be made in “plain English” given the complexity of the underlying assets. He then remarked that the U.S. should work to provide digital asset rules that are clear and consistent and that reward opportunity while protecting consumers from fraud and deception. He noted how several countries are currently developing their own frameworks to govern cryptocurrencies. He criticized U.S. regulators for their inconsistent messaging around cryptocurrencies and called on SEC Chairman Gary Gensler to testify before the Committee. He stated that U.S. regulators have failed to provide clear rules for cryptocurrency businesses and asserted that this lack of direction had been responsible for recent cryptocurrency business failings (including FTX, Celsius, and BlockFi). He asked Prof. Jeng to provide recommendations for Congress as it works to develop a governance framework for the cryptocurrency industry. He also asked Prof. Jeng to address how Congress could balance the need for appropriate cryptocurrency regulation and the promotion of cryptocurrency innovation.
  • Prof. Jeng discussed how the U.S. economy is becoming a data-driven digital economy, which means that consumer activities are increasingly based upon data and blockchain technologies. She stated that Congress would need to consider policies around consumer protection, consumer rights, and consumer empowerment. She mentioned how other countries are currently considering ways to take advantage of cryptocurrency technologies. She highlighted how China is very interested in cryptocurrency technology as a way for the Chinese government to better control personal data. She stated that the U.S. could create a cryptocurrency policy framework that empowers consumers through providing consumer data rights.
• Ranking Member Scott then discussed how innovation could expand access to traditional financial services and foster new technologies that promote financial independence, access to credit, and capital formation. He stated that financial innovation is not limited to cryptocurrencies and commented that financial technology (FinTech) is another example of progress within the financial services space. He asked the witnesses to discuss how the digital asset space would benefit Americans. He also asked the witnesses to address the importance of ensuring that regulation would not stifle innovation within this space.
  • Prof. Yadav discussed the current efforts to improve the efficiency of the U.S.’s payments system. She stated that while the U.S. maintains an elite financial system, she asserted that the U.S.’s payments system lags behind other countries. She noted how FinTech innovators are currently working to improve payments and mentioned the development of smartphone contactless payments as an example of this innovation. She highlighted however that the U.S.’s payments system still involved lengthy settlement times and had high associated costs (which reduced access to the payments system for many Americans). She stated that many proposed digital asset technologies are seeking to address the aforementioned problems within the U.S. payments system. She suggested that the U.S. consider using digital assets to address these problems so long as the digital assets are substantively and properly regulated.
  • Prof. Jeng remarked that the U.S. needs a clear set of rules for consumer rights and responsibilities for cryptocurrency market participants.

Sen. Robert Menendez (D-NJ):

