[Joint House and Senate Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 117-151
DEMYSTIFYING CRYPTO: DIGITAL ASSETS
AND THE ROLE OF GOVERNMENT
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
of the
CONGRESS OF THE UNITED STATES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 17, 2021
__________
Printed for the use of the Joint Economic Committee
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available via the World Wide Web: http://www.govinfo.gov
______
U.S. GOVERNMENT PUBLISHING OFFICE
46-819 WASHINGTON : 2022
JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Donald S. Beyer Jr., Virginia, Martin Heinrich, New Mexico, Vice
Chairman Chairman
David Trone, Maryland Amy Klobuchar, Minnesota
Joyce Beatty, Ohio Margaret Wood Hassan, New
Mark Pocan, Wisconsin Hampshire
Scott Peters, California Mark Kelly, Arizona
Sharice L. Davids, Kansas Raphael G. Warnock, Georgia
David Schweikert, Arizona Mike Lee, Utah, Ranking Member
Jaime Herrera Beutler, Washington Tom Cotton, Arkansas
Jodey C. Arrington, Texas Rob Portman, Ohio
Ron Estes, Kansas Bill Cassidy, M.D., Louisiana
Ted Cruz, Texas
Tamara L. Fucile, Executive Director
Vanessa Brown Calder, Republican Staff Director
Colleen J. Healy, Financial Director
C O N T E N T S
----------
Opening Statements of Members
Page
Hon. Donald Beyer Jr., Chairman, a U.S. Representative from the
Commonwealth of Virginia....................................... 1
Hon. Mike Lee, Ranking Member, a U.S. Senator from Utah.......... 3
Witnesses
Ms. Alexis Goldstein, Director of Financial Policy, Open Markets
Institute, Washington, DC...................................... 5
Mr. Timothy Massad, Research Fellow, Harvard Kennedy School,
Adjunct Professor of Law, Georgetown Law Center, Washington, DC 7
Mr. Kevin Werbach, Professor of Legal Studies and Business
Ethics, Director of the Blockchain and Digital Asset Project,
The Wharton School, University of Pennsylvania, Philadelphia,
PA............................................................. 9
Mr. Peter Van Valkenburgh, Director of Research, Coin Center,
Washington, DC................................................. 10
Submissions for the Record
Prepared statement of Hon. Donald Beyer Jr., Chairman, a U.S.
Representative from the Commonwealth of Virginia............... 36
Prepared statement of Hon. Mike Lee, Ranking Member, a U.S.
Senator from Utah.............................................. 37
Prepared statement of Ms. Alexis Goldstein, Director of Financial
Policy, Open Markets Institute, Washington, DC................. 38
Prepared statement of Mr. Timothy Massad, Research Fellow,
Harvard Kennedy School, Adjunct Professor of Law, Georgetown
Law Center, Washington, DC..................................... 59
Prepared statement of Mr. Kevin Werbach, Professor of Legal
Studies and Business Ethics, Director of the Blockchain and
Digital Asset Project, The Wharton School, University of
Pennsylvania, Philadelphia, PA................................. 72
Prepared statement of Mr. Peter Van Valkenburgh, Director of
Research, Coin Center, Washington, DC.......................... 100
Response from Ms. Alexis Goldstein to Questions for the Record
submitted by Chairman Beyer.................................... 110
Response from Ms. Alexis Goldstein to Question for the Record
submitted by Senator Cassidy................................... 111
Response from Ms. Alexis Goldstein to Questions for the Record
submitted by Senator Klobuchar................................. 111
Response from Mr. Timothy Massad to Questions for the Record
submitted by Chairman Beyer.................................... 112
Response from Mr. Timothy Massad to Question for the Record
submitted by Senator Cassidy................................... 114
Response from Mr. Timothy Massad to Question for the Record
submitted by Senator Klobuchar................................. 114
Response from Mr. Kevin Werbach to Questions for the Record
submitted by Chairman Beyer.................................... 116
Response from Mr. Kevin Werbach to Question for the Record
submitted by Senator Cassidy................................... 118
Response from Mr. Peter Van Valkenburgh to Questions for the
Record submitted by Chairman Beyer............................. 119
Response from Mr. Peter Van Valkenburgh to Question for the
Record submitted by Senator Cassidy............................ 120
DEMYSTIFYING CRYPTO: DIGITAL ASSETS
AND THE ROLE OF GOVERNMENT
----------
WEDNESDAY, NOVEMBER 17, 2021
United States Congress,
Joint Economic Committee,
Washington, DC.
The hearing was convened, pursuant to notice, at 2:30 p.m.,
in Room 210, Cannon House Office Building, Hon. Donald S. Beyer
Jr., Chairman, presiding.
Representatives present: Beyer, Schweikert, Peters, Estes,
Beatty, Arrington, and Pocan.
Senators present: Cruz, Hassan, and Kelly, and Lee.
Staff: Vanessa Brown Calder, Ismael Cid-Martinez, Hugo
Dante, Sebi Devlin-Foltz, Carly Eckstrom, Tamara Fucile, Sean
Gogolin, Devin Gould, Owen Haaga, Erica Handloff, Colleen
Healy, Jeremy Johnson, Adam Michel, Michael Pearson, Elisabeth
Raczek, Alexander Schunk, Nita Somasundaram, Sydney Thomas, and
Emily Volk.
OPENING STATEMENT OF HON. DONALD BEYER JR., CHAIRMAN, A U.S.
REPRESENTATIVE FROM THE COMMONWEALTH OF VIRGINIA
Chairman Beyer. It is exactly 2:30 and I think it is 1930
Greenwich Mean Time. So I want to officially call this hearing
to order.
Senator, nice to see you.
I would like to welcome everyone to the Joint Economic
Committee's hearing entitled, ``Demystifying Crypto: Digital
Assets and the Role of Government.''
I want to thank all of our truly distinguished witnesses
for sharing their expertise today. We will begin with my
opening statement and then hear from Senator Lee.
Since the introduction of Bitcoin in 2009, the market for
cryptocurrencies and other digital assets has expanded from a
niche product to a globally significant asset worth nearly $3
trillion last week. While this rapid rise in value has made
some early adopters quite wealthy, it also poses an array of
risks, both to everyday investors and the broader financial
system.
The purpose of this hearing is to explore emerging trends
in the digital asset market and discuss prudent steps that
Congress and the Federal Government can take to update our
regulatory framework and bring much needed clarity to issuers,
ensure transparency for investors, and protect the integrity of
our financial system, while also leveraging exciting
developments in blockchain technology. Congress can promote
responsible innovation in this market, while also providing
basic protections to the investing public.
Interest and involvement in the digital asset market has
become increasingly mainstream in recent years. The growth of
these products has been especially pronounced since the start
of the coronavirus pandemic, as the reported total market value
of all digital assets soared from $200 billion, with a ``B,''
in January 2020 to nearly $3 trillion, with a ``T,'' just last
week. To put that in perspective, recent price volatility in
digital assets has erased $400 billion in value just in the
last 7 days, an amount roughly equal to the entire size of the
market just a year ago.
As the market has grown, we have seen digital asset
investors broaden from a narrow group of true believers in
cryptocurrencies to an expanding community that includes
everyday investors. A Pew survey conducted this fall found that
16 percent of American adults have personally owned or invested
in cryptocurrency at some point, up from just 1 percent that
held any Bitcoin in 2015.
While many early Bitcoin transactions occurred on little-
known platforms, today investors can buy digital assets through
Robinhood or Venmo or on large exchanges run by publicly-traded
companies like Coinbase. But this growth in value and interest
presents a number of challenges for our economy. The current
digital asset market structure and accompanying regulatory
framework are ambiguous and risky for both investors and the
broader economy. Digital asset holders have been subjected to a
market that is, as SEC Chairman Gary Gensler has described,
``rife with fraud, scams, and abuse.''
The mainstreaming of digital assets is laying the
foundation for a huge swath of the economy to invest in this
market. Increased crypto market volatility, or digital bank
runs, could disrupt more mainstream financial institutions like
pension funds and mutual funds. And the underlying assets can
create significant consumer protection issues, given existing
patterns of financial fraud, hacks, and market manipulation.
Retail investors may be lured in by the hype around a new
coin with improbably high rates of return, only to be caught on
the wrong end of a speculative bubble and lose their entire
investment. A recent example is Squid, a blatant scam token
that used the excitement around the popular TV show Squid Game
to dupe unwitting investors out $3.3 million.
While all investments involve risk, the lack of disclosure
and reporting requirements in many parts of the crypto asset
industry tilt the playing field toward the largest investors
who can leverage their size to exploit regulatory gaps at the
expense of retail investors. It is currently difficult for
regulators to prevent market manipulation by large players who
can exploit their access to multiple sides of a trade or trade
on inside information.
Despite these issues, Congress has not yet weighed in on a
comprehensive legal framework around these assets. Updating the
U.S. regulatory framework for digital assets would be in line
with how officials have responded to past financial
innovations, although often after the fact, with stronger rules
to protect consumers and market integrity. For example, Dodd-
Frank created stronger rules on complex swaps and derivatives
in the wake of, that is, after, the 2008 financial crisis.
Updated regulation could also reduce the likelihood that
these emerging developments would destabilize financial markets
in the broader economy. For example, the largest stablecoin,
Tether, was recently found not to hold or to not hold
sufficient reserves of cash and equivalents to fully pay back
their $70 billion value. Applying regulatory scrutiny to assets
like Tether and platforms on which they are used could ensure
that cracks in one asset don't spread to the larger economy.
Increasing reporting for decentralized finance platforms
will shine a light on a fast-growing but lightly regulated
segment of the market. Increased information sharing would also
improve tax compliance for capital gains from the sale of
crypto assets.
The many issues we will discuss today are why I introduced
the Digital Asset Market Structure and Investor Protection Act
earlier this year, just a start. This legislation would
establish much-needed guardrails and provide clarity to
regulators and investors without stifling innovation. The
present moment gives us an opportunity to take action before a
potential crisis hits the broader economy.
So I really look forward to learning from each one of our
witnesses today and from my peers' questions.
So, Senator Lee, the floor is yours.
[The prepared statement of Chairman Beyer appears in the
Submissions for the Record on page 36.]
OPENING STATEMENT OF HON. MIKE LEE, RANKING MEMBER, A U.S.
SENATOR FROM UTAH
Senator Lee. Thanks so much, Mr. Chairman.
Throughout the history of our great Nation, entrepreneurs
and creators have served as the heartbeat of the American
economy and the engine for America's economic growth. Their
advances into unknown frontiers of science and technology have
transformed the quality of life for millions upon millions of
Americans and also for people around the world.
Today American innovators are advancing into unknown
frontiers of cryptocurrencies, using novel technologies to
securely, create, and trade digitally scarce assets. Like the
internet of the 1990s, cryptocurrencies are still in their
infancy. This evolving technology has vast and still very much
untapped potential to revolutionize established industries and
to create entirely new ones. Cryptocurrencies are already
democratizing finance by lowering costs and expanding access to
an industry that has historically been hard to reach for
millions of Americans, including hundreds of thousands of
Utahans.
Beyond the better known applications to finance,
blockchain, which is, of course, the technology behind
cryptocurrencies, has even broader potential. Blockchain can
securely share health records, efficiently track cross-border
transactions in global supply chains, and allow online
consumers to verify the authenticity of pictures or videos.
I have great optimism that, like the internet before it,
the technology behind cryptocurrencies, meaning, again,
blockchain, is something that is going to create a wealth of
new opportunities, many of which we can't even really imagine
yet.
As new markets like this one emerge and grow, there is
always going to be a temptation here in Washington to expand
the Federal Government's reach, a temptation to centrally
control the innovative process and regulate the products of
those individuals who are at the forefront of American
advancement. But this is a temptation that must be resisted.
Rigid one-size-fits-all regulation is something that is kind of
scary, especially when it is targeted at the cryptocurrency. It
is certainly unnecessary. And it would all but ensure that this
next generation of technology companies would end up moving to
other countries, countries other than the United States.
Americans would lose access to cryptocurrency markets and miss
out on the potential economic and social benefits.
If we want the center of innovation to remain right here in
the United States for the benefit of American workers and
American families, Congress should focus on creating clarity
around how existing rules apply to these new technologies.
In the case that existing law proves outdated or
insufficient, then we can assess the need for new rules.
However, as it stands today, we just need to appropriately
apply the rules that we already have and are already on the
books, most of which are applicable here and most of which are
very much sufficient.
The proper role of government is to empower innovation
through clear rules with a light touch. The best approach is
one in which Congress acts in a manner that is tailored to its
limited constitutional authority. It is one where the Federal
Government acts with restraint and, in so doing, protects the
creation and ingenuity that powers our great country because,
when we restrain government, we unlock unlimited human
potential, potential that among the American people is immense.
In today's hearing, I hope we can focus on policies that
protect a flexible regulatory framework for Americans who are
building our future. If we can resist centralizing power in
Washington, as has long been the impulse of Democrats and
Republicans alike in this town, and instead preserve the space
for American innovation to flourish, entrepreneurs across the
country stand ready to unleash the tremendous opportunity of
new digital economies.
Thank you, Mr. Chairman.
[The prepared statement of Senator Lee appears in the
Submissions for the Record on page 37.]
Chairman Beyer. Senator Lee, thank you very much.
Now I would like to introduce our four distinguished
witnesses.
Ms. Alexis Goldstein is the Financial Policy Director at
the Open Markets Institute. She previously worked in financial
regulatory policy, climate finance, consumer investor
protection, and higher education for Americans for Financial
Reform. Prior to working in advocacy, she spent 7 years working
on Wall Street as a programmer at Morgan Stanley Electronic
Trading, as a business analyst at Merrill Lynch and Deutsche
Bank in equity derivatives.
Mr. Timothy Massad is Senior Fellow at the Kennedy School
of Government at Harvard University and an adjunct professor of
law at Georgetown Law School. From 2014 to 2017, he served as
chairman of the U.S. Commodity Futures Trading Commission.
Under his leadership, the agency declared virtual currencies to
be commodities, introduced reforms to address automated
trading, and strengthened cybersecurity protections. Mr. Massad
has a BA from Harvard College and a JD from Harvard Law School.
Mr. Kevin Werbach is a Professor and Department Chairperson
of Legal Studies and Business Ethics and director of the
Blockchain and Digital Asset Project at the Wharton School of
the University of Pennsylvania. His work focuses on
telecommunications in internet policy, as well as applying
digital game design techniques to business. Before joining the
Wharton faculty, he served as Counsel for the New Technology
Policy at the Federal Communications Commission during the
Clinton administration. He has published four books including
``The Blockchain and the New Architecture of Trust.'' Mr.
Werbach received a BA from the University of California at
Berkeley and a JD from Harvard Law School.
Finally, we have Mr. Peter Van Valkenburgh who is the
Director of Research for Coin Center. Formerly he was the
Google policy fellow for TechFreedom. He is a graduate of NYU
School of Law and a self-taught designer and coder.
So welcome, all of you. We have 5 minutes for each of your
testimony, and we will begin with Ms. Goldstein and then
continue in the order of introductions.
Ms. Goldstein.
STATEMENT OF ALEXIS GOLDSTEIN, DIRECTOR OF FINANCIAL POLICY,
OPEN MARKETS INSTITUTE, WASHINGTON, DC
Ms. Goldstein. Thank you so much.
Chair Beyer, Ranking Member Lee, and distinguished members
of the committee, thank you for inviting me to testify today.
My name is Alexis Goldstein, and I am the Director of Financial
Policy at the Open Markets Institute where my work focuses on
financial regulation and consumer protection.
As the chair mentioned, I previously worked on Wall Street
as a programmer at Morgan Stanley and then as a business
analyst at Merrill Lynch and Deutsche Bank prior and during the
2008 financial crisis.
I am not only a researcher of digit asset markets, I am
also a user of them. I have used large exchanges. I have used
so-called decentralized finance platforms, or DeFi. I have
tried out layer-2 solutions. And I have bridged from one
blockchain to another. And my impression as a user and a
student of these systems is that, while many claim that this is
the future of finance, it looks a lot like the history of
finance to me.
The space is full of intermediaries and rent-seeking. For
example, if you wanted to swap one crypto asset for another on
Ethereum today, you would have to pay over $100 to a miner to
execute your transaction on the Ethereum blockchain. If you
wanted to do it last week, it might have cost you hundreds of
dollars to do so. If you are a large entity, you can also
front-run transactions by effectively bribing the miners. You
can essentially up the transaction fee that you want to pay to
the miner, and they will execute your transaction before
others.