• Sen. Menendez mentioned how the U.S. Financial Stability Oversight Council (FSOC) had released its Report on Digital Asset Financial Stability Risks and Regulation last fall. He noted how the Report had recommended that Congress pass legislation to provide financial regulators with rulemaking authority over the spot market for non-security digital assets. He asked the witnesses to address why Congress should address this gap in regulation and to provide recommendations for providing such rulemaking authority to financial regulators (as specified in FSOC’s recommendation).
  • Mr. Reiners noted how the major debate surrounding cryptocurrency regulation involves whether cryptocurrencies constitute commodities or securities. He indicated that the test under the U.S. Supreme Court’s SEC v. W.J. Howey Co. decision (known as the Howey test) has been used to determine whether cryptocurrencies should be defined as either commodities or securities. He expressed agreement with SEC Chairman Gary Gensler that most cryptocurrencies constitute securities. He stated however that there do exist some cryptocurrencies (such as Bitcoin) that should constitute commodities because of their decentralized natures. He noted how the CFTC does not regulate commodity spot markets and can only regulate commodity derivatives markets under current law. He indicated however that the CFTC does possess fraud and manipulation authority in commodity spot markets. He stated that this lack of regulation over commodity spot markets needs to be addressed with respect to digital assets. He recommended that Congress carve out cryptocurrencies from the definition of commodities under the Commodity Exchange Act and include cryptocurrencies as a new category of securities under U.S. securities laws. He commented that this policy change would provide the SEC with clear and exclusive rulemaking authority and jurisdiction over cryptocurrencies.
  • Prof. Yadav remarked that exchanges play an important role within the cryptocurrency space and that Congress needs to have exchanges ensure that the cryptocurrency market is safe. She specifically recommended that cryptocurrency exchanges become SROs and indicated that her proposal would still subject these exchanges to oversight from federal agencies. She stated that cryptocurrency exchanges are currently becoming very big and susceptible to conflicts of interest and asserted that the U.S. must bring cryptocurrency exchanges under control. She highlighted how cryptocurrency exchanges are providing “on ramps” into the cryptocurrency market for most of the population.
  • Prof. Jeng discussed how there exist a wide variety of digital asset types, including digitally native cryptocurrencies (such as Bitcoin) and fiat currency-backed stablecoins. She stated that traditional physical currencies work because the owner of the physical currencies has full interest and title over the currencies. She asserted that the U.S. must ensure that digital currency holders have full interest and title over their currencies. She stated that putting digital currencies under an SEC regulatory framework would be problematic because securities could not be used as a form of payment.
• Sen. Menendez expressed interest in ensuring that any federal digital asset legislation would prioritize the issue of transparency and investor protection. He then noted how the U.S. has long been a leader in the global financial system and commented that this leadership has benefited U.S. consumers and has supported the U.S.’s foreign policy goals. He stated that the U.S.’s digital asset policies should look to preserve this leadership. He asked witnesses to discuss current global trends in cryptocurrency regulation. He also asked the witnesses to address how the U.S.’s regulatory system for digital assets compares to the regulatory systems of other countries.
  • Prof. Yadav lamented that the U.S. is “extremely behind the curve” in terms of regulating digital assets. She stated that the U.S. has traditionally been able to export its financial regulatory standards abroad, which has improved the efficiency and safety of global financial markets. She specifically highlighted how the U.S. has exported its leverage ratio requirements abroad. She stated however that other countries have become global leaders in digital asset regulatory standards. She mentioned how the European Union (EU) had recently released its Markets in Crypto-Assets (MiCA) Regulation, which she described as a comprehensive framework for digital assets regulation. She indicated that the MiCA regulation is expected to go into effect later in 2023. She concluded that the U.S. has allowed other countries to dictate the global regulatory standards for digital assets.
  • Prof. Jeng discussed how other countries are pursuing “very thoughtful” national digital strategies in addition to adopting digital asset regulations. She noted how the EU maintains a comprehensive digital strategy that includes the MiCA regulation, the General Data Protection Regulation (GDPR), and the Digital Markets Act. She also mentioned how the UK, Australia, Hong Kong, and Singapore are developing their own regulatory frameworks for digital assets. She further highlighted how China has pursued a multi-year cryptocurrency strategy.
  • Mr. Reiners remarked that the U.S. should focus on developing the best possible regulations rather than work to develop regulations as quickly as possible. He stated that other jurisdictions are rushing to develop cryptocurrency regulations in the hopes of obtaining an advantage within the cryptocurrency space. He commented however that cryptocurrencies posed risks to adopters. He mentioned how the Bahamian government had embraced cryptocurrencies and highlighted how FTX’s collapse had harmed the Bahamas. He asserted that the drawbacks of cryptocurrencies outweighed the benefits of cryptocurrencies. He specifically stated that cryptocurrencies are undermining the U.S.’s national security through facilitating sanctions evasion and terrorist financing. He argued that the U.S. should not embrace cryptocurrencies when cryptocurrencies undermine U.S. sovereignty. He remarked that the U.S.’s regulation of cryptocurrencies should involve a dual mandate for protecting investors and preserving financial stability. He applauded the SEC and the federal banking regulators for successfully preventing problems within the cryptocurrency space from impacting the traditional financial system. He stated that these regulators had been prudent to prevent traditional banks from engaging in cryptocurrency-related activities.