Many of these ostensibly decentralized finance platforms
also make use of the very same forced arbitration clauses and
class action bans that the biggest banks in the United States
do in order to deny their customers the right to sue over
disputes in a court of law.
We have also seen the CEO of a major crypto lending and
borrowing platform called Compound unilaterally threaten to
report their users to the IRS if they had benefited from a
software bug that Compound itself created, raising more
questions about whether this particular platform is truly
decentralized.
One of the problems that we see in the existing financial
systems is that users with the least amount of money often pay
disproportionately high fees. And, unfortunately, I have found
this problem is largely replicated in digital asset markets.
Coinbase, for example, has two cryptocurrency exchange
platforms, Coinbase and Coinbase Pro. Coinbase is aimed at
newer users but charges astronomically higher fees than its
Coinbase Pro offering.
There are also large concentration concerns in the digital
asset space. Facebook is one example who is moving ahead on its
digit asset pilot, despite ongoing questions and concerns from
lawmakers, concerns that their plans may be incompatible with
financial regulatory--the current financial regulatory
landscape.
Venture capitalists also play a significant presence in the
cryptocurrency markets and appear to hold considerable market
power and power over the governance of many of these platforms,
and their investment is growing fast. VC firms invested $17
billion in digital asset firms in the first 6 months of 2021,
which is more than three times what they invested in all of
2020.
Hedge funds, family offices, and large too-big-to-fail
banks are also a growing presence in the crypto markets. There
are also questions about conflicts of interest among major
market players. To take a single example, the CEO of the
exchange FTX, Sam Bankman-Fried, reportedly also owns 90
percent of a proprietary crypto trading firm, Alameda Research.
In traditional financial markets, barring a serious
liquidity crisis, you will be able to sell back the product
that you purchase. But on DeFi, it is very easy for malicious
actors to design tokens that can be bought but never sold. Some
crypto investors solve for this by reading the code of new
coins to look for pitfalls and ensure they don't fall prey to
these kinds of scams, but this is a fairly high bar for non-
programmers.
I worked on Wall Street before enduring the 2008 financial
crisis before Dodd-Frank, and much what I saw working with the
then unregulated over-the-counter derivatives market reminds me
of some of the things I see in today's digital asset
marketplace.
Systemic risk tends to arise when the scope, size, scale,
or interconnectedness of certain activities metastasize and
spread contagion to the broader financial system. There are
several concerning items including leverage, opacity in market
data, and poorly understood interlinkages between market
participants that are currently present in digital asset
markets and may indicate potential systemic risk.
Congress should continue to examine if there are regulatory
gaps that require new legislation in order to ensure consumer
and investor protections and ensure that regulators have the
market data they need to evaluate for systemic risks. For their
part, regulators should continue to monitor the space and
ensure compliance with existing laws and regulations.
Thank you, and I look forward to your questions.
[The prepared statement of Ms. Goldstein appears in the
Submissions for the Record on page 38.]
Chairman Beyer. Thank you, Ms. Goldstein, very much.
Next hear from Mr. Massad.
STATEMENT OF TIMOTHY MASSAD, RESEARCH FELLOW, HARVARD KENNEDY
SCHOOL, ADJUNCT PROFESSOR OF LAW, GEORGETOWN LAW CENTER,
WASHINGTON, DC
Mr. Massad. Chair Beyer, Ranking Member Lee, and members of
the committee, thank you for inviting me to testify today. I
first testified about crypto in 2014, and it is an honor to be
here.
I would like to make eight points. First, there is no
question that digital asset innovation is incredibly important
and beneficial overall. But there should also be no question
that the time to strengthen and clarify regulation of digital
asset markets is long overdue. If done responsibly, it will
support, not suppress innovation.
Second, stablecoins are one of the most urgent challenges.
If properly regulated, they might help modernize our payment
system. But today they pose significant risks. The recent
report of the President's Working Group on Financial Markets
describes this very well. It calls on Congress to adopt
legislation that limits stablecoin issuers to ensure depositary
institutions.
I prefer a slightly different formulation where we have
some bank-like specific regulations of the risks but we limit
the issuer's activities so they aren't making loans and they
aren't doing all the things that traditional banks do. And in
that model deposit insurance may not be necessary. This is a
better way, I believe, to foster competition and innovation and
address the risks.
Third, I agree with the PWG report on the need to regulate
stablecoin arrangements generally, not just the stablecoin
issuer. Once issued, stablecoins trade on decentralized
blockchains pursuant to smart contracts, as well as on
centralized exchanges. This means that no single authority is
responsible for the overall operation of the stablecoin. And
with regard to decentralization, or what is called DeFi,
generally, it can be a good thing. But calling something DeFi
should not make it a regulatory free zone, and we should keep
in mind that that label can mean lots of different things. We
need to apply standards, appropriate standards, to financial
market activities, not the technology itself, that occur on
such platforms.
Fourth, Bitcoin is neither a widely accepted means of
payment or a stable store of value today. It is a highly
volatile, speculative investment. It might be tempting to just
say let the buyer beware. But the continued growth of a largely
unregulated crypto market poses risks to society including
risks of illicit activity, tax evasion, ransomware, investor
fraud, and potential harm to broader financial markets.
We do not have sufficient information about this market.
Neither the SEC nor the CFTC has authority today to regulate
the cash or spot market, if you will, for digital assets, that
are not considered securities. That is a point that is actually
not understood by many people, and that is where most trading
activity occurs today. So we should expand that authority. At
the same time we should make sure our regulatory policies are
adequately informed by technological expertise. This is very,
very important.
Fifth, in regulating crypto generally, we must balance
reasonable expectations of privacy and financial transactions
with the government's legitimate interests such as preventing
illicit activity and tax evasion.
Sixth, the evolution of the digital assets has made it
clear that we need to modernize our payment system. It is
relatively slow and expensive. A central bank digital currency
is one way of doing so. There may be other ways as well. My
concern is we are not moving fast enough to either develop a
prototype CBDC or to determine what the best strategy is.
Seventh, CBDC, stablecoins, and digital assets generally
are often cited as a means to achieve greater financial
inclusion, and we should consider their potential for doing so.
But we should act now to prevent--to improve access to
financial services through other means as well. The need is too
great, and this should not be deferred.
Finally, the challenge we face is not unusual, because the
financial sector constantly innovates and our regulatory system
has to catch up. I helped draft the original agreements for
swaps 30 years ago, and swaps created a lot of beneficial
hedging. But the industry resisted regulation and eventually
generated excessive risks that almost brought down our
financial system. It was only then that we created a regulatory
framework under which the industry is thriving today.
To conclude, we should take some actions now to strengthen
the regulatory framework. And some key things that Congress
should do are, first, require that stablecoin issuers and
related arrangements be supervised by the Fed or the OCC along
the lines I have suggested.
Two, give the SEC or the CFTC clear authority to regulate
the cash market for cryptocurrencies.
Three, make sure FinCEN has the tools and resources it
needs to implement KYC, AML, and CFT standards thoroughly.
And, four, urge the Fed and the Biden administration to
accelerate work on modernizing our payment system, including by
developing a hypothetical CBDC.
Thank you, and I look forward to your questions.
[The prepared statement of Mr. Massad appears in the
Submissions for the Record on page 59.]
Chairman Beyer. Thank you very much, Mr. Massad.
We will next hear from Professor Werbach.
STATEMENT OF KEVIN WERBACH, PROFESSOR OF LEGAL STUDIES AND
BUSINESS ETHICS, DIRECTOR OF THE BLOCKCHAIN AND DIGITAL ASSET
PROJECT, THE WHARTON SCHOOL, THE UNIVERSITY OF PENNSYLVANIA,
PHILADELPHIA, PA
Mr. Werbach. Chairman Beyer, Ranking Member Lee, members of
the committee, thank you for the opportunity to speak before
you today.
Blockchain technology and the digital asset ecosystems it
enables could well represent the most important developments in
information technology since the internet. The potential exists
to not only improve the efficiency of many kinds of
transactions but to make markets more fair, inclusive, open,
dynamic, and transparent. At the same time, there is no
question these same technologies can be and are used by
criminals, fraudsters, and other bad actors. There are major
risks involved in digital asset-based markets, and it is
important to distinguish potential from reality.
These are still in many ways immature technologies. There
are important questions about energy usage of proof of work
networks. Holdings of most digital assets are highly
concentrated, and there are serious concerns about market
manipulation. It is essential for both market participants and
policymakers to set a course to accentuate the benefits, while
limiting the harms.
Regulation and innovation are not necessarily in conflict.
In many cases regulatory action to address abuses and provide
clarity is an important or even necessary condition for long-
lasting and transformative innovation.
A quarter century ago I served on the White House working
group that drafted the Framework for Global Electronic
Commerce, the U.S. Government's approach to the internet. The
policy adopted then was not that the internet should be a
totally unregulated space or that the harms it brought should
be ignored in light of its benefits. While the framework
opposed, quote, ``undue restrictions,'' it also identified the
need for a predictable, minimalist, consistent, and simple
legal environment. That is what we should be seeking today for
cryptocurrencies and digital assets.
Take, for example, decentralized finance, or DeFi. DeFi
could create a more open, inclusive financial services
environment by removing intermediaries and improving access to
capital. Increasing the velocity of assets, facilitating
service composability, unlocking yield opportunities, all have
the potential to increase risk-adjusted returns available to
market participants.
However, DeFi also poses significant dangers which were
detailed in the DeFi policymaker toolkit, a collaboration of
the Wharton Blockchain and Digital Asset Project and the World
Economic Forum.
The challenge DeFi poses is how to address these challenges
and risks through regulation. A centralized cryptocurrency
exchange has a corporate parent, offices, management team,
custodial assets, and typically licenses or registrations. An
automated market maker, AMM, or other OnChain DeFi protocol,
though, need only be software code running on a decentralized
global blockchain network.
While this may sound like an insoluble problem, it is
likely to be manageable in practice. First, DeFi services are
heavily dependent on stablecoins as on-ramps and off-ramps.
Clarifying the regulatory context around stablecoins and
ensuring they are subject to appropriate obligations could help
address the DeFi regulatory conundrum.
Second, users often access DeFi functionality through
websites and services maintained by protocol developers. Some
developers have already taken steps such as blacklisting tokens
whose trading would clearly violate securities laws.
Finally, DeFi protocol and governance tokens do not appear
from nowhere. The moment of token issuance is an important
regulatory opportunity. This is, for example, an area of focus
of MiCA, the European regime under development now for non-
securities digital assets.
The history of peer-to-peer, or P2P, file sharing
applications such as Napster 20 years ago also provides a
helpful roadmap for how seemingly unregulable services can be
addressed. These applications were held liable for copyright
infringement when they maintained essential components of
central control or when they knowingly induced illegal
activity.
Going forward, Congress should take a three-pronged
approach to the regulatory questions that cryptocurrencies
raise.
First, where possible, provide breathing space and help
policymakers gain greater understanding of market dynamics.
Second, quickly address the low-hanging fruit. There are
laws and regulations with language that inadvertently fails to
accommodate digital assets, and fixes are relatively
uncontroversial. There are also too many obvious bad actors who
have not faced legal consequences and large players in the
blockchain ecosystem credibly accused of systemic market
manipulation.
Third, at some point outdated legal frameworks are no
longer technology neutral or effective. Over time, we will need
to reconsider the basic foundations of financial regulation put
into place nearly 90 years ago after the Great Depression. Such
an effort will position the U.S. to maintain its leadership in
the global financial system as it moves into its next
technological transition and leadership in the emergent sphere
of blockchain based activity.
I look forward to your questions.
[The prepared statement of Mr. Werbach appears in the
Submissions for the Record on page 72.]
Chairman Beyer. Thank you, Professor, very much.
And, last, we will hear from Mr. Van Valkenburgh.
STATEMENT OF PETER VAN VALKENBURGH, DIRECTOR OF RESEARCH, COIN
CENTER, WASHINGTON, DC
Mr. Van Valkenburgh. Chair Beyer, Ranking Member Lee,
members of the committee, thank you for this opportunity to
speak with you today.
On Halloween 13 years ago, an email to a public mailing
list shared a link to a PDF. It was the Bitcoin white paper,
3,192 words, a handful of simple illustrations, and some C++
computer code. The following January, a 2-megabyte computer
program was made freely available for download to the same
public mailing list. Less than 5 years later, the person or
persons sending these emails under the pseudonym Satoshi
Nakamoto sent their last message and has not been heard from
since.
Today, a few thousands words, a computer file smaller than
a cat video, and a missing author have brought about an
economic revolution, over $3 trillion worth of economic
activity recorded and secured on blockchains, shared ledgers
that no single person, corporation, or government permissions
or controls.
Who can we thank for that remarkable, utterly unpredictable
outcome? Not just the person or persons who went by Satoshi.
They stood on the shoulders of brilliant cryptographers and
computer scientists. Perhaps above all, they were inspired by
another shared and open computer network that no single person
controls, the internet, a place where a good idea shared
anonymously and publicly can stand on its merits, spread to a
community of like-minded innovators, and flourish.
America grew rich because of that openness, The ingenuity
of immigrants, entrepreneurs, explorers, and technological
pioneers. We don't like permissioned systems in this country
because we know that you can't prejudge genius. We want open
systems that afford dignity and access even to people we don't
yet know or understand. As Steve Jobs would have put it, the
crazy ones, the misfits, the rebels.
So I am not going to tell you who is going to show up on
the bitcoin blockchain or the coming decentralized web or what
exactly they are going to build. I couldn't tell you that today
anymore than I could have told you in 1990 that Satoshi would
show up on the internet alongside Sergey and Larry with Google
and Jimmy Wales with Wikipedia.
All I am going to tell you is that we finally built a tool
that can make money work without banks, make organizations work
without corporations and courts, make sharing and transacting
online work without big tech, and that, because of all that,
there is a better chance that tomorrow's misfits will be able
to speak, share, and innovate.
This uniquely American ideal, however, isn't about anarchy.
It is about opportunity under the law. Bitcoin and follow-on
cryptocurrencies are not unregulated. Sensible, technology-
neutral regulations have protected consumers and investors and
prevented money laundering and illicit finance. The American
approach is to flexibly regulate activities, not to ban or
blacklist the publishing of new ideas and tools.
Anyone can freely write and share the open source software
that makes these technologies works. Any prior restraint on
sharing that expressive content violates our First Amendment
rights. But if you promise an investor you will invent and
build them a new future cryptocurrency, we expect you to
register as the issuer of the security.
No one is made to open their homes and private bitcoin
wallets to a search by the police without a warrant. But if you
provide a service to help people buy and sell bitcoin as a
third party, you are expected to know your customers and apply
anti-money laundering controls.
There are some gaps in America's crypto public policy. The
gaps are not, contrary to popular belief, a central bank
digital currency gap with China. The CCP is more interested in
banning permissionless tools like bitcoin and substituting a
surveillance tool that will give them even more control over
the misfits within their borders. We should not emulate that
policy.
The gaps are much more mundane. On the margin, securities
and commodities futures laws can be improved. And there are
well-drafted bills in the House that address those issues.
Other gaps concern taxes. The recently passed infrastructure
bill included rushed language that could unintentionally stifle
innovation and invade personal privacy. There was a bipartisan
solution with widespread support, but procedurally it was
impossible to implement before the bill's passage.
Existing IRS policy leaves taxpayers uncertain of their
obligations with regard to cryptocurrency transactions. Tax
issues are complex. So I have left specifics to my written
testimony.
Suffice it to say, there is no reason why America can't
continue to be a home for permissionless innovation, while also
enriching its treasury. We did it with the early internet, and
we will do it again with cryptocurrency networks.
Thank you.
[The prepared statement of Mr. Van Valkenburgh appears in
the Submissions for the Record on page 100.]
Chairman Beyer. Thank you, Mr. Van Valkenburgh.
Thank you all very much. Fascinating testimonies. I
encourage all of us to read the larger versions, too, because
there is so much more content in them.
Let me begin my five minutes of questions.
Mr. Massad, you talk some about stablecoins. And we just
heard Mr. Van Valkenburgh say that, you know, already we are
sufficiently protected against too much illicit use of
stablecoins or cryptocurrencies, tax evasion, terrorism. And we
have read a number of times in the last week about Tether
having the $64 billion, $70 billion but not enough actual
assets if converted.
How do we protect investors from a run on a stablecoin like
Tether?
Mr. Massad. Sure. Thank you, Mr. Chairman, for the
question.
We have to have policies that require that the reserves
that they receive, in other words, the money they receive for
the tokens, are invested in highly safe liquid assets, ideally
just cash so that it is always there.
What we have today is a situation where there are no
requirements, and a firm like Tether has investments in
commercial paper. We don't even know what kind of commercial
paper. There is a lot of speculation that it is commercial
paper in China. They have loans. They were found to have loans
to affiliates. They may even have investments in
cryptocurrencies.
So that risk is that if there is a sudden spike in demand
for redemptions, they will not be able to meet it. Or if they
have to liquidate assets, that could cause downward pressure on
assets prices. If they, in fact, have $30 billion of commercial
paper, that is a huge amount that would affect the market. So
that is the main thing.
And then we also have to address the ancillary
arrangements, the fact that these things are traded on
decentralized blockchains.
Chairman Beyer. We often wonder how many of these investors
realize that these are not insured deposits, you know, with the
FDIC.
Mr. Massad. Well, that is a good question. There is a lot
of stickiness, though, to people's use of Tether because Tether
plays a very important role. It allows people to move value
around between exchanges and between cryptocurrencies. And,
frankly, Tether illustrates that our payment system needs to be
modernized, needs to be improved. That is why it has grown so
much. It has also probably grown because it is a vehicle for
tax evasion and potentially for illicit activity.
Chairman Beyer. Thank you.
Ms. Goldstein, in your written testimony you highlighted
the Squid incident where developers pulled all the liquidity
out of the coin. Can you explain how a rug pull works and what
we can do to prevent rug pulls?
Ms. Goldstein. So a rug pull typically happens when a
developer creates a token, puts it on a blockchain, whether it
be the Ethereum blockchain or another blockchain. There is lots
to choose from: Avalanche, Harmony ONE--take your pick--Binance
Smart Chain. And you create what is called a liquidity pull for
it.
And what that involves is going to a decentralized exchange
like Uniswap or one of their competitors and basically putting
two tokens together, your new token, your Squid Game token, and
usually a stablecoin. And you put enough volume of those two
tokens on there so that people who want to buy your Squid token
can go in, use the stablecoin that they have put into the
liquidity pull, and buy their Squid Game token.
But because they are the ones who have sort of initially
provided the liquidity for that pull, once people come in and
they buy the Squid Game token, they can also pull that
liquidity out at any time and essentially cause the price of
the token to crash.
So they basically tend to wait until enough people buy it
up that the price begins to run up. And it runs up sufficiently
enough that this new token that they have minted out of thin
air, right, they have created it out of nothing, is worth
something. And they pull all the liquidity out and run off with
the money and that is what happened with the Squid Game token.
Chairman Beyer. Thank you very much, I think.
Professor Werbach, Senator Lee talked about a light touch
and not centralizing everything in Washington, DC, you know,
with the fear that too much regulation stifles innovation. How
do you see that tradeoff or even that that supported network
between regulation on the one hand and innovation on the other?
Mr. Werbach. Innovation is not just one thing. There are
many different kinds of regulation, and I think the concern is
a valid one. There are ill-fitting regulations. There are
situations where regulation is not necessary. But it is not
inherently the case that having a regulated market is
inconsistent with having innovated market. If that were the
case, then the U.S. would be the least regulated financial
market in the world instead of one of the most regulated.
Regulation can promote trust. There is a reason why our
capital markets are so successful. People come here because
they trust that it is a fair and open market and one that will
allow their sophisticated activities in an appropriate way.
So the question is really what kinds of regulations we
have, and I agree with Mr. Van Valkenburgh. It is not that
there is no regulation in this digital asset space. We have
existing rules which in some cases are not being enforced. In
some cases there are questions about how they can be enforced
for new kinds of assets. In some cases there are gaps.
So what we need to do is something like what we did 25
years ago with the internet. Do an inventory. Identify what the
issues are. Identify what the existing regulatory structures
are and identify where there are gaps, where there are
problems, where the danger is that either the absence of
regulation or the lack of clarity about regulation that exists
will lead to these kinds of abuses and will lead to a situation
where the market potentially collapses.
Chairman Beyer. Thank you very much.
Let me now yield to Senator Lee from Utah for five minutes.
Senator Lee. Thanks so much, Mr. Chairman.
Mr. Van Valkenburgh, I would like to start with you, if
that is all right.
Sometimes when Congress discusses cryptocurrency, you see
concerned faces. You see sometimes people reflecting a certain
degree of fear or anxiety. But the conversation is almost
always alarmist in nature when it comes up in these hallways
and those on the other side of the Capitol. We hear claims to
the effect that this is a space that is sort of analogous to
the Wild Wild West and could likely lead to chaos, pandemonium,
more criminal activity and financial ruin on a widespread basis
including victimization by those who are least able to absorb
risk.
But as you have pointed out, the industry is, in fact,
already regulated. I mean, crypto markets do, in fact, face
consumer protections when enforced by a whole host of alphabet
soup Federal regulatory agencies--CFPB, FTC, FT--CFTC, SEC, and
FinCEN, just to name a few. State attorneys general also have
authority. Is that accurate?
Mr. Van Valkenburgh. It is quite accurate, Senator.
Senator Lee. And cryptocurrency and the blockchain
technology that it is built on itself contains its own sort of
mechanism for self-regulation and protections against fraud and
abuse, does it not?
Mr. Van Valkenburgh. That is the foundational principle
behind bitcoin is the double spending which is the most obvious
type of fraud. Counterfeiting of digital money is policed for
by a public transparent ledger that anyone can audit and check
themselves.
Senator Lee. In fact, for these very reasons aren't there
ways in which crypto markets are always improving consumer
safety and reducing financial risk?
Mr. Van Valkenburgh. Always improving is a strong
statement. I think, by virtue of these networks being
inherently public, we have great advantages. However, by these
technologies being very new, there is a steep learning curve. I
am very optimistic for the long-term future of the technology,
however.
Senator Lee. Because they are based on a new technology,
they could offer some real advantages, it seems to me, to
lower-income customers who are looking either at them from the
standpoint of something to invest in or something to use as a
means of transferring money from one place to another. In some
ways there could be economic benefits to poor and middle-class
consumers everywhere from them, wouldn't there?
Mr. Van Valkenburgh. I think its greatest benefits, quite
frankly, are not even here in the U.S. They are in countries
that have literally no access to financial services because
they don't have the rule of law, and the technology even in its
current state can easily fill a gap in those places that have
been left behind.
Senator Lee. Like the underbanked, the underbanked could
benefit significantly from it.
So if we ban some of these privacy features in
cryptocurrencies or if we regulate them to death, how might we
be precluding or missing out on some of the beneficial
innovations that require privacy protections?
Mr. Van Valkenburgh. I think innovation and creativity
require some sphere of privacy so that you are not immediately
judged for the things that you are going do that are
nontraditional, and that was the big story of the internet was
a bunch of misfits who felt like they could come up with a new
idea for a social network or something like that and be able to
experiment freely. I think the same will be true of open block
networks which also afford people that free and open platform
for experimentation.
Senator Lee. Are you familiar with the phrase ``born in
regulatory captivity'' versus ``born in regulatory freedom''?
Mr. Van Valkenburgh. Yes.
Senator Lee. It seems like it might be apropos here.
Now for Americans who own a little Bitcoin and use it to
buy something or to send some money back home, how could
Congress help make it easier for them to comply with the
Byzantine labyrinth of legal implications that could accompany
that?
Mr. Van Valkenburgh. I think the thing Congress can do to
help those folks most would be to regularize and make clear our
tax policies, especially by providing a de minimis exemption
from capital gains taxation for small cryptocurrency
transactions which otherwise trigger a capital gain and a need
to report and simply make using the technology very difficult.
We have that kind of exemption for foreign currency
transactions. It makes sense to have the same for
cryptocurrency transactions.
Senator Lee. Where would you be inclined to set the limit,
if you were king for a day and you had the ability to set the
de minimis safe harbor? Where would you put it?
Mr. Van Valkenburgh. Being a humble person, I would set it
where the foreign currency exemption is. And that is where it
is set in legislation we have seen in the House from DelBene
and Mr. Schweikert.
Senator Lee. You know, as you have noted, a lot of the
barriers to innovation for cryptocurrencies come from existing
laws and uncertainty about how those laws might be enforced,
some variation in whether it is in enforcers or in
interpretation of existing authorities.
In many cases that uncertainty and overly broad
interpretations of these existing financial regulations have
begun to push some of this technology overseas or at least some
of the pioneering U.S. technology companies overseas.
What do you think is the best way to protect consumers and
to ensure America remains, you know, at the cutting edge of
this type of innovation?
Mr. Van Valkenburgh. I would agree with my fellow panelists
that stablecoins are an interesting area, and the regulatory
field there is somewhat convoluted. There are certainly
stablecoin issuers who are violating the law, who have not
registered as State money transmitters, or who have not
chartered themselves as State banks or trust charters. There
are also regulated stablecoin issuer, and there is also the
possibility of creating more of a Federal home for regulation
of stablecoins. We don't have a legal gap there, I think. We
just have an enforcement gap, and that is a real problem.
Senator Lee. My time has expired. I appreciate year
testimony. This really could be a boon for America's poor and
middle class. Let's not get in the way of it.
Chairman Beyer. Thank you, Senator, very much.
I now recognize the Senator from New Hampshire, Senator
Hassan.
Senator Hassan. Well, thank you very much, Mr. Chair and
Ranking Member Lee. And thanks to all the witnesses today for
your work.
Ms. Goldstein, I want to start with a question to you. I
recently wrote to several agencies including the Department of
Justice and the Treasury, highlighting a cyberattack on the
town of Peterborough, New Hampshire. The perpetrators quickly
converted most of the $2.3 million, which in a small town in
New Hampshire I can assure you is a lot of money, in taxpayer
dollars that they stole. And they converted it into
cryptocurrency, making it unrecoverable.
What actions can agencies take to prevent this kind of
criminal activity such as the rapid conversion of illicit funds
into cryptocurrency?
Ms. Goldstein. Senator, thank you for your question.
There are four suggestions that I have. The first is that a
large portion of this marketplace likely falls under existing
securities laws. And applying those rules, including rules that
apply to broker dealers, I think would help stop illicit
actors' ability to move money anonymously and help prevent that
sort of ransomware conversion.
My second suggestion is that the Treasury Department can
enforce some guidance that they just put out in October. OFAC
put out this clarification that if you do digital assets, you
need to comply with sanctions. You need to check whoever is
using your platform against the sanctions list. And I think the
Treasury Department enforcing that guidance would be a good
step forward.
The third is anything the agencies can do with your help,
if needed, to promote more information sharing can always help.
FinCEN analysts can put out reports as a result of that.
And the last think I would suggest is that FinCEN has a
very specific set of financial regulations regarding financial
crimes specifically. And I know you are already talking to them
about this, but I think strong enforcement of those would also
be helpful.
Senator Hassan. Okay. Thank you so much.
Mr. Massad, in the letters that I wrote, I emphasized how
stronger know your customer requirements for cryptocurrency
exchanges can curtail the criminal use of cryptocurrency. It
becomes much harder to evade law enforcement when your name is
attached to the cryptocurrency wallet you are using to commit
crimes like ransomware attacks, drug trafficking, and money
laundering.
How could stronger know your customer requirements for
cryptocurrency exchanges help authorities prevent and prosecute
criminal uses of cryptocurrency?
Mr. Massad. Thank you for the question, Senator.
It is extremely important, and one big example of this is
what is happening with ransomware. There was a recent FinCEN
report just issued a couple of weeks ago that documented how
ransomware is increasing rapidly. I think the Colonial Pipeline
incident was a real wake-up call, too, because that is a
company that didn't have a lot of personal identifying
information. It was an infrastructure company, and yet it was
hit. I think we are going to see more of that.
The FinCEN report talks about how these illicit actors
often act through the crypto exchanges. They reuse addresses.
They make multiple transfers of the illicit profits so they
can't be traced. And, you know, KYC is critical here. And we
need to bolster, you know, FinCEN in this. But it is more than
that. We also have to have a structure of regulation around
these exchanges.
Coinbase, Kraken, these other exchanges, they are not
subject to the same standards that we have for securities and
derivatives exchanges. They are registered as money
transmitters. That is a pretty light touch of regulation. They
don't have standards to prevent fraud, to prevent conflicts of
interest, to prevent things like wash trading. Wash trading is
where you essentially trade with yourself or with an affiliate.
That is very, very common.
And there is a very interesting CFTC action here. The CFTC
only regulates derivatives contracts. So to say that, you know,
the SEC or the CFTC has power over these exchanges is wrong
because the CFTC can't regulate that cash market for Bitcoin
anymore than it can regulate the sale of cows just because it
regulates cattle futures.
And yet it does have very limited power to bring fraud
actions, but that takes a lot of resources to do. They did
bring one against Coinbase. But even one of the Republican
commissioners said, ``you know, this is going to mislead the
public into thinking that we regulate these exchanges. And we
don't.'' So that is--it is a broader problem than just KYC
standards but that is critical.
Senator Hassan. That is very helpful. Thank you.
One more question again for you, Ms. Goldstein. I recently
introduced a bipartisan bill with Senator Ernst that would
require Treasury to report to Congress on how cryptocurrency is
used globally and its effects on global supply chains. How has
cryptocurrency mining affected global supply chains in recent
years including for critical technologies such as
semiconductors?
Ms. Goldstein. Well, Senator, I commend you and your fellow
senator for the bill and the report that you request.
Essentially cryptomining has an arms race. Their technology
needs to improve all the time so they can keep up and make
money. And that means often they have to replace the equipment
very fast, and that means more demand for semiconductors. And
that means less, you know, electronics makers who use
semiconductors for other things are able to access them.
So I do think that there a lot of research, in particular,
showing, for example, graphics card needs secondhand goes in
conjunction with the price of ether, for example.
Senator Hassan. Okay. Thank you very much.
And thank you Mr. Chair.
Chairman Beyer. Thank you, Senator, very much.
I now recognize the gentleman from Arizona, Mr. Schweikert.
Representative Schweikert. Thank you, Mr. Chairman.
I may take this a slightly different way just because you
and I have worked on discussions around this for a long time. I
have a fascination with distributive ledger technologies. I
think I hold the record of being the first one to actually
mention bitcoin in a Ron Paul hearing, believe it or not, many
years ago.
Could we spend a couple of seconds, because three of you
have sort of touched on it, let's do some societal good.
Transaction costs, using of my credit card, the wire transfer,
what do we as policymakers need to do to in many ways use the
technology that should crash the price of someone walking into,
whether it be Walmart and using a credit card or sending money
back to the family in Guatemala? This technology should be
crashing that price.
First, what do we as regulators need to do on that? And
then we are going to go down the rabbit hole on a couple of
other things like identity and other things that could actually
help. We were trying to do an experiment in Arizona of using a
blockchain to identify homeless activities and the benefits
attached to them and have it in a universal spot.
Mr. Massad. Thank you, Congressman. It is an excellent
question. Stablecoins are one possible way to do that if they
are properly regulated. A stablecoin is simply a token.
Representative Schweikert. Well, I am sorry. I am going to
geek out with you just----
Mr. Massad. Yes.
Representative Schweikert. I am very familiar with the
underlying mechanism. Matter of fact, years ago I worked on an
escrowing for a blockchain code----
Mr. Massad. Uh-huh. Uh-huh.
Representative Schweikert [continuing]. to show you how far
down the rabbit hole I went.
But you think a stablecoin would be your methodology for
creating a----
Mr. Massad. A faster----
Representative Schweikert [continuing]. rail.
Mr. Massad [continuing]. pace. It certainly could be
because, again, it is a token that is then backed by the dollar
and there is a lot of proposals----
Representative Schweikert. Would you use a stable token?
Mr. Massad. A stable token?
Representative Schweikert. Yes, where there is a----
Mr. Massad. An algorithmic kind of----
Representative Schweikert. Yes.
Mr. Massad [continuing]. formula?
Representative Schweikert. You know, here is my piece of
plastic. I swipe it over here. We have an agreement that it
represents this many units.
Mr. Massad. Well, that is the hardware----
Representative Schweikert. Yes.
Mr. Massad [continuing]. the plastic part.
What I am talking about is, you know, currently, as you
point out, our system, our payment system is it is essentially
bank deposit dominated. Credit cards still go through banks.
Representative Schweikert. Uh-huh.