Sen. J.D. Vance (R-OH):

• Sen. Vance first mentioned how he personally owns cryptocurrency. He stated that the U.S.’s regulatory approach to cryptocurrencies should seek to protect cryptocurrency consumers while not destroying the “dynamic upside” of cryptocurrency technology. He acknowledged that while there exists cause for cryptocurrency skepticism following FTX’s recent collapse, he stated that cryptocurrency technology has significant potential that is currently unknowable. He commented that an overbearing approach to cryptocurrencies might prevent the U.S. from ever realizing this potential. He asked the witnesses to address how the U.S. could regulate cryptocurrencies in a manner that protects consumers while ensuring that cryptocurrency innovation occurs in a free and fair manner and supports the U.S.’s foreign policy and economic objectives.
  • Mr. Reiners emphasized that cryptocurrencies are not new and noted how the first Bitcoin transaction had occurred in 2009. He commented that it had not taken the internet 14 years to prove its value. He questioned the fundamental value of cryptocurrencies. He noted how normal financial assets involved issuers and asserted that cryptocurrencies are unlikely to keep generating returns indefinitely into the future. He remarked however that blockchain technology could still have value and suggested that the U.S. could allow for traditional financial services to experiment with blockchain technology in a safe fashion. He asserted that the U.S.’s existing financial regulatory framework could keep pace with the application of blockchain technology to traditional financial services. He reiterated his assertion however that cryptocurrency assets without backing have no fundamental value.
  • Prof. Jeng recounted how the U.S. Federal Communications Commission (FCC) had considered whether to require internet providers and websites to register with the Agency during the internet’s early years. She stated that such a registration requirement would have likely resulted in a less innovative internet. She remarked that the U.S. should promote open and interoperable standards for blockchain technology to guard against future monopolies. She stated that digital identity would serve as the “cornerstone” of the digital economy. She discussed how companies are currently digitizing driver’s licenses in closed wallet solutions. She warned that these companies would have advantages within the digital wallets space and have greater levels of access to consumer data. She asserted that the U.S. must proactively establish guardrails to ensure that dominant companies could not leverage exclusive access to consumer data for their own market advantage.
  • Prof. Yadav remarked that innovation has been a constant theme throughout the history of the U.S.’s financial system and stated that U.S. regulators have historically worked in tandem to respond to these innovations. She noted how industry stakeholder input has informed these responses. She then acknowledged that while Bitcoin has existed for 14 years, she stated that there has occurred a noticeable uptick in cryptocurrency activity over the previous three years. She specifically highlighted recent increases in DeFi and cryptocurrency exchange transactions as evidence of this trend. She stated that policymakers must work to understand and address cryptocurrency-related risks and suggested that the adoption of disclosure rules, minimum capital buffers, and internal controls could support this effort. She expressed optimism that the U.S. could balance the needs for market integrity and consumer protection within the cryptocurrency space with the goal of innovation.

Sen. Chris Van Hollen (D-MD):

• Sen. Van Hollen expressed agreement with Mr. Reiners’s statement that bank regulators should learn from previous incidents where cryptocurrency failures have impacted banks. He mentioned how American University Washington College of Law Prof. Hilary Allen had previously recommended that the Committee consider “Glass-Steagall 2.0” legislation that would separate banking activities entirely from cryptocurrency-related activities. He noted how Mr. Reiners’s testimony had stated that U.S. banking regulators currently lack the authority to enforce such a separation. He also mentioned how Mr. Reiners’s testimony had called on the Committee to develop a comprehensive framework that clarifies the type of cryptocurrency-related activities that banks can engage in and the prudential requirements (including capital and liquidity requirements) for engaging in such activities. He asked Mr. Reiners to elaborate on this recommendation.
  • Mr. Reiners expressed agreement with Prof. Allen’s sentiment that the U.S. should take actions to restrict cryptocurrencies from entering the banking system. He noted however that cryptocurrency-related firms are entitled to banking services so long as cryptocurrencies are legal. He noted how the FDIC, the OCC, and the U.S. Federal Reserve all maintain guidance that calls on banks wishing to engage in cryptocurrency-related activities to first notify their regulators. He indicated that while he supported this guidance, he asserted that more protections are needed in this space. He recommended that U.S. banking regulators assess all of the ways that banks are exposed to cryptocurrencies and make these assessments public. He commented that these assessments would make bank customers and bank investors aware of cryptocurrency-related risks. He stated that the current guidance to banks is imperfect and noted how there had been banks (such as Silvergate Bank) with greater cryptocurrency exposures than previously realized. He stated that Silvergate Bank’s overexposure to cryptocurrencies would have likely caused it to fail absent the receipt of emergency liquidity from the Federal Home Loan Bank of San Francisco. He mentioned how the Basel Committee had recently finalized their guidance on a global bank prudential standard for crypto assets. He called on the U.S. to build off of this standard. He warned that the fallout from FTX’s collapse could have been even worse had FTX been more integrated with the traditional banking system.
• Sen. Van Hollen asked Mr. Reiners to indicate whether U.S. banking regulators are taking all available actions under current law to prevent cryptocurrency-related risks from entering into the traditional banking system. He also asked Mr. Reiners to indicate whether Congress needs to pass additional legislation to ensure the separation of cryptocurrency activities and traditional banking activities.
  • Mr. Reiners noted how U.S. banking regulators have broad legal authority to prohibit banks from engaging in activities that could not be conducted in a safe and sound manner. He stated that U.S. banking regulators could thus be more prescriptive around what specific cryptocurrency-related activities could be done in a safe and sound manner. He asserted that banks should not be permitted to hold cryptocurrencies as principal on their balance sheets. He called on U.S. banking regulators to issue guidance to prohibit such holdings.