Mr. Massad. You know, wire transfers go through banks. And
banks, frankly, haven't innovated enough. With a stablecoin, if
properly regulated, you could potentially have new entrants
into payments that then are creating new payment rails using
that digital technology.
Representative Schweikert. Okay. So, instead of you and I
going over thin line technology because we have white-boarded a
fixed--a stable token actually----
Mr. Massad. Uh-huh.
Representative Schweikert [continuing]. which is pretty
much the same thing, what do we have to do policywise to make
that available? Because overnight that would actually change
costs in our society of using----
Mr. Massad. Right.
Representative Schweikert [continuing]. three percent, five
percent?
Mr. Massad. Yes, it could. I think we need to create a
regulatory framework to regulate those issuers so that--and the
PWG report I think lays out a lot of issues. My only concern
with it is it recommends that Congress adopt legislation that
says only insured depository institutions can do this.
Representative Schweikert. But that would----
Mr. Massad. And----
Representative Schweikert [continuing]. screw up the cost
structure again.
Mr. Massad. I think that limits competition.
Representative Schweikert. Okay.
Mr. Massad. Right.
Representative Schweikert. Okay. The same sort of question.
How do I make--how do I use distributive ledger, blockchain
technology, whatever title you want to give it--I know this is
more crypto--but also using the knowledge that we are
developing here to benefit society and those transactions?
Mr. Van Valkenburgh. So, I think my fellow witness, Mr.
Werbach, with his insights about the Clinton administration's
Framework for Global Electronic Commerce is on the money.
Technologies back then in the 1996 hearings about the
internet could not have allowed people to share high-speed
video, could not have allowed people to have Zoom conferences
instead of hearings, could not have allowed people to do online
banking. You could send a very small amount of data through the
internet at that point. I didn't have----
Representative Schweikert. I was involved in the old Check
21, to give you an idea how far back.
Mr. Van Valkenburgh. Yes. And in a very real sense today,
we still are at that point with respect to cryptocurrencies. As
my fellow witness said, sometimes the fees are actually quite
high. And it seems as though there is no hope of moving more
economic activity, let alone social networking transactions,
identity transactions onto these networks.
The layered architecture of these technologies, however,
means we have lots of avenues to build more scaleable, more
efficient solutions. And it is a story of free and open
platforms that allow anyone to build that innovation.
We gave a briefing in the House, I think in this very
building, where we used the Lightning Network, an open payment
network built on top of bitcoin's open protocol, to buy candy
from a candy machine. A transaction of half a penny got you
M&Ms from the machine, and the fee for that transaction was 1/
250 of a penny. That was actually a settled transaction that
ultimately ended up batch settled without just on the
blockchain by the Lightning Network far better than the
corresponding banking system that we have today, ACH, credit
card authorizations.
Representative Schweikert. I am actually up against the
time. But that is actually part of the discussion of ID,
licensing, benefits, my ability to send some resources to
grandma. I know we--I know the money is in the cryptocurrency.
That is where the enthusiasm is. But sometimes I think we
failed to understand. If we do this smartly, the benefits of
distributive ledger and stable code--and code is ultimately
insurable, if we can ever get that far--could we actually also
do some really good thing to society, not only in our country
but around the world?
And with that, I yield back.
Chairman Beyer. Thank you, David, very much.
Now I recognize the Senator from southern California, Mr.
Peters.
Representative Peters. I wish I was a Senator. That would
be a nice six year term, but I am just a lowly Representative.
Thank you very much, Mr. Chairman. Thanks for having this
hearing. This has actually been fascinating and a really good
presentation.
It sounds like we are struggling at the beginning of this
phenomenon with using government to come up with fair rules
like the markets have that people can trust without getting in
the way of innovation that can happen. I think that is a pretty
common story, and we are just at the beginning of it.
One issue I had for you, though, Ms. Goldstein, is to be
fair, we want to make sure that there is--this currency is not
used for tax evasion. And I just want to refer to the
bipartisan infrastructure framework. There was a provision that
attempts to prevent tax evasion in the crypto space by
requiring starting in 2024 brokers to report cryptocurrency
gains in a 1099-B form.
I wonder what you thought of that as a measure to curb tax
evasion. Is that sufficient, or do you think there are other
particular measures that we should pursue?
Ms. Goldstein. I am a supporter of that language. I think
it is important. I think, you know, we talk a lot about
innovation in this space, but, you know, there are a lot of
companies we think of as so innovative like Charles Schwab or
TD Ameritrade and they are supplying those sorts of tax
reporting every day.
And I think--I had to do my cryptocurrency taxes last year
because I did not get a 1099-B form from a lot of the different
platforms that I used. I had to pay a third-party vendor over
$100 or $200, I don't exactly remember, in order to generate my
tax form for me so that I could submit it to the IRS and make
sure that my crypto taxes were paid appropriately.
And so, I think not only is there a benefit of sort of
going after some of the tax evasion that the administration has
reported is happening, but there also is a benefit to the end
user. It would make it a little bit easier for them to do their
own taxes. The burden would no longer be on the own individual
investors, it would be on the platform.
Representative Peters. Right. And I assume in this industry
we won't hear any back talk about how difficult it is to
calculate this, because appreciables and standard operations it
seems like.
I had a question for Mr. Massad. In a recent Brookings
Report you suggest that the Financial Stability Oversight
Council should commence a review of stablecoins. Can you tell
us a little more about what you think in general we are going
to get out of this, not at the level Mr. Schweikert would
understand but maybe the public could. Not to ding Mr.
Schweikert, but it is no surprise that he understands this at
the same level as the witnesses.
Mr. Massad. The Financial Stability Oversight Council has
the power under the Dodd-Frank Act to designate a payment
activity as systemically important or likely to become
systemically important. And I think the growth of stablecoins
from very low numbers to over $130 billion today, plus the
potential future growth if we did allow them to do broader
application might very well meet that test.
If they do that, then the Federal Reserve is charged with
developing risk management standards. So I think that is a way
to create a regulatory framework, certainly Congress could pass
legislation too, but I think the FSOC could take that action
and that could address a lot of the issues that we have
mentioned, making sure the reserves are invested in cash,
making sure there is liquidity, making sure there is
operational resilience, and making sure things like KYC are
adequately dealt with.
Representative Peters. That would certainly be an important
thing in lieu of there is no deposit guarantee----
Mr. Massad. Correct.
Representative Peters [continuing]. There is cash behind
it.
Mr. Massad. That is right. And today some of the stablecoin
issuers are registered as trust companies, but that State
registration doesn't mandate all the standards that I am
talking about. It is still a light touch.
Representative Peters. Mr. Werbach, tell me what the key
differences are you would identify between decentralized
finance in traditional banking and whether you think there is a
potential that affects the integrity of the dollar, this whole
phenomenon.
Mr. Werbach. Well, decentralized finance is essentially
transforming finance and financial services entirely to
software. So it is about financial services that settle on a
blockchain, a decentralized ledger that are noncustodial so you
don't give up control of your assets to the third party and
that are open, programmable, and composeable.
So this is basically open so software and these pieces can
be plugged into each other. It is a much more open and dynamic
way of doing financial services, and it is one reason that we
have seen an explosion of activity in DeFi and companies coming
up with new opportunities, which can be very beneficial.
The problem is they do it without the kinds of restraints
that we have in the traditional system. And some of those
restraints are very important for all the reasons that my
fellow witnesses and I talked about, whether it is about money
laundering or about protecting investors. So the answer is not
to go back to the banking system and to prevent DeFi from
happening.
The question is first of all understanding what those risks
are and also understanding what is happening in the
marketplace. Because for example, there are DeFi insurance
platforms are coming into existence that allow you to hedge
against the risk that there is a hack on a DeFi service. But
again, all of this is so new that we don't have an
understanding of what it is.
Representative Peters. I appreciate it. My time has
expired, but again thank you for the hearing. Thank you to the
witnesses.
Chairman Beyer. Thank you very much, Congressman.
I next recognize the Congressman from Kansas, Mr. Estes.
Representative Estes. Thank you, Mr. Chairman. And thank
you for all the witnesses for being here today. This is a great
topic for us to be talking about. Obviously, when we look to
the future there is a lot of technology out there and where we
can possibly go with the country.
And I want to go back and we talked a little bit about
this, but, you know, over the past 30 years we have seen a
number of innovations tied directly to the internet, and a lot
of rapid developments, and adaptation. And really it was
impossible to really know how the internet would function back
when it was first being formed.
So today we see that the blockchain technology and the
capability there that gives Americans ability to reliably
record information without having an intermediary to act as the
recorder of that information. I think there is a whole host of
potential applications from across the economy from land titles
and ownership records, to contracts, to improving security over
and above what we frequently have talked about in terms of
crypto technology as being used as a currency. And I think
there is a lot of decisions we have to make in both areas.
Just like when the internet was new, we need to be careful
about how Congress approaches these new technologies and what
regulations we put in place. Just like there were many false
starts with internet there in the dot.com bubble, but today it
is really a critical tool that we have.
It is good that the Congress didn't regulate the internet
out of existence in the 1990s before it was clear what all
those uses could be. And I hope that, you know, as we work
through this process we come up with a goal that makes sure
that we don't impose unnecessary barriers to the innovation. I
hope that along with looking for protection from bad actors,
Congress is very deliberative in its process and coming up with
those legislative decisions that will help this technology grow
and expand for things we haven't thought of today or discussed
today.
I do have a couple questions. Mr. Van Valkenburgh, what do
you see are some of the exciting technologies that are citing
applications that we can use with the blockchain technology
going forward?
Mr. Van Valkenburgh. Thank you, Congressman. And your
colleague, Mr. Schweikert was going down this avenue as well. I
think I would like to talk about identity. So when we think of
blockchain networks as you said just now, we often think mostly
about money.
And cryptocurrencies are the scarce commodity tokens that
power them are essential to the operation of these systems,
because they create a fair reward for anyone who donates
computing power to secure the blockchains and the data on that
blockchain.
So you don't need permission who can secure that data, you
have an open competition of people securing that data and doing
it transparently and getting a fair reward on the blockchain.
With that said, one the blockchain is secure, you can put
information in that blockchain that goes beyond merely a
transaction where I paid Mr. Schweikert a bitcoin. You can put
a transaction on that blockchain where I testified in front of
Congressman Schweikert and I attested to my identity by using a
unique cryptographic key in my phone when they let me in the
front door. This kind of identity transaction is another
intermediated transaction when it takes place on the internet
today.
We rely on major corporations to run our social networks,
to run our credit reporting agencies, to run all the tools and
systems that identify us that permission our access to
buildings. The OPM uses major enterprise identity providers in
order to secure government buildings for personnel.
All of these ledgers are centralized and siloed and can
ultimately be improved and decentralized by using open
blockchain networks to secure identity transactional data,
rather than trusting one corporation or company to do that. To
that end, Microsoft has pioneered something called the ION
network.
It is not Microsoft's technology, per se. They are
developing an open standard and contributing along with other
corporations to a decentralized identity standard that would
actually anchor identity data into the bitcoin blockchain so it
is more secure and less vulnerable as a centralized data
repository would be to hacking, and ransomware, and such.
Representative Estes. What you have taken was very complex,
trying to figure out how to deal with cryptocurrency and now
made it even much more complex in terms of the other
applications.
I am about out of time. I don't know if you can say a quick
comment about cybersecurity and how that might effectively be
positive through this.
Mr. Van Valkenburgh. Sure when we think of cryptocurrencies
and cybersecurity we often jump to ransomware because it is
used as a payment for ransomware. I think it is important to
point out that Deputy Treasury Secretary Wally Adeyemo said in
his speech last week, ``ransomware is not a cryptocurrency
problem in the same way online fraud schemes are not the fault
of the internet.''
In fact I would go further and say that cryptocurrency
technologies are ultimately the solution to ransomware
cybersecurity issues because the big tech paradigm of securing
user data in a centralized database is what creates
vulnerability to hacking.
If we decentralized control over that data, decentralized
the social network, decentralized an identity provider you lose
that single point of failure and that vulnerability from a
ransomware and hacking perspective.
Representative Estes. You certainly give us a lot to think
about in trying to figure out what we do.
Mr. Chairman, I yield back.
Chairman Beyer. Thank you, Mr. Estes, very much.
I now recognize the distinguished Congresswoman from
Columbus, Ohio, Ms. Beatty.
Representative Beatty. Thank you, Mr. Chairman and thank
you to our witnesses, and my colleagues. This is very
intriguing. And I want to come back to it, but I want to say
this before my times runs out. I am really interested in the
capital gains issue in how that would work as we deal with it
in crypto versus I know how it works in real money when you
have capital gains and how you have to apply to it.
So I don't know if I have enough time. I will ask my
questions, but I want to come back to that.
But I will stay with you Mr. Van. I have a large Somali
immigrant population in my district. As a matter of fact, I
have the second highest in the country next to Minnesota.
And I have worked with them, and many business individuals,
and the Treasury for years to help them solve their remittances
issue, because Somali does not have an adequate central banking
system.
Can you describe how bitcoin and crypto can potentially
help with remittances or not? Because right now, they are
traveling to Dubai once a month and sometimes with incredibly
large, millions of dollars in a briefcase to get it back to
come to Somali.
Mr. Van Valkenburgh. So the value of bitcoin and other
permissionless open blockchain networks for remittances is that
it makes starting a new remittances business the barriers to
entry to that field of endeavor much lower. You don't need to
gain access to an ACH network, you don't need to have a well-
functioning financial system in say the destination nation for
the payment.
With that said, I want to be sober about this, you still
may have last mile concerns. If the person at the other end of
remittance is happy get a decentralized cryptocurrency then
they may be able to receive that cryptocurrency using nothing
more than a phone and an internet connection, which in many
parts of the world may be something you would be more likely to
have than access to well functioning financial services.
However, if you want local currency, you will need to find
someone willing to exchange the decentralized cryptocurrency
for the local currency, and that is another point for potential
failures or a place where regulation may be necessary because
it is a trusted activity.
Representative Beatty. Mr. Werbach, I know you have gone
around the country giving lectures to business folks, attorneys
and in your book when you talk about this being the new
architect. Any comments on that?
Because I think you hit on something. You have to have it
on both ends and how advanced do we know for this population
that I just mentioned, do we have any Intel on what is
happening in Somali with this.
Mr. Werbach. Well, this is something that is developing in
the marketplace. Early on when bitcoin came around and
cryptocurrencies came into existence, people said obviously
this is going to be the solution for remittances. It is so much
cheaper and you don't have the intermediation.
Many companies went into the market thinking they would
deploy these solutions and in most cases they failed or in most
cases they were outcompeted by traditional kinds of services in
part because of these last mile issues.
And in part because in many ways the transaction in the
middle of the network is fairly efficient under modern
financial systems.
So really what we need to see is how the market is
developing and whether there are solutions as the technology
evolves on both ends. And for example, as which have systems
like the Lighting Network that Mr. Van talked about that may
lead to more efficiency of these payments. It is certainly
possible that a cryptocurrency-based remittances system will be
a better solution but, we shouldn't prejudge.
We shouldn't be in favor of one technology over the other.
We should encourage the so-called traditional financial
technologies to evolve and develop as well and have a
marketplace that ultimately is best for the people using it.
Representative Beatty. Thank you. I will try it get one
more question in.
Mr. Massad, in your testimony you spent a great deal of
time addressing the slow and expensive payment system that we
have in the United States. You even say that cryptocurrency
namely, Central Bank Digital Currency, is one way to address
this, but the Federal Reserve has been working on a faster
payment system for a few years and many other countries--with
many other countries around the world have a real-time payment
system without the use of the Central Bank Digital Currency.
Wouldn't the easiest route to address this outdated payment
system be just to move into a real-time payment system which
the Feds is already working on as opposed to creating a whole
new system with Central Bank Digital Currency?
Mr. Massad. It is an excellent question, Congresswoman. The
Fed initiative which is called FedNow will certainly help a
lot. The question, though, is first is it going to take a
little while before it even comes online, but more importantly,
will the benefits of FedNow really be widely decision
contributed?
Banks have to decide if they can manage it, if their own
systems are capable of using it? And will they pass on the
benefits? My concern is we need more competition to ensure
innovation. The other thing about FedNow is that technology
probably doesn't have the throughput that blockchain type
technologies have.
So I don't think it would be as good. And it is not clear
you can develop smart contracts and so forth. So you know, it
is one option, but I think we need to look at these others.