Sen. Katie Britt (R-AL):

• Sen. Britt remarked that the U.S.’s current laws and regulations fail to account for recent financial sector innovations. She asserted that Congress must establish rules to ensure “robust” transparency and protection for consumers and investors within the digital assets space. She asked Prof. Jeng to identify key considerations for Congress as it works to develop these types of rules for digital assets.
  • Prof. Jeng remarked that Congress needs to provide digital asset consumers and investors with clear legal rights. She noted how U.S. Bankruptcy Courts currently cannot recognize digital asset property rights as part of bankruptcy proceedings. She stated that Congress should make clear that digital asset holders have property rights (which could be recognized in bankruptcy proceedings). She also discussed how digital assets technology seeks to democratize financial services. She recounted her experience moving back to the U.S. from Europe and noted how had needed to pay $4,000 to her European bank to move her own savings back to the U.S. She also indicated that she could not profit from the spread made by her bank as part of the currency conversion process. She stated that blockchain technology could support cross-border transfers and enable consumers to profit from the associated spread. She asserted that these equitable benefits made Web 3.0 different from Web 2.0. She remarked that the U.S. must work to provide consumers with data rights while also providing them with disclosures and legal protections in bankruptcy processes.
• Sen. Britt then highlighted how 55 percent of digital asset purchasers do not have college degrees, 44 percent of digital asset purchasers are not White, and how 41 percent of digital asset purchasers are women. She asked Prof. Jeng to address whether the U.S. could increase access to economic opportunities if it adopts proper guidelines and guardrails for digital assets.
  • Prof. Jeng noted how 4 percent of Americans are unbanked and 14 percent of Americans are underbanked. She called these rates very high considering the U.S.’s wealth. She stated that these unbanked and underbanked Americans feel excluded from the traditional financial system. She contended that digital assets could lower the costs of financial services and improve access to these services.
• Sen. Britt asked Prof. Jeng to indicate whether the overregulation of U.S. markets could drive jobs and innovation abroad to adversarial countries (such as China).
  • Prof. Jeng remarked that regulatory uncertainty causes market uncertainty and commented that innovators will always migrate to jurisdictions with regulatory clarity. She stated that an unclear regulatory environment for digital assets would therefore drive innovators to new markets or into the shadow banking sectors (where regulators would have limited insight and oversight of an innovator’s operations). She remarked that either outcome would result in a bifurcated U.S. financial system, which would have unintended consequences. She asserted that a bifurcated U.S. financial system would undermine the U.S.’s efforts to be a global leader in digital innovation and would drive innovation to foreign jurisdictions.

Sen. Tina Smith (D-MN):