And if I may going back to your question on remittances
also incredibly important it really should be as easy as
sending an email to send money abroad. And I think again
digital technologies--digital assets probably regulated could
do that. I would favor stablecoins or CDBCs over something like
bitcoin.
Representative Beatty. My time is up. Thank you, Mr.
Chairman.
Chairman Beyer. Thank you, Congresswoman.
And now the gentleman from Texas, Mr.----
Representative Arrington. Bringing up the rear over here,
Mr. Chairman. Thank you all for your insights. It was a great
discussion so far. And the panel has certainty helped educate
me on something that I am not so familiar with, so I admit that
from the outset.
Mr. Van Valkenburgh, what an eloquent and powerful picture
of America as the laboratory of innovation as a result of
freedom, free people, free markets, unleashing creativity,
ingenuity, and creating value for customers, not just here but
around the world.
So thank you for that. I loved listening to the uniquely
American ideal that I think we all subscribe to, by the way, at
least that is what I am hearing from the other witnesses.
And I heard Mr. Werbach talk about a light touch. Maybe you
said something like minimalistic legal construct. We want to
all balance innovation and the need for having rules and basic
safeguards. Because I don't know as much as I need to give any
informed comments beyond this, I was a former regulator, chief
of staff at the FDIC for many years. A lot of regulations there
were derived from the risk to the deposit insurance. Right?
I mean, with that came a lot of risk management on the
safety and soundness and then there were a lot of consumer
protection regulations and rules to follow. Absent systemic
risk and the deposit insurance for consumers that the taxpayers
are ultimately accountable for as a backstop, what are the gaps
here?
If there was one thing that you could all agree on in terms
of filling the gaps to make sure we had basic safeguards, but
we were not in any way I think you said in some ways regulation
appropriately applied at the right time in the maturation
process could support this not stifle it. I agree with that.
So what would you all agree on, one or two things that
maybe kind of the 80/20 rule, a few things that could close the
gap, most significantly where there would be common ground
among my colleagues and I.
Mr. Van Valkenburgh. Thank you, Congressman. That is an
excellent question. I think we would all actually agree on
taxes. I did want to bring up a point earlier about the
bipartisan infrastructure legislation and the self-reporting--
third-party reporting provisions, sorry, that were in that
piece of legislation.
As I said, there is language that it was vague and
therefore could stifle innovation and harm personal privacy.
And so, I do think a fix to that language was important and
there was a bipartisan fix in the Senate, it could just not be
procedurally implemented. But I am not saying that because I am
against third-party reporting.
In fact, folks in the cryptocurrency ecosystem have been
asking for guidance from IRS, if they are running a company
that helps someone buy Bitcoin, how can they do specifically
third-reporting for their customers to make sure their
customers can easily comply with taxes.
Because I agree with Ms. Goldstein. When I filed my crypto
taxes, it is not easy. So clarity there is important. I just
think we should be careful the way we draft these laws and
there was some slight issues with the language in the
infrastructure bill.
Again I would say de minimis exception from capital gains
transaction for small transactions is essential to tax policy.
And we can also have better tax policy with respect to assets
that people receive because of cryptocurrency forks, which I
will not dare explain at the moment, but Representative Emmer
in the House you actually has proposed excellent legislation to
address that issue.
Representative Arrington. Thank you.
Mr. Werbach, would you agree? And what you would add to
that?
Mr. Werbach. Thank you, Congressman.
I would agree with that. I think we all agree that
stablecoins are an area where there needs to be some
investigation. We may not all agree on precisely what that
should entail or whether additional legislation is needed, but
I think we would agree that there are actors in that
marketplace who are non-compliant, who purport not to do
business in the U.S. and yet are listed on virtually every U.S.
exchange.
So I think we might agree about something where there is a
need for action. I think we might agree on this issue that Mr.
Massad talked about in terms of the gap on spot market exchange
regulation.
Again, not necessarily exactly what it looks like, but if
there is third-party exchange then there needs to be some
oversight for market integrity just as we have with other kinds
of exchanges. And the fact that the split between the CFTC and
the SEC is what it is, if that it just creates an unfortunate
byproduct in this area.
Representative Arrington. Thank you.
Mr. Massad?
Mr. Massad. Yes.
Representative Arrington. And Ms. Goldstein in the final
seconds here.
Mr. Massad. First I am pleased that Mr. Van Valkenburgh
agrees on the stock market. And just to clarify, a lot of
people think while it is either a security or a commodity so
that means the SEC and the CFTC just have to decide how to
regulate this, which one is going to do it. That is not the
case.
The SEC can only regulate the digital assets that are
securities. The CFTC regulates futures and swaps that are based
on those other digital tokens and even sometimes on digital
tokens that are securities. But again, that means the CFTC can
regulate bitcoin futures the same way it regulates cattle
futures.
But the CFTC doesn't regulate the buying and selling of
cows, nobody regulates the buying and selling of bitcoin, it
just--other than the States, but that is a very light touch.
The other thing I think we might be able to agree on is the
importance of KYC, know your customer an anti-money laundering.
The system we have now is essentially trying to check that at
what we call the on ramps and the off ramps. So as you go into
the crypto market, or come out of crypto market and exchange
that for dollars, that is good and I think FinCEN has done a
pretty good job there.
But where we might start to differ is as the cryptomarket
grows and you are able to do more and more things with crypto
and you don't have to cash out, how do we prevent that illicit
activity then? That is where it gets tougher, where what do we
do about what is called unhosted wallets? What do we do about
DeFi transactions?
How do we have reasonable KYC that is risk based, that
doesn't try to, you know, regulate every single transaction,
that recognizes people are entitled to some privacy and we
still have to prevent that illicit behavior. That is tricky.
Representative Arrington. Thank you, Mr. Massad. Mr.
Chairman.
Ms. Goldstein. If the chair might allow.
Representative Arrington. Would you indulge a final comment
from the witness?
Chairman Beyer. Absolutely.
Representative Arrington. He is never this nice to me, by
the way, when you are not around.
Ms. Goldstein. I appreciate the flexibility and I
appreciate all the fellow witnesses' comments. I thank Mr. Van
Valkenburgh and I certainly agree that crypto tech is very
difficult. I think we may disagree about the solution. I would
prefer the base infrastructure above tech.
I think two things we may all agree on, there are laws that
apply currently to digital asset marketplaces and those laws
should be enforced. And the other thing that maybe we could
agree on is that the market data could be a lot better. Right
now, we really rely on the exchanges themselves to self report.
And I think some standardization of that market data is
something we could potentially all agree on.
Representative Arrington. Excellent. Thank you.
Thank you, Mr. Chairman.
Chairman Beyer. And I want to announce our next hearing, it
will be on cryptocurrency forks.
I recognize the penultimate questioner. Apparently Senator
Cruz is on his way. And a vote has just been called in the
House so the distinguished gentleman from Madison.
Representative Pocan. This has been a great education,
perhaps I will say for someone like myself that isn't super
well versed in cryptocurrency. I spend much of my time thinking
about the 40 percent of the people who don't have $400 in the
bank for emergency expense.
And so I guess the questions I am going to ask are more
based on the calls we get into our office. I know that in about
an 8-month period just recently I think from October 2020 to
May 2021, 7,000 people reported scams to the tune of about $80
million in cryptocurrency or crypto scams really. It is not
necessarily in currency.
Ms. Goldstein, I am just kind of curious, what are some of
the inherent risks to digital assets that aren't necessarily in
traditional investments? And specifically what are some of the
areas as regulators should be in investigating in this space to
protect consumers, that average person who calls a
congressional office, who doesn't follow cryptocurrency
anywhere near the level of discussion we had today?
Ms. Goldstein. Well, thank you for the question,
Congressman, I think there is a lot of different risks in the
digital asset marketplace that are particularly unique. One is
that individual users are sort of--they need to manage the
counterparty risk themselves in a way that you traditionally
wouldn't in the banking system. Right? You have a bank account
and FDIC insurance, you are not worrying about who is on the
other side.
That is also true if you are trading stocks. Right? You
might rely on SIPC. And you pretty much can guarantee that if
you trade a stock at the end of the day you will probably get
it. Right? And there are protections in place, because we have
markets and those markets have rules. You don't necessarily
know that that is true when in gauging in some of the
cryptocurrency transactions.
I think some of the other risks are the kind of scams that
you are getting calls about. Right? We mentioned the Squid
coin. Right? The ability to create these tokens that you can
buy and then never sell. And if you are not able to read the
code to identify that when you are purchasing a token, you may
fall prey to that scam.
There is also a potential for market manipulation. There is
a lot of really big what they call whales, whether those are
crypto hedge funds or exchanges that have prompt trading arms
that are owned by CEOs, whatever it may be, there is real
potential here for market manipulation.
There is even a whole technical term for it, minor
extractable value, which is the ability of cryptocurrency
minors to sort of rearrange transactions in a way that they
profit from.
So all of this would benefit obviously from existing laws
being enforced, but also perhaps to the extent that you and
Congress see that there are gaps, making sure that the rules
that we are used to in this sort of traditional markets are
applied here so that individual investors aren't subject to
these kinds of market manipulations.
Representative Pocan. If you crank it up a couple notches,
so rather than an individual getting scammed, are we at any
risk of having a broader more systemic risk to our country? And
what specific kind of regulatory effects do we need to do in
order to safeguard against that?
Ms. Goldstein. Well, Congressman, I think it is a great
question and it is a hard one to answer because the market is
very opaque right now. And there are a lot of entities that are
private funds, whether they are family offices, or hedge
funds--hedge funds do some basic reporting, but they are not
required to report their cryptocurrency transactions on the
form 13-F that the SEC make them file every quarter. Family
offices have no reporting requirements whatsoever.
So it is a little hard to tell that we have industry data.
Right? We know that institutional investors are more and more
interested, private funds in particular in getting in this
space. And what I think about, what I worry about is contagion.
So I think about Archegos. Right? That was one family
office that was--that was able to cost billions of dollars in
losses to banks who all happen to be on the side of same basket
of trades. If big--too big to fail banks are also
counterparties to hedge funds who also have big cryptocurrency
portfolios and there is volatility in that market that may lead
them to sell noncrypto assets, and they are all selling
noncrypto assets at the same time, you could lead to a spiral
which could perhaps impact the economy.
So that is the way I am thinking about contagion given the
limited data that we have to really understand the complete
picture.
Representative Pocan. Well, I look forward to however this
conversation, Mr. Chairman, continues. I know our colleague--
former colleague, Jared Polis, was quite successful in this
area. But he was quite successful to begin with.
You know, I think what I am looking for on that average
call we get into the office, someone who didn't have a lot of
money to begin with and tried something and got scammed, just
make sure that we have the right regulatory network to protect
that person.
So I yield back. Thank you very much.
Chairman Beyer. Thank you, Congressman Pocan.
Now the distinguished Senator from Arizona, Senator Kelly.
Senator Kelly. Thank you, Mr. Chairman and thank you
everybody for being here today. I really appreciate it.
Ms. Goldstein, a question about stablecoins but first of
all a new technology is something I am always very interested
in innovation. I think it is one of the things our country does
so well.
But and I am concerned about cryptocurrency and
unstablecoins, and one aspect of stablecoins is that in theory
provide a bit more stability, linking the coin to a reserve,
but key issue to address as it relates to stablecoins is
insuring sufficient transparency to protect the users, the
folks who buy stablecoins.
So how do we ensure that there are--is sufficient
transparency about the reserves utilized in stabilizing the
coins value?
So could you talk a little bit about that transparency and
the requirements for disclosure if there are some.
Ms. Goldstein. Thank you for the question, Senator. I think
there are a lot of different ways that we could approach this
problem and it sort of depends on the State locally. Right?
Some stablecoins are algorithmic, and they have a basket of
assets and they move around, some are meant to be pegged to the
dollar or another Fiat currency.
And I think there are a lot of different places that
regulators could approach this problem. Some stablecoins may be
securities, but should be regulated by the SEC which would
bring a substantial amount of transparency. The Presidential
Working Group has considered, you know, that the prudential
regulators have asked Congress to look into doing some
legislation around stablecoins.
There is also a role for FinCEN to play and make sure that
stablecoin issuers who are doing redemptions and also issuing
these new stablecoins aren't doing anything that involves any
sort of financial crimes. There is also I think an important
piece about stablecoins, which is that DeFi doesn't work
without stablecoin.
And that is a new and emerging piece of this marketplace.
It is operating in some cases without adherence to solve our
existing laws, like know your customer, anti-money laundering,
compliance and combating terrorist financing.
So I think unfortunately there is no easy answer. There is
perhaps a role for every single regulator and of course the
role for State Attorneys General. Right? I actually think that
Tether might be a bit behind that they are supposed to give a
quarterly disclosure of their reserves and I am not quite sure
that they have done that on time. So there is also a goal for
State law enforcement as well.
Senator Kelly. So in general, do you feel we need more
transparency and disclosure than we have today with regard to
stablecoins?
Ms. Goldstein. I think that that would be helpful, but I
also think that the regulators have a number of tools to ensure
that currently. And I would encourage them to use the tools
they currently have to maybe have that happen.
Senator Kelly. Thank you, Ms. Goldstein.
And Mr. Chairman, I yield back the remainder of my time.
Chairman Beyer. Senator, thank you very much.
And our ultimate questioner, the distinguished Senator from
Texas, Senator Cruz.
Senator Cruz. Thank you, Mr. Chairman. And I appreciate the
adjective as the ultimate questioner. I will take that with a
chuckle.
You know, I have to say, I think cryptocurrency and bitcoin
mining provide enormous opportunities. They are creating vast
amounts of wealth, they are creating a hedge for people against
inflation. Inflation is a growing concern across the country.
They are creating entrepreneurs in all 50 States.
I am also particularly proud that my home State of Texas is
becoming an oasis for the blockchain community, for bitcoin
miners, for innovators, and entrepreneurs in the crypto world.
Unfortunately, the one thing that is capable of screwing all of
this up is the United States Congress. And I have deep concerns
that Congress is already in the process of doing so.
As most people watching this hearing know, in the recently
passed so-called bipartisan infrastructure bill, there are
provisions targeting and inflicting enormous harms on the
crypto industry.
As originally drafted, the infrastructure packaged a
provision that expands the definition of broker to nearly all
participants in the cryptocurrency structure, treating them as
a financial institution, which means they have to report
consumer information to the IRS, even if those participants
don't have access to that information.
Additionally, the infrastructure bill included language
incorporating digital assets under section 6050I of the
Internal Revenue Code which states that in a broad range of
scenarios, any person who receives over $10,000 in digital
assets must verify the sender's personal information, including
Social Security number, and sign and submit a report to the
government within 15 days. And failure to comply results in
mandatory fines and can be a felony with up to 5 years in
prison.
We have seen how crypto poses a threat to totalitarian
regimes. For that reason, the Chinese communist government
recently acted to ban bitcoin mining. And the sad reality of
Congress legislating in this matter, I can speak at least for
the Senate, I doubt there are five Members of the United States
Senate that could tell you what the hell a Bitcoin is. And
legislating is always a messy process, but when it comes to
legislating in an area where most Members of this body have
very little familiarity of the details, it is highly perilous.
So Mr. Van Valkenburgh, your testimony has addressed many
of these concerns, but can you share what the impact is of the
provisions in the bill just signed into law? And in particular
address what I have this week introduced stand alone
legislation that would repeal these crypto provisions. And
should Congress legislate in this area? Almost certainly, but
it should do so after an awful lot of hearings and awful lot of
learning what is going on. And it should do so with an eye to
not destroying this industry rather than simply using a machete
and letting the consequences fall on the American people.
Mr. Van Valkenburgh. Thank you, Senator. I strongly agree
the 6050 reporting requirement represents a rather grave threat
to personal privacy and the fact I believe it is in
contravention of our Fourth Amendment rights, to not have our
personal papers searched without a warrant.
The Fourth Amendment protects our private papers when we
keep them in our homes and when we have them on our persons.
The Bank Secrecy Act which is our know your customers rules and
anti-money laundering rules is constitutional because those
reports are filed by third parties, by banks where the customer
voluntarily provides their private information to the third
party, and the third party holds it for a legitimate business
purpose.
The U.S. Supreme Court found that to be constitutional then
if the governments gets that information without a warrant
which is the Bank Secrecy Act is constitutional to this day. It
is also why the government can go to Google and get your gmail
email history without a warrant. That was a compromise and a
reading of the over the Fourth Amendment of the Supreme Court
came up with in 1970 in California Bankers Association v.
Shultz and Miller.
Now in the 6050I reporting context, please tell me who the
third party is to a two-party transaction where someone
received more than $10,000 worth of bitcoin? There is no third
party so how can the third party doctrine make a warrant
unnecessary for the collection of that very intimate
information, a Social Security number.
Senator Cruz. And let me ask you if this new legislative
provision particularly if it is enforced aggressively by the
Biden Treasury Department and Biden IRS, if it succeeds in
decimating the bitcoin and crypto industry in driving it
overseas, is that good or bad for America?
Mr. Van Valkenburgh. Well, I believe it would be bad.
However, I am optimistic. The provision doesn't go into effect
until 2024. There are very reasonable and I think strong
constitutional arguments to invalidate it before that happens.
And I also think a lot of folks in Treasury have the right
idea about this stuff and would actually agree that some level
of privacy protections are important. So I don't think we are
on the cusp of apocalypse as of yet.
Senator Cruz. Well, I hope you are right. And I hope
Congress also acts to avoid apocalypse without rolling the dice
and seeing if that prediction is right or wrong.
Chairman Beyer. Only appropriate that the ultimate
questioner brings up the apocalypse.
Thank all of you very much for gathering with us. It has
been a fascinating conversation. I promise every one of our
other panelists up here, Democratic and Republican, really
enjoyed learning a lot more about cryptocurrency. I personally
would love to learn how to become a backup, a miner, Ms.
Goldstein. Although, when I was in Glasgow last week, at least
more than one were talking about the energy impacts of mining,
and this contribution to climate change.
So formally let me thank you for this important
conversation on a very complex topic, digital assets and
cryptocurrencies have grown to become a globally significant
financial market. Understanding these new and complicated forms
of financial assets, activities, and products is necessary for
Congress to address both the risks and benefits of this growing
technology and hopefully to do it in a balanced way that
doesn't stifle innovation, that doesn't chase it overseas, but
it makes sure that we are doing all the kind of protections
that we need.
I thank each of you for your timely contributions. Thank
you for written remarks that are ten times longer than what you
offer verbally which are excellent ideas. And thank all my
colleagues who have all gone to vote for their part in this
discussion.
This record will remain open for three days. This hearing
is now adjourned.
[Whereupon, at 5:10 p.m., Wednesday, November 17, 2021, the
hearing was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared statement of Hon. Donald Beyer Jr., Chairman,
Joint Economic Committee
recognitions
This hearing will come to order. I would like to welcome everyone
to the Joint Economic Committee's hearing titled ``Demystifying Crypto:
Digital Assets and the Role of Government.''
I want to thank each of our truly distinguished witnesses for
sharing their expertise today. Now, I would like to turn to my opening
statement.
statement
Since the introduction of Bitcoin in 2009, the market for
cryptocurrencies and other digital assets has expanded from a niche
product to a globally significant asset worth nearly three trillion
dollars just last week. While this rapid rise in value has made some
early adopters quite wealthy, it also poses an array of risks to both
everyday investors and the broader financial system.
The purpose of this hearing is to explore emerging trends in the
digital asset market and discuss prudent steps that Congress and the
Federal Government can take to update our regulatory framework and
bring much-needed clarity to issuers, ensure transparency for
investors, and protect the integrity of our financial system--while
also leveraging exciting developments in blockchain technology.
Congress can promote responsible innovation in this market while also
providing basic protections to the investing public.
Interest and involvement in the digital asset market has become
increasingly mainstream in recent years. The growth of these products
has been especially pronounced since the start of the coronavirus
pandemic, as the reported total market value of all digital assets
soared from two hundred billion dollars in January 2020 to nearly three
trillion dollars today.
As the market has grown, we have seen digital asset investors
broaden from a narrow group of true believers in cryptocurrencies to an
expanding community that includes everyday investors. A Pew survey
conducted this fall found that sixteen percent of American adults have
personally owned or invested in a cryptocurrency at some point, up from
just one percent who reported holding Bitcoin in 2015. While many early
Bitcoin transactions occurred on little-known online platforms, today,
investors can buy digital asset through Robinhood or Venmo, or on large
exchanges run by publicly-traded companies like Coinbase.
But this growth in value and interest presents a number of
challenges for our economy. The current digital asset market structure
and accompanying regulatory framework are ambiguous and risky for both
investors and the broader economy. Digital asset holders have been
subjected to a market that is, as SEC Chairman Gary Gensler described
it ``rife with fraud, scams, and abuse''.
The mainstreaming of digital assets is laying the foundation for
huge swaths of the economy to invest in this market. Increased crypto
market volatility or a digital bank-run could disrupt more mainstream
financial institutions like pension funds or mutual funds. And the
underlying assets can create significant consumer protection issues
given existing patterns of financial fraud, hacks, and market
manipulation.
Retail investors may be lured in by the hype around a new coin with
improbably high rates of return, only to be caught on the wrong end of
a speculative bubble and lose their entire investment. A recent example
was ``Squid'', a blatant scam token that used the excitement around the
popular TV show Squid Game to dupe unwitting investors out of 3.3
million dollars.
While all investments involve risk, the lack of disclosure and
reporting requirements in many parts of the crypto asset industry tilt
the playing field toward the largest investors who can leverage their
size to exploit regulatory gaps at the expense of retail investors. It
is currently difficult for regulators to prevent market manipulation by
large players who can exploit their access to multiple sides of a
trade, or trade on inside information.
Despite these issues, Congress has not yet weighed in on a
comprehensive legal framework around these assets.
Updating the U.S. regulatory framework for digital assets would be
in line with how officials have often responded to past financial
innovations with stronger rules to protect consumers and market
integrity. For example, Dodd-Frank created stronger rules on complex
swaps and derivatives in the wake of the 2008 financial crisis.
Updated regulation can also reduce the likelihood that these
emerging developments would destabilize financial markets and the
broader economy. For example, the largest stablecoin Tether was
recently found to not hold sufficient reserves of cash and equivalents
to fully back their seventy billion dollar value. Applying additional
regulatory scrutiny to assets like Tether, and the platforms where they
are used, could ensure that cracks in one asset don't spread to the
broader economy.
Increasing reporting requirements for decentralized finance
platforms will shine a light on a fast-growing but lightly regulated
segment of the market. Increased information sharing would also improve
tax compliance for capital gains from the sale of crypto assets.
The many issues we will discuss today are why I introduced the
Digital Asset Market Structure and Investor Protection Act earlier this
year. This legislation would establish much-needed guardrails and
provide clarity to regulators and investors without stifling
innovation. The present moment gives us an opportunity to take action
before a potential crisis hits the broader economy.
I am looking forward to learning from each of our witnesses today.
__________
Prepared statement of Hon. Mike Lee, Ranking Member,
Joint Economic Committee
Throughout the history of this great nation, entrepreneurs and
creators have served as the heartbeat of the American economy and the
engine of America's growth. Their advances into unknown frontiers of
science and technology have transformed the quality of life for
millions of Americans, and for people around the world.
Today, American innovators are advancing into the unknown frontiers
of cryptocurrencies, using novel technologies to securely create and
trade digitally scarce assets. Like the internet of the 1990s,
cryptocurrencies are still in their infancy. This evolving technology
has vast--and still untapped--potential to revolutionize established
industries and create entirely new ones.
Cryptocurrencies are already democratizing finance by lowering
costs and expanding access to an industry that has historically been
hard to reach for millions of Americans, including hundreds of
thousands of Utahns.
Beyond the better-known applications to finance, blockchain--the
technology behind cryptocurrencies--has even broader potential.
Blockchain can securely share health records, efficiently track cross-
border transactions in global supply chains, and allow online consumers
to verify the authenticity of pictures or videos.
I have great optimism that, like the internet before it, the
technology behind cryptocurrencies will create a wealth of new
opportunities, many of which we cannot yet imagine.
As new markets like this one emerge and grow, there is always a
temptation in Washington to expand the Federal Government's reach--a
temptation to centrally control the innovative process and regulate the
products of those individuals who are at the forefront of American
advancement.
This temptation must be resisted.
Rigid, one-size-fits-all regulation targeted at the cryptocurrency
economy is unnecessary, and it will all but ensure that this next
generation of technology companies moves to other countries. Americans
could lose access to cryptocurrency markets and miss out on the
potential economic and social benefits.
If we want the center of innovation to remain here in the United
States, for the benefit of American workers and American families,
Congress should focus on creating clarity around how existing rules
apply to these new technologies. In the case that existing law proves
outdated, we can assess the need for new rules. However, as it stands
today, we just need to appropriately apply the rules we already have on
the books.
The proper role of government is to empower innovation through
clear rules with a light touch. The best approach is one where Congress
acts in a manner that is tailored to its limited constitutional
authority. It is one where the Federal Government acts with restraint,
and in so doing, protects the creation and ingenuity that powers our
great country.
In today's hearing, I hope that we can focus on policies that
protect a flexible regulatory framework for the Americans who are
building our future.
If we can resist centralizing power in Washington, and preserve the
space for American innovation to flourish, entrepreneurs across the
country stand ready to unleash the tremendous opportunity of new
digital economies.
Thank you.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Response from Ms. Alexis Goldstein to Questions for the Record
submitted by Chairman Beyer
1. Given the increasing number of countries exploring digital
currencies, including China, do you think that the Federal Reserve
should be given explicit authority issue a digital dollar? If the Fed
does not issue a digital dollar, are you concerned about the U.S.
dollar losing its role as the world's reserve currency?
To the extent that the Federal Reserve (``Fed'') needs
additional authorities to issue a digital dollar, Congress should
contemplate granting it. Some cryptocurrency market actors have implied
they do intend to challenge the primacy of the U.S. dollar \1\ or that
so-called stablecoins and so-called decentralized finance enable
participants to ``get rid of their fiat.'' \2\ The CEO of the
cryptocurrency exchange Kraken has also made derisive statements about
Federal Reserve notes,\3\ suggesting that market participants would
like to overtake U.S. dollars as a mode of exchange, despite Kraken
applying for a master account with the Fed. \4\ The Fed should monitor
for any current, potential, and ongoing risks to the dollar, including
the introduction of private money.
---------------------------------------------------------------------------
\1\ Investor Presentation, Circle (Jul. 7, 2021), https://
www.sec.gov/Archives/edgar/data/0001824301/000121390021036070/
ea143875ex99093_concordacq.htm at 23. (In the Investor Presentation
included in Circle's July 2021 8-F SEC filing, Circle states that the
``opportunity'' and ``long-term addressable market'' for USDC is all
$130 trillion of the M2 money supply.)
\2\ Jake Chervinsky, head of policy for the Blockchain Association
(@jchervinsky), Twitter (Aug. 27, 2021, 3:09 PM), https://twitter.com/
jchervinsky/status/1431333014907277312. (``I mean sure, that's a cute
retort, but the point of decentralized exchange is to let people get
rid of their fiat & buy bitcoin without relying on a centralized
intermediary to execute the trade. You need a decentralized fiat
instrument to do that.'')
\3\ Jesse Powell, CEO of Kraken (@jespow), Twitter (Aug. 29, 2021,
2:48 AM), https://twitter.com/jespow/status/1431871317138018306.
(``Except #bitcoin is issued by the public, transparently, predictably
according to math and code that is freely available for all to audit.
Contrast this with the privately issued, unpredictable, shadowy,
Federal Reserve Note, operated by the elite, without independent
audit.'')
\4\ Robert Stevens, Kraken Will Be First US Crypto Bank. Here's
Why It Matters, Decrypt (Sep. 16., 2020), https://decrypt.co/42077/
kraken-first-us-crypto-bank-heres-why-matters.
2. It is my understanding that thousands of transactions a day for
millions of dollars are not recorded on the blockchain and are instead
settled ``off-chain''. Are ``off chain'' digital asset transactions a
problem and should regulators require that these transactions are
---------------------------------------------------------------------------
reported to a central repository?
One of the purported benefits of various blockchains and
distributed ledgers is transparency--including that transactions are
publicly viewable. Off-chain transactions lack this transparency, and
leave both the public and regulators reliant on the firms and/or
entities conducting the off-chain transactions to provide full and fair
disclosure. One indicator of potential systemic risk is opacity (in
addition to leverage and interlinkages between market participants),
and the prominent of off-chain transactions raise this risk. The
opacity of off-chain transactions does raise risks. Regulators and
Congress alike should consider ways to bring more transparency, not
just to off-chain transactions, but to the crypto asset markets
broadly.
3. The CFTC just fined Tether--the issuer of USDt--$41 Million for
making false and misleading statements about its reserve holdings,
after finding that USDt was only backed one for one with dollars just
27 percent of the time. Given that USD Tether is the most actively
traded digital asset in the World, should the CFTC fine have been
bigger to discourage similar activities by other fiat based stablecoin
issuers in the future?
All regulators, including the Commodity Futures Trading
Commission (CFTC), should ensure that settlement fines are sufficiently
large to deter future offenses, rather than being seen as merely the
cost of doing business by the offending firm. I would also note that
transaction volumes in cryptocurrency markets need to be viewed
skeptically, as the market lacks regulatory oversight to allow for
reliable market data reporting.
4. In 2018 senior SEC officials announced that Bitcoin and
Ethereum, the two largest digital assets by market capitalization,
would not be treated as securities. The CFTC has taken the position
that both Bitcoin and Ethereum are commodities and permitted CFTC
exchanges to offer futures and swaps contracts on both digital assets.
However, the regulatory status of many other digital assets remains
unclear. Should Congress mandate that the SEC and CFTC work together to
clarify the status of other major digital assets?
The Commodity Futures Trading Commission (CFTC) and the
Securities and Exchange Commission (SEC) have multiple avenues for
ongoing dialog and collaboration, including but not limited to formal
MOUs and informal modes of engagement. As previously noted by CFTC
Commissioner Dan Berkovitz, the Commodity Exchange Act ``does not
contain any exception from registration for digital currencies,
blockchains, or `smart contracts.' '' \5\ SEC Chair Gensler has stated
that ``It doesn't matter whether it's a stock token, a stable value
token backed by securities, or any other virtual product that provides
synthetic exposure to underlying securities. These products are subject
to the securities laws and must work within our securities regime.''
\6\ The SEC and the CFTC should continue to enforce all existing laws
and regulations.
---------------------------------------------------------------------------
\5\ CFTC Commissioner Dan M. Berkovitz, Keynote Address Before FIA
and SIFMA-AMG, Asset Management Derivatives Forum, Commodity Futures
Trading Commission (Jun. 8, 2021), https://www.cftc.gov/PressRoom/
SpeechesTestimony/opaberkovitz7.
\6\ SEC Chair Gary Gensler, Remarks Before the Aspen Security
Forum, Securities and Exchange Commission (Aug. 3, 2021), https://
www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-
03.
---------------------------------------------------------------------------
__________
Response from Ms. Alexis Goldstein to Question for the Record
submitted by Senator Cassidy
Discussions around cryptocurrency, especially at this hearing,
focus on what the Federal Government's role in cryptocurrency
regulation should be. While the Federal Government considers its
approach, states are starting to take action. Some examples include
Wyoming setting up regulations allowing for cryptobanks, while New York
has introduced its BitLicense. From the different approaches taken by
states toward digital currency, what lessons can the Federal Government
take away?
A number of states take different approaches to crypto
asset oversight. State based regulation is often inadequate to mitigate
national risks, including systemic risks, and may also lead to market
fragmentation. The Federal Government should focus its attention on
oversight, ensuring there is adequate enforcement of existing
securities and derivatives laws, as well as identifying if there are
any regulatory gaps that require action to ensure consumer and investor
protection in the cryptocurrency space--including the ability for
regulators to monitor for systemic risk.
__________
Response from Ms. Alexis Goldstein to Questions for the Record
submitted by Senator Klobuchar
1. As mentioned in your testimony, late last month, developers of a
new cryptocurrency sought to take advantage of the popularity of
Netflix's Korean thriller ``Squid Game'' and introduced a ``Squid''
coin. Between October 26 and November 1, the value of a Squid coin rose
by more than 23 million percent, from a little more than a mere cent to
$2,861.80.
Early on the morning of November 1, the value of a Squid coin
collapsed from a high of just over $2,860 to effectively zero as
cryptocurrency traders watched the token's unknown creators clean out
some $3.3 million in funds, according to digital records. The maneuver,
known as a ``rug pull'' in cryptocurrency circles, occurs when a
token's creators abandon the project by exchanging many virtual coins
for real-world cash. They quickly drain liquidity from the product,
effectively driving 3 the coin's value to zero and leaving other
investors holding the bag in an apparent scam.