• Sen. Smith noted how the cryptocurrency market had lost $2 trillion in market value in 2022. She stated that the size of this loss demonstrates the relevance of the market and called on the U.S. to be weary regarding the risks that the cryptocurrency market poses to consumers and the economy. She mentioned how she had joined Sen. Elizabeth Warren (D-MA) in questioning the decision of Fidelity Investments to offer Bitcoin as part of 401(k) plans. She also mentioned how she had recently asked federal regulators to detail the exposure of banks to cryptocurrency-related risks. She raised concerns that highly volatile cryptocurrencies could become more intertwined with the traditional financial system. She commented that this closer relationship could lead problems in the cryptocurrency space to spread to the broader financial system. She noted how Mr. Reiners had stated that the failure of cryptocurrencies to fully integrate into the traditional financial system is attributable to a combination of luck and prudent action from several regulators. She asked Mr. Reiners to elaborate on the role that luck has played in preventing cryptocurrency problems from impacting the broader U.S. economy. She also asked Mr. Reiners to identify additional actions that policymakers could take to avoid relying upon luck as a strategy for protecting the U.S. from future financial crises.
  • Mr. Reiners first remarked that there does not exist any evidence that cryptocurrencies promote financial inclusion. He asserted however that there exists “overwhelming” evidence that cryptocurrencies undermine financial inclusion. He noted how most people that have invested in cryptocurrencies have lost money and indicated that a plurality of these people are minorities and low-income Americans. He raised concerns that minorities and low-income Americans are being targeted with very risky cryptocurrency products. He described this situation as “predatory inclusion.” He then remarked that the U.S. had been lucky to not have problems within the cryptocurrency space impact the broader market. He mentioned how FSOC’s recent Report on Digital Asset Financial Stability Risks and Regulation had stated that two factors could make the cryptocurrency market systemically risky: the size of the cryptocurrency market and the cryptocurrency market’s connection to the traditional financial system. He stated that the cryptocurrency industry is diligently working to integrate the cryptocurrency market with the traditional financial system. He called these integration efforts ironic given that cryptocurrencies are supposed to bypass banks and the traditional financial system. He stated that the cryptocurrency industry is attempting to adopt similar terminology to the traditional financial system (including the use of terms like brokers, exchanges, and banks) as a way to deceive customers into viewing the industry as safe. He further highlighted how Voyager had even lied to customers that their products had been FDIC-insured. He then argued that cryptocurrencies are a form of gambling and should not be included within 401(k) plans. He applauded the DoL for its recent letter asserting that the inclusion of cryptocurrencies in retirement plans would be a violation of a plan administrator’s fiduciary duty. He further discussed how FTX had sought to offer retail traders 24/7 direct access to cryptocurrency derivatives using margin. He noted how this proposal had been under consideration at the CFTC at the time of FTX’s collapse. He stated that the CFTC’s granting of this proposal would have made FTX’s collapse very different. He also discussed how there have been multiple attempts to launch exchange-traded funds (ETFs) that track Bitcoin and mentioned how Grayscale Investments had sued the SEC for not permitting such an ETF. He stated that the approval of a Bitcoin ETF would have caused many investors to lose money. He remarked that the decisions of regulatory agencies to restrict permissible cryptocurrency activities had prevented problems within the cryptocurrency space from impacting the broader economy. He asserted that the U.S. must adopt a clear regulatory framework moving forward for cryptocurrencies to ensure that cryptocurrencies do not become intertwined with the traditional financial system. He added that the cryptocurrency industry continues to be relentless in their attempts to integrate with the traditional financial system.
• Sen. Smith expressed agreement with Mr. Reiners’s concerns over cryptocurrencies. She questioned whether digital assets functioned more like bets than assets given how many digital assets do not have underlying value. She also raised concerns over how many cryptocurrency investors and consumers are losing money and being taken advantage of and called for the adoption of basic consumer protections.

Sen. Thom Tillis (R-NC):