With the anonymity and complexity of cryptocurrency, what
protections do American investors, particularly retail investors, have
from predatory creators of digital currencies?
Retail investors should receive the same protections when
they trade crypto assets as they do when they trade equities and/or
derivatives. Regulators have noted that there are no exceptions from
existing laws for crypto assets. For example, former CFTC Commissioner
Dan Berkovitz has noted that the Commodity Exchange Act ``does not
contain any exception from registration for digital currencies,
blockchains, or `smart contracts.' '' \7\ Securities and Exchange
Commission Chair Gensler has also noted in remarks before the SEC's
Investor Advisory Committee that many crypto asset tokens ``may be
unregistered securities, without required disclosures'', further
clarifying that ``to the extent that there are securities on these
trading platforms, under our laws they have to register with the
Commission unless they meet an exemption.'' \8\ All investors in crypto
assets deserve the protections that Americans have come to expect when
trading in U.S. markets.
---------------------------------------------------------------------------
\7\ CFTC Commissioner Dan M. Berkovitz, Keynote Address Before FIA
and SIFMA-AMG, Asset Management Derivatives Forum, Commodity Futures
Trading Commission (Jun. 8, 2021), https://www.cftc.gov/PressRoom/
SpeechesTestimony/opaberkovitz7.
\8\ SEC Chair Gary Gensler, Remarks before the Investor Advisory
Committee, Securities and Exchange Commission (Dec. 2, 2021), https://
www.sec.gov/news/statement/gensler-iac-statement-120221.
2. There are many national security concerns in this space, from
ransomware to illicit payments and financial crimes. This October, the
Treasury's Office of Foreign Assets Control (OFAC), which publishes
lists of individuals and companies owned or controlled by, or acting
for or on behalf of, countries subject to U.S. sanctions, released new
guidance--clarifying that all digital market participants are expected
---------------------------------------------------------------------------
to monitor their users against the sanctions list.
What are the challenges for the industry in complying with this
guidance?
The October guidance from Treasury's Office of Foreign
Assets Control noted that Specially Designated Nationals and Blocked
Persons List (the ``SDN List'') has included virtual currency addresses
since 2018, and this list is downloadable across a variety of formats.
The accessibility of this list, and the further clarity provided in the
October guidance, should make it straightforward for the cryptocurrency
industry to comply, and ensure their platforms and protocols are not
interacting with virtual currency addresses on the SDN list. Further,
as noted in the guidance, the industry should also conduct historical
lookbacks of past transactional activity ``after OFAC lists a virtual
currency address on the SDN List to identify connections to the listed
address.'' \9\
---------------------------------------------------------------------------
\9\ Sanctions Compliance Guidance for the Virtual Currency Industry
(Brochure), Office of Foreign Assets Control, (Oct. 2021), https://
home.treasury.gov/system/files/126/
virtual_currency_guidance_brochure.pdf. (See, e.g.: ``OFAC's inclusion
of virtual currency addresses on the SDN List may assist the industry
in identifying other virtual currency addresses that may be associated
with blocked persons or otherwise pose sanctions risk, even if those
other addresses are not explicitly listed on the SDN List. For example,
unlisted virtual currency addresses that share a wallet with a listed
virtual currency address may pose sanctions risk because the sharing of
a wallet may indicate an association with a blocked person. Similarly,
virtual currency companies may consider conducting a historic lookback
of transactional activity after OFAC lists a virtual currency address
on the SDN List to identify connections to the listed address.'').
---------------------------------------------------------------------------
__________
Response from Mr. Timothy Massad to Questions for the Record
submitted by Chairman Beyer
1. Given the increasing number of countries exploring digital
currencies, including China, do you think that the Federal Reserve
should be given explicit authority issue a digital dollar? If the Fed
does not issue a digital dollar, are you concerned about the U.S.
dollar losing its role as the world's reserve currency?
The critical issue is ramping up our research and development to
determine exactly how we should design a U.S. CBDC and whether its net
benefits make it worthwhile. The Fed will ultimately want explicit
authority to issue a digital dollar. But I would be concerned that if
we focus on that issue now, the process of building the consensus to
grant that authority may raise all the issues of what would it look
like, how would it work, is it worth it, would it disintermediate the
banks, etc. I have no objection to granting the authority now if it can
be done; I am simply suggesting that it is not the most urgent task,
because we have not answered these other questions about CBDC design
and benefits.
I don't think there is a near term risk of the dollar losing its
role as the world's reserve currency but we cannot afford to be
complacent either. The role of the dollar as the world's reserve
currency is attributable to a number of factors, many of which are not
directly tied to the technological form of money, such as the size and
liquidity of the U.S. Treasury market (so that investors can obtain
``safe'' assets in times of stress), the stability of our government,
the size and resilience of our economy, the strength of the rule of
law, etc.
The dollar's prominence in international payment systems is
sometimes thought of as part of its role as the world's reserve
currency, but in many ways, it is distinguishable and more directly
tied to the speed and efficiency of our payments system. That is why I
think modernizing our payments system, and making sure it is
interoperable with other countries' systems, is critical. A CBDC is
potentially one way to do that; there may be other means as well. That
is why we need to accelerate our research and design of CBDCs.
2. It is my understanding that thousands of transactions a day for
millions of dollars are not recorded on the blockchain and are instead
settled ``off-chain.'' Are ``off chain'' digital asset transactions a
problem and should regulators require that these transactions are
reported to a central repository?
You are correct that there are a lot of transactions involving
crypto-assets that are not recorded on any blockchain and are instead
settled off-chain. The most common form of this is transactions made on
a centralized exchange, which are recorded in the exchange's ledger.
The exchange itself has a master account(s) on the blockchain which
contains all of the particular crypto-asset that its customers own. But
the absence of a regulatory framework for these exchanges means there
is no assurance that the amount of say, bitcoin, held by the exchange
on the blockchain is even equal to all of its customers holdings on the
ledger. The general absence of transparency is a problem. I would focus
first on creating an overall framework of regulation, particularly for
crypto exchanges and other intermediaries, that requires reporting,
disclosure and transparency similar to what we have in the derivatives
and securities market. Exchanges should be required not only to keep a
record of all bids, offers and transactions, but make that record
available for appropriate regulatory and law enforcement purposes, and
provide adequate pre and post-trade transparency to investors. I would
do that first, and then consider whether we need a central repository.
3. The CFTC just fined Tether--the issuer of USDt--$41 Million for
making false and misleading statements about its reserve holdings,
after finding that USDt was only backed one for one with dollars just
27 percent of the time. Given that USD Tether is the most actively
traded digital asset in the World, should the CFTC fine have been
bigger to discourage similar activities by other fiat based stablecoin
issuers in the future?
I cannot comment on how the CFTC determined the size of its fine,
but I would say that I do not think the CFTC has sufficient authority
to discourage similar activities by other stablecoin issuers. The
CFTC's action was based on application of its anti-fraud authority
under Section 6(c) of the Commodity Exchange Act. The CFTC does not
have general power to regulate stablecoins or to set standards for
stablecoin issuers. The best way to discourage bad actors is to create
such a regulatory framework. CFTC Commissioner Dawn Stump expressed
this very well in her concurring statement. She explained that while
the action was an appropriate application of the anti-fraud provisions
of Section 6(c) of the CEA, it was likely to cause confusion about the
CFTC's role, since the agency does not regulate stablecoins.
Specifically, she said the CFTC action may give investors a ``false
sense of comfort that we are overseeing those who issue and sell these
coins such that they are protected from wrongdoing.'' See https://
www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement101521.
We need to create a regulatory framework for stablecoin issuers
that requires them to keep all reserves in cash (or, possibly, other
highly liquid assets), guarantee redemption at par, and restrict their
other activities, among other things, as I discussed in my testimony.
4. In 2018 senior SEC officials announced that Bitcoin and
Ethereum, the two largest digital assets by market capitalization,
would not be treated as securities. The CFTC has taken the position
that both Bitcoin and Ethereum are commodities and permitted CFTC
exchanges to offer futures and swaps contracts on both digital assets.
However, the regulatory status of many other digital assets remains
unclear. Should Congress mandate that the SEC and CFTC work together to
clarify the status of other major digital assets?
I believe the key problem is a lack of regulatory authority over
the cash or spot market, not whether any particular token is a
commodity or a security. The fact that Bitcoin and Ethereum are
regarded as commodities gives the CFTC authority over derivatives
pertaining to Bitcoin and Ethereum; it does not give the agency plenary
authority to regulate Bitcoin and Ethereum, just as it does not have
plenary authority to regulate any other commodity. Instead, it
regulates derivatives based on commodities. Congress has given the CFTC
limited power to prevent fraud and manipulation in the commodities
markets themselves because of concern that fraud and manipulation would
undermine the derivatives market, but that does not constitute general
power to set standards for the trading of commodities.
Moreover, the derivatives the CFTC regulates includes derivatives
on securities. Thus, while it would certainly be helpful for the SEC to
clarify which crypto-assets it views as securities, there would still
be a gap in regulation of those that are not securities. Congress
should provide authority to the SEC or the CFTC to regulate the cash
market for crypto-assets that are financial instruments. I would be
happy to provide more information about that.
__________
Response from Mr. Timothy Massad to Question for the Record
submitted by Senator Cassidy
``Discussions around cryptocurrency, especially at this hearing,
focus on what the Federal Government's role in cryptocurrency
regulation should be. While the Federal Government considers its
approach, states are starting to take action. Some examples include
Wyoming setting up regulations allowing for cryptobanks, while New York
has introduced its BitLicense. From the different approaches taken by
states toward digital currency, what lessons can the Federal Government
take away?''
The Federal Government can certainly examine what the states are
doing and learn from it, and I think there are areas where the states
should retain their traditional primary jurisdiction, such as in
uniform commercial code issues and how those might apply to digital
currency, how State banking laws and regulations apply to digital
assets, and so forth. But I think we need a Federal framework of
regulation for digital assets that are financial instruments generally,
just as we have in securities, derivatives, banking and other core
financial markets. For example, although some might say that
stablecoins are adequately regulated by State money transmitter laws or
the specific digital laws of certain states, I think that we need a
uniform national approach that protects against run-risk and other
risks to financial stability, and ensures a basic level of investor
protection. In addition, market development will be hampered if we have
variations in approaches on those basic issues.
__________
Response from Mr. Timothy Massad to Question for the Record
submitted by Senator Amy Klobuchar
A report by the President's Working Group on Financial Markets
(PWG), the Federal Deposit Insurance Corporation, and the Office of the
Comptroller of the Currency on cryptocurrency stated in part that
stablecoins, which are cryptocurrencies pegged to a central currency
like the dollar, have failed to maintain a stable value and could
expose users to unexpected losses.
Can you explain why the recommendations made in the report
are so important, and what if any changes you would make to the
report's recommendations?
The recommendations are important because of the risks that
stablecoins pose today, as well as their potential for broader use. But
I would make significant changes to those recommendations.
First, regarding the risks: stablecoins have grown enormously in
value in a short time (from around $20 billion a year ago to over $130
billion today in market capitalization) because they facilitate trading
of other crypto-assets. They have the potential for much broader use,
as payment mechanisms generally. The risks they pose are described at
length in the report. A primary one is run risk: similar to a money
market fund, a stablecoin issuer might not have sufficient liquid
reserves to redeem tokens particularly if there were a spike in demand
for redemption. This could trigger a run on that issuer or potentially
other stablecoin issuers as well (as happened with money market funds
in September 2008), and that could create stresses in interconnected
markets or financial products. For example, sales of assets to meet
redemption demands in a run could create downward pricing pressure on
those asset markets. Inability to meet redemption demands could cause
holders to default on obligations, and to the extent those holders have
leveraged positions, that can increase the stress and damage. There are
other risks as well related to the fact that stablecoins operate on
decentralized blockchains that may have varying degrees of security,
resilience etc.
But at the same time, stablecoins have the potential to improve the
speed and efficiency of payments, outside of the crypto sector. They
are effectively privately issued digital dollars. This could be a great
benefit to individuals and businesses. Our payments system is based on
bank deposits, and while it is reliable, safe and relatively efficient,
it is actually slower and more expensive than the systems in many other
developed countries, and probably much slower than what a digitized
system could be.
That is why we need to create a sound regulatory framework. The
report calls for legislation that would limit stablecoin issuers to
insured depository institutions subject to appropriate supervision and
regulation. It also calls for oversight of custodial wallet providers
and for appropriate risk-management standards for other entities that
perform activities critical to the functioning of the stablecoin
arrangements. Finally, it calls for stablecoin issuers to comply with
restrictions to limit affiliation with commercial entities and for
standards to promote interoperability.
My primary disagreement is with the recommendation that we limit
stablecoin issuers to IDIs. I believe we should develop a more tailored
model of regulation for stablecoin issuers, with standards that are
more specific to the risks posed and which would also facilitate more
competition and innovation in the payments industry.
We should require that stablecoins are at all times fully backed by
cash that is deposited with a bank, or in a master account with the
Federal Reserve. This will eliminate the risk that exists today where
stablecoin reserves may be invested in other assets that could lose
value, or be difficult to liquidate, or whose sudden liquidation might
drive asset prices down. Such a requirement would effectively prohibit
maturity transformation by stablecoin issuers--the practice of taking
demand deposits, which are short-term liabilities, and using them to
fund longer-term loans or investments. We could also restrict the
activities of a stablecoin issuer so that it does not engage in many of
the activities that a traditional IDI might engage in. We should
require some capital, even if the tokens are fully backed by cash,
because there can be operational or other losses. This approach could
be implemented through novel or special purpose charters.
The PWG report refers to the possibility of ``access to appropriate
components of the Federal safety net.'' While it is unclear whether or
on what terms this might include deposit insurance, I am not persuaded
that is necessary if the tokens are fully reserved with cash, the
entity's activity is sufficiently isolated and other safeguards are in
place. I believe it would be better to design a regulatory framework
that does not include deposit insurance.
I am concerned that the recommendation to limit stablecoin issuers
to IDIs under present supervisory standards would not sufficiently
address the particular risks that stablecoins pose, and could result in
limiting competition as a practical matter. Let me address the second
point first.
Limiting stablecoin issuers to IDIs is likely to favor existing
banks over new entrants because of the length of time it could take new
entrants to get a charter and deposit insurance. (None have that
today.) It could also mean that the largest banks are favored over all
other banks because of capital advantages as well as technological
advantages (they may be more able to create the platforms to issue and
manage stablecoins, which settle instantly, as discussed below). The
more tailored regulatory approach described above would allow new
entrants, provided they can meet requirements of the type noted above,
which would facilitate more competition in payments. (An existing bank
holding company could still enter the stablecoin business by creating a
ringfenced subsidiary that meets the requirements.)
As to the risks, simply saying an issuer should be an IDI does not
ensure it has the technological platform to manage instantly settled
stablecoins (most banks do not). Moreover, it means the stablecoin
activity would be co-mingled with all the other activities that many
IDIs engage in, such as making loans and other investments. That makes
it far more difficult to isolate the stablecoin activity.
Because this is a new activity, it would be much better to isolate
it, and design regulations specific to the risk.
Some may object to allowing special purpose payment entities to
have master accounts at the Federal Reserve, particularly if they are
not FDIC-insured and do not have the same business models as
traditional banks. But in fact, the Fed has already granted master
accounts to uninsured entities whose business models are very different
from traditional banks. Two derivatives clearinghouses have master
accounts with over $100 billion on deposit on a combined basis, which
monies represent customer funds. They are not regulated as banks nor
insured by the FDIC. They are permitted to have master accounts because
they were designated by the FSOC as systemically important financial
market utilities under Article VIII of the Dodd Frank Wall Street
Reform and Consumer Protection Act. They are subject to Federal Reserve
oversight as a result of that designation.
I would be happy to elaborate on any of these issues.
__________
Response from Mr. Kevin Werbach to Questions for the Record
submitted by Chairman Beyer
1. Given the increasing number of countries exploring digital
currencies, including China, do you think that the Federal Reserve
should be given explicit authority issue a digital dollar? If the Fed
does not issue a digital dollar, are you concerned about the U.S.
dollar losing its role as the world's reserve currency?
Mr. Chairman, thank you for holding the hearing on Demystifying
Crypto, and for your ongoing interest in the digital asset market. I am
pleased to respond to your questions.