• Sen. Tillis expressed interest in pursuing more targeted cryptocurrency policies at the current time, especially considering the fact that the U.S. currently has a divided government. He also cautioned that overly ambitious cryptocurrency policies could significantly hamper cryptocurrency innovation. He expressed interest in adopting a proof of reserves requirement for cryptocurrency businesses and commented that such a requirement should not be very controversial. He asked the witnesses to comment on the merits of a proof of reserves requirement for cryptocurrency businesses. He also asked the witnesses to recommend other types of targeted cryptocurrency reforms that Congress could act on. He accused SEC Chairman Gary Gensler of being too aggressive in his regulatory approach to cryptocurrencies.
  • Mr. Reiners remarked that the proof of reserves for many cryptocurrency businesses are often mere attestations whose veracity could not be ensured. He mentioned how Binance had maintained proof of reserves from Mazars and how Mazars had abruptly pulled this proof of reserves off of their website.
• Sen. Tillis interjected to ask Mr. Reiners to clarify whether proof of reserve requirements are not a worthwhile pursuit.
  • Mr. Reiners remarked that audits of cryptocurrency businesses are a worthwhile pursuit and commented that Congress should consider audit requirements for cryptocurrency businesses (including intermediaries and exchanges). He stated that proof of reserves disclosures are distinct from full audits.
• Sen. Tillis stated that his proposed proof of reserve requirements for cryptocurrency businesses would involve independent third parties that would report their findings to the U.S. Department of the Treasury. He commented that this reporting should address Mr. Reiners’s concerns that these proof of reserves disclosures lack value.
  • Mr. Reiners also recommended that Congress consider policies to require that cryptocurrency platforms segregate firm assets from customer assets.
  • Prof. Jeng discussed how cryptocurrency businesses could disclose their proof of reserves through a variety of ways, including through the use of Generally Accepted Accounting Principles (GAAP) accounting disclosures, on-chain confirmations, and supervisory examinations. She stated that proof of reserves determinations are fundamentally about on-chain and off-chain verifications.
• Sen. Tillis mentioned how his office is currently developing proof of reserves legislation. He indicated that the legislation sought to address the co-mingling of firm assets and customer assets.
  • Prof. Yadav remarked that policymakers must ensure that the methodology of any proof of reserves requirement for cryptocurrency businesses is clear and robust. She raised concerns that there exists uncertainty over whether liabilities are being comprehensively disclosed as part of current proof of reserves disclosures. She stated that robust and systematic third-party audits could address these concerns over proof of reserves disclosures. She also remarked that the U.S. needs to ensure that cryptocurrency businesses maintain sufficient internal controls to ensure that their assets are properly segregated, that their valuations are regularly done on mark-to-market basis, and that proof of reserves disclosures are completed regularly. She commented that a quarterly proof of reserves disclosure would be insufficient given the constantly changing nature of the cryptocurrency market. She then remarked that policymakers should consider proof of solvency requirements for cryptocurrency businesses. She noted how many cryptocurrency exchanges held self-minted coins on their balance sheets and commented that the values of these self-minted coins remain unclear. She noted how FTX had relied heavily upon its own FTT token and indicated that the value of the FTT token had dropped “precipitously.” She stated that the U.S. must therefore ensure that the assets being held on the balance sheets of cryptocurrency exchanges are liquid and tradable. She commented that proof of reserve disclosures might fail to adequately convey these liquidity concerns.

Sen. Elizabeth Warren (D-MA):

• Sen. Warren remarked that cryptocurrencies serve as the payment method of choice for international drug traffickers, North Korean hackers, and ransomware perpetrators. She noted how the cryptocurrency market had taken in $20 billion in illicit transactions in 2022 and commented that this figure only accounts for known illicit transactions. She stated that AML rules are meant to stop illicit transactions. She asked Mr. Reiners to discuss why drug dealers, human traffickers, and adversarial countries use cryptocurrencies for payments (as opposed to banks, credit unions, and traditional money transfer companies).
  • Mr. Reiners remarked that the pseudonymity features of cryptocurrencies make cryptocurrencies ideally suited for bad actors. He also highlighted how cryptocurrency transactions are not subject to AML and CFT statutes, which facilitates the use of cryptocurrencies in illicit transactions.
• Sen. Warren asked Mr. Reiners to indicate whether cryptocurrencies enabled drug traffickers and rogue states to quickly launder money.
  • Mr. Reiners answered affirmatively.
• Sen. Warren asked Mr. Reiners to indicate whether ransomware gangs would exist if the gangs could not make use of cryptocurrencies.
  • Mr. Reiners answered no.
• Sen. Warren asked Mr. Reiners to explain why cryptocurrencies are integral to ransomware activities.
  • Mr. Reiners remarked that cryptocurrencies are the exclusive payment method of choice for ransomware perpetrators.
• Sen. Warren then discussed how current AML rules did not cover large parts of the cryptocurrency industry and commented that the cryptocurrency preferred this situation. She noted how the cryptocurrency industry has claimed that the application of AML rules to the cryptocurrency space would be unnecessary and impossible. She recounted how the banking industry had previously contended that AML rules would be overly burdensome during Congress’s consideration of the Bank Secrecy Act of 1970 (BSA). She commented however that the banking industry has been able to comply with the BSA without issue. She expressed doubts regarding cryptocurrency’s claims that the application of AML rules to the cryptocurrency space would impose significant compliance burdens. She asked Mr. Reiners to address whether the cryptocurrency industry should not be subject to AML rules and that these rules would impose an undue burden on the cryptocurrency industry.
  • Mr. Reiners answered no.
• Sen. Warren also noted how some cryptocurrency industry stakeholders have argued that AML rules could be applied to the cryptocurrency space so long as the rules exempt decentralized entities. She indicated that these decentralized entities include cryptocurrency exchanges, lenders, and other financial intermediaries. She asserted that these cryptocurrency industry stakeholders want a “giant loophole” for DeFi entities that would enable the entities to launder funds. She accused cryptocurrency exchange ShapeShift of seeking to engage in money laundering activities through restructuring itself as a DeFi platform. She asked Mr. Reiners to indicate whether Congress should support the creation of “loopholes” for money laundering.
  • Mr. Reiners answered no.
• Sen. Warren asserted that similar transactions with similar risks ought to be subject to the same rules. She mentioned how she would be reintroducing bipartisan AML legislation to combat cryptocurrency-related crimes with Sen. Roger Marshall (R-KS).

Sen. Bill Hagerty (R-TN):

• Sen. Hagerty remarked that the U.S.’s national and economic security are greatly enhanced by the preeminence of the U.S.’s financial system. He asserted that the U.S. must stay abreast of financial innovation in order to maintain its national and economic security. He stated that blockchain technology represents an area of rapid innovation and contended that the U.S. should work to foster a safe and certain environment for this technology within the U.S. He then expressed interest in the growing use of payment tokens (such as stablecoins) and commented that these tokens would help to usher in faster and cheaper payments. He also asserted that these payment tokens would advance the role of the U.S. dollar internationally. He stated however that trust in a digital asset’s backing assets would be crucial to the asset’s adoption. He mentioned how he had introduced legislation in the 117th Congress that would establish standards for the assets that back stablecoins and require stablecoin issuers to publish audited reports of the reserves for their stablecoins. He asked Prof. Jeng to indicate whether only central bank digital currencies (CBDCs) could serve payment token functions.
  • Prof. Jeng remarked that CBDCs could serve as one approach of many for transferring value.
• Sen. Hagerty interjected to ask Prof. Jeng to discuss the types of legal clarity that would be necessary for encouraging the adoption of stablecoins.
  • Prof. Jeng called it important for the U.S. to adopt a clear regulatory framework for stablecoins that makes use of public feedback. She commented that the U.S.’s current approach to stablecoins had not made significant use of the formal rulemaking process (which entails public comment).
• Sen. Hagerty noted how the SEC and the CFTC had only engaged in two minor rulemaking activities. He highlighted that the SEC had engaged in 30 retroactive litigation cases and that the CFTC had engaged in 18 retroactive litigation cases. He criticized this regulatory approach for stablecoins. He then discussed how several federal regulators have recently called on the U.S. to “sever” cryptocurrencies from the traditional financial system. He commented that this approach seems similar to Operation Choke Point, which he explained was an Obama administration exercise to limit financial services to “politically disfavored entities.” He expressed opposition to Operation Choke Point. He also stated that some Congressional Democrats have argued that the U.S. should not regulate cryptocurrencies because regulation would legitimize cryptocurrencies. He stated that this approach would jeopardize the safety of current cryptocurrency users within the U.S. He also raised concerns over how this approach would impact U.S.-based cryptocurrency innovators. He contended that Congress must develop legislation to properly regulate the cryptocurrency industry so that it could protect consumers and maintain the U.S.’s position in a rapidly evolving space. He asked Prof. Jeng to project the impact of a “wholesale debanking” of the cryptocurrency industry on the industry’s activities.
  • Prof. Jeng remarked that the cryptocurrency industry needs access to banking services. She stated that the cryptocurrency industry’s failure to access these services would cause the industry to move abroad or to use the shadow banking sector. She remarked that either result would prevent U.S. regulators from monitoring and influencing the cryptocurrency activities that are outside of their jurisdictions. She also stated that the movement of cryptocurrency activity to foreign countries would enable these countries to become global leaders in digital innovation.

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