I believe the Federal Reserve should be given authority to issue a
digital dollar. However, whether the Fed should actually do so, and
what exactly a ``digital dollar'' would involve, are questions that
require further study. The Fed should be given encouragement and a
green light because the development of central bank digital currencies
forces consideration of essential attributes of the next evolution of
money and payments. Concerns such as interoperability, privacy,
scalability, and financial stability, as well the transformative
potential of programmable money, will not be adequately explored unless
the Fed engages aggressively.
I am not worried about the U.S. dollar losing its reserve currency
status to a CDBC in the near term. Given its tight capital controls and
limitations on exchange rates, as well as the absence of central bank
independence, China's effort to internationalize the RMB will run into
limits regardless of how advanced its eCNY initiative is relative to
the rest of the world. However, over time, there is no question that
existing U.S. and global payments systems will need to evolve and be
further digitized. They are too slow, too inefficient, too inflexible,
and too reliant on established intermediary firms. If the U.S. fails to
participate actively in the global effort to rethink money which
cryptocurrencies and CBDCs have kicked off, in time the primacy of the
dollar will be in jeopardy.
2. It is my understanding that thousands of transactions a day for
millions of dollars are not recorded on the blockchain and are instead
settled ``off-chain''. Are ``off chain'' digital asset transactions a
problem and should regulators require that these transactions are
reported to a central repository?
It is true that many digital asset transactions are not recorded on
the blockchain. On-chain transactions can be costly, slow, and lacking
in finality, especially on the most prominent blockchains such as
Bitcoin and Ethereum. Custodial cryptocurrency exchanges, for example,
typically net transactions among their customers in a manner similar to
conventional stock exchanges. Payment intermediaries may similarly not
record each transaction on-chain. Also, with layer-2 solutions such as
the Bitcoin Lightning Network, transactions are conducted on temporary
off-chain connections, with the net results recorded on the blockchain
when the channel is closed. On the other hand, the rise of
decentralized finance (DeFi) a financial services ecosystem operating
completely in the form of on-chain smart contracts, could point the way
toward more transactional activity on-chain.
Put simply, an off-chain transaction is not decentralized in the
same manner as an on-chain one, and it should not be treated as such.
Whether off-chain transactions are a problem depends on what concern is
being raised, and on how the off-chain activity is happening. If, for
example, an exchange handles transactions through its own records, that
exchange can and should provide analogous reporting to conventional
securities exchanges. The issues may be different if the question is
tax avoidance, AML/CFT compliance, market surveillance for securities
and commodities regulation, or something else. A universal rule that
all transactions be reported to a central repository would far exceed
how conventional financial services are treated, and would likely be
inconsistent with the Fourth Amendment and American norms of financial
privacy.
3. The CFTC just fined Tether--the issuer of USDt--$41 Million for
making false and misleading statements about its reserve holdings,
after finding that USDt was only backed one for one with dollars just
27 percent of the time. Given that USD Tether is the most actively
traded digital asset in the World, should the CFTC fine have been
bigger to discourage similar activities by other fiat based stablecoin
issuers in the future?
There are grave concerns about Tether's role in the digital asset
trading ecosystem. The proven accusations in the CFTC action and the
New York Attorney General case alone would be sufficient to undermine
trust in any normal financial instrument, and its backers. The opacity
of Tether's reserves, regulatory status, and practices are deeply
alarming for a coin whose entire purpose is to be a stable underpinning
for the market. And there are even more serious allegations than those
considered by the CFTC, such as evidence presented in peer-reviewed
academic research suggesting that Tether was deliberately used to
manipulate the Bitcoin market; questions about the veracity of Tether's
current reserve disclosures; and purported transactions among Tether,
related entities, and a small number of influential market actors.
These allegations have not, to my mind, been convincingly disproven.
The fact that Tether nominally does not operate in the U.S. seems
inconsistent with the reality that USDT the dominant trading pair for
most cryptocurrencies on most U.S.-based exchanges. Tether also
provides large volumes of USDT for undisclosed collateral directly to
U.S.-based market-makers and cryptocurrency lenders.
The CFTC, the Department of Justice, and other U.S. financial
enforcement agencies should seriously investigate these claims, and the
relationships among Tether, its related entities, and the large digital
asset firms it appears to do significant transactions with. While I
cannot prejudge what the evidence will show in such investigations, if
even some of the more serious accusations are trust, a fine of any size
is an insufficient penalty. Moreover, the penalties should not be
limited to Tether alone if, in fact, its transaction partners knew and
deliberately capitalized on fraudulent or otherwise illegitimate
business arrangements. Finally, U.S. regulation of the stablecoin
market should cover any stablecoin provided, held, or listed as a
trading pair on U.S. based exchanges and other digital asset platforms,
regardless of its nominal place of incorporation.
4. In 2018 senior SEC officials announced that Bitcoin and
Ethereum, the two largest digital assets by market capitalization,
would not be treated as securities. The CFTC has taken the position
that both Bitcoin and Ethereum are commodities and permitted CFTC
exchanges to offer futures and swaps contracts on both digital assets.
However, the regulatory status of many other digital assets remains
unclear. Should Congress mandate that the SEC and CFTC work together to
clarify the status of other major digital assets?
Congress should seek to ascertain whether the gaps between the SEC
and CFTC on cryptocurrency regulation are an artifact of coordination
failures under the prior Administration; an enduring turf battle; or a
reflection of flaws in our regulatory structure. For example, the
limits on the CFTC's authority to regulate spot markets in commodities
mean that only digital assets classified as securities are subject to
the full range of market integrity and other oversight. Telling the
agencies to coordinate will not address this legal gap; only Congress
can.
In my estimation, while coordination between the SEC and CFTC would
be valuable, it is not the central problem today. An asset can be both
a security (or more precisely, the consideration for an investment
contract) and a commodity, depending on the circumstances. Both
agencies could provide significantly greater clarity in how they apply
the relevant classifications in the digital asset context. It is
distressing that the definitive SEC statement on Ethereum is a 2018
speech by a staff member, which did not even explicitly the status of
the original Ether crowdsale. (In some ways, Ether is the most
important digital asset because of its foundational role for
decentralized applications, and because other tokens are generally
issued in a manner much closer to Ether than bitcoin.) I personal find
the ``sufficiently decentralized'' concept articulated by Director
Hinman in that speech quite promising. However, it has not been taken
up by the Commission in any meaningful way.
__________
Response from Mr. Kevin Werbach to Question for the Record
submitted by Senator Cassidy
``Discussions around cryptocurrency, especially at this hearing,
focus on what the Federal Government's role in cryptocurrency
regulation should be. While the Federal Government considers its
approach, states are starting to take action. Some examples include
Wyoming setting up regulations allowing for cryptobanks, while New York
has introduced its BitLicense. From the different approaches taken by
states toward digital currency, what lessons can the Federal Government
take away?''
Thank you, Senator, for your interest in this topic.
The financial services sector is an area of shared responsibility
between states and the Federal Government. Corporate and commercial law
requirements are determined primarily at the state level, and states
play a major role in regulation of money transmitters, banks, and trust
companies. State attorneys general also play an essential part in
enforcement actions. The challenge is to balance the experimentation
that multiple state regimes allow with the need for consistency and
minimum standards for activities that are not just national but, in
some senses, global in scope.
New York is to be commended for moving early to develop a
regulatory regime for digital assets, with the adoption of the
BitLicense in 2015. Unfortunately, the BitLicense was written and
interpreted in such a way that, for some time, it was too difficult for
firms to meet the licensure requirements. Many firms left the State
because they found the BitLicense too onerous. The New York Department
of Financial Services has in recent years taken a somewhat more
flexible approach. The BitLicense also may have been too early. The
digital asset market at the time had not yet developed the level of
sophistication and integration with traditional finance that it now
enjoys. A safe harbor mechanism, a longer compliance window, or a
carve-out for smaller entities, might have made the BitLicense more
viable.
Wyoming and several other states have more recently adopted a
variety of laws to create a viable environment for digital asset
activity. The Wyoming Special Purpose Depository Institution framework,
in particular, offers a pathway forward for the provision of narrow
banking services to cryptocurrency firms that seeks to address the
major risk areas regulators and banks have expressed. Without taking a
position on any of the specific provisions of these state laws, the
question is whether having varied state regimes for crypto-native banks
represents the best solution, or is necessary only because Federal
entities such the FDIC, Fed, and OCC have made it artificially
difficult for conventional banks to participate in these markets. There
is also the question of how State rules interact with the Federal
system, such as whether state-chartered institutions can access Federal
Reserve master accounts.
Important lessons from the history state activity in this area
include the following. First, bespoke regimes may be necessary to
tailor rules to the distinctive aspects of digital asset markets.
Second, there are many different issues under the umbrella of
cryptocurrency regulation, which will not all have the same solutions.
Third, policymakers should clearly identify the problems they are
trying to address, and how the specified requirements address them.
Fourth, as noted earlier, rules should reflect the maturity of the
industry and the nature of the entities subject to their requirements.
__________
Response from Mr. Peter Van Valkenburgh \1\ to Questions for the Record
submitted by Chairman Beyer
---------------------------------------------------------------------------
\1\ Peter is Director of Research at Coin Center, the leading
independent non-profit research and advocacy group focused on the
public policy issues facing cryptocurrency technologies such as
Bitcoin. http://coincenter.org.
---------------------------------------------------------------------------
1. Given the increasing number of countries exploring digital
currencies, including China, do you think that the Federal Reserve
should be given explicit authority to issue a digital dollar? If the
Fed does not issue a digital dollar, are you concerned about the U.S.
dollar losing its role as the world's reserve currency?
That other countries are exploring central bank digital currencies
is not a sufficient reason for the Federal Reserve to be given
authority to issue one. Historically most money has been issued by
private entities rather than by the Federal Reserve itself, and the
mere fact that money can be digital is not reason to change this
policy.\2\ If the Fed does not issue a digital dollar there's no
greater or lesser chance that the dollar will lose its role as the
world's reserve currency. Currencies are strong when they are backed by
nations that have strong rule of law, stable and accountable
institutions, and transparent monetary policies.\3\ On these margins
America is well ahead of, for example, China, whose recent announcement
of a digital yuan has driven headlines. Indeed, China's motivations for
issuing a digital yuan are likely based on the need to retain power
over its population through surveillance and central control; \4\ it
may serve only to weaken protections for human rights and the certainty
of business relationships in China thereby undermining rather than
strengthening the yuan.
---------------------------------------------------------------------------
\2\ Randal K. Quarles, ``Parachute Pants and Central Bank Money,''
Speech before the 113th Annual Utah Bankers Association Convention, Sun
Valley, Idaho, June 28, 2021, https://www.federalreserve.gov/
newsevents/speech/quarles20210628a.htm.
\3\ Henry M. Paulson Jr., ``The Future of the Dollar,'' Foreign
Affairs, May 19, 2020, https://www.foreignaffairs.com/articles/2020-05-
19/future-dollar; Jerry Brito, ``China's digital yuan is not a threat
to the dollar,'' blog, January 13, 2020, https://blog.jerrybrito.com/
2020/01/13/chinas-digital-yuan-is-not-a-threat-to-the-dollar/.
\4\ Samantha Hoffman et al., ``The flipside of China's central bank
digital currency,'' Australian Strategic Policy Institute, Policy Brief
No. 40, 2020, https://s3-ap-southeast-2.amazonaws.com/ad-aspi/2020-10/
Digitalcurrency_1.pdf.
2. It is my understanding that thousands of transactions a day for
millions of dollars are not recorded on the blockchain and are instead
settled ``off-chain''. Are ``off chain'' digital asset transactions a
problem and should regulators require that these transactions are
---------------------------------------------------------------------------
reported to a central repository?
Off-chain transactions are no different from internal transactions
between customers within a major bank or a payment intermediary such as
PayPal or Venmo. Neither leave any record outside of the internal
records of the institution, and both are potentially subject to
existing recordkeeping and reporting rules here in the U.S. A
transaction between two users of a money transmitter like PayPal is
subject to the same state money transmission licensing rules and
requirements and Federal anti-money laundering reporting requirements
as transactions between two users of a cryptocurrency exchange.
3. The CFTC just fined Tether--the issuer of USDt--$41 Million for
making false and misleading statements about its reserve holdings,
after finding that USDt was only backed one for one with dollars just
27 percent of the time. Given that USD Tether is the most actively
traded digital asset in the World, should the CFTC fine have been
bigger to discourage similar activities by other fiat based stablecoin
issuers in the future?
I do not have an opinion regarding the size of the fine. Any issuer
or redeemer of a backed stablecoin to American users is engaging in a
regulated activity. Depending on the specific circumstances, the
stablecoin may be a security (requiring registration with the SEC),\5\
a commodities derivative (subject to CFTC oversight),\6\ or money
transmission and/or deposit-taking activities triggering state and/or
federal licensing and/or bank chartering obligations.\7\ There is also
no reason that the issuer could not be subject to multiple overlapping
rules from any of these regulatory structures. All in all, the CFTC
fine is certainly not likely to be the last or largest penalty for non-
compliant issuers, and there will likely be more significant deterrent
effects from the collection of enforcement actions taken as a whole.
---------------------------------------------------------------------------
\5\ ``Stablecoin Regulation,'' Coin Center Tangents Podcast,
October 15, 2021, https://www.youtube.com/watch?v=5wJtM52G9_w.
\6\ ``CFTC Orders Tether and Bitfinex to Pay Fines Totaling $42.5
Million,'' Commodity Futures Trading Commission, Press Release Number
8450-21, October 15, 2021, https://www.cftc.gov/PressRoom/
PressReleases/8450-21.
\7\ See e.g. ``NYDFS Grants First Charter to a New York Virtual
Currency Company,'' New York Department of Financial Services, Press
Release, May 7, 2015, https://www.dfs.ny.gov/reports_and_publications/
press_releases/pr1505071.
4. In 2018 senior SEC officials announced that Bitcoin and
Ethereum, the two largest digital assets by market capitalization,
would not be treated as securities. The CFTC has taken the position
that both Bitcoin and Ethereum are commodities and permitted CFTC
exchanges to offer futures and swaps contracts on both digital assets.
However, the regulatory status of many other digital assets remains
unclear. Should Congress mandate that the SEC and CFTC work together to
---------------------------------------------------------------------------
clarify the status of other major digital assets?
Ultimately the question of whether an asset is a security is one
for the courts, which almost 70 years ago saw fit to create a flexible
test for investment contracts.\8\ I believe that judge-made test
remains a good fit even when these assets are digital.\9\ That said,
judge-made tests take time to apply to new facts as cases only
gradually make their way to the courts and eventually into clarifying
precedent from new judicial holdings building on old.
---------------------------------------------------------------------------
\8\ SEC c. Howey Co., 328 U.S. 293 (1946), https://
supreme.justia.com/cases/federal/us/328/293/.
\9\ Peter Van Valkenburgh, ``Framework for Securities Regulation of
Cryptocurrencies,'' Coin Center, August 2018, https://
www.coincenter.org/framework-for-securities-regulation-of-
cryptocurrencies/.
The best way to reduce uncertainty in this realm would be either
(1) to press the SEC to take more cases to court, rather than settling
them (which does not leave a precedential record in the form of new
judge-made law), (2) to offer a safe harbor from arbitrary enforcement
actions for token issuers who register and perform sensible
disclosures,\10\ or else (3) to overrule the courts and replace the
flexible definition of securities with something more rigid in
legislation.\11\ Mandating that the SEC and CFTC work together will not
inject any certainty into this arena because it would merely empower
the two agencies to make policy arbitrarily, without guidance from
congress, without judicial oversight, without binding precedent, and
with all of the inconsistencies and transience inherent in periodic
political upheavals within the executive branch.
---------------------------------------------------------------------------
\10\ See e.g. ``Clarity for Digital Tokens Act of 2021,'' H.R.
5496, 117th Congress (2021-2022), https://www.congress.gov/bill/117th-
congress/house-bill/5496/text; Hester Peirce, ``Token Safe Harbor
Proposal 2.0,'' U.S. Securities and Exchange Commission, April 13,
2021, https://github.com/CommissionerPeirce/SafeHarbor2.0.
\11\ See e.g. ``Securities Clarity Act,'' H.R. 8378, 116th Congress
(2019-2020), https://www.congress.gov/bill/116th-congress/house-bill/
8378; ``Securities Clarity Act,'' H.R. 4451, 117th Congress (2020-
2021), https://www.congress.gov/bill/117th-congress/house-bill/4451.
---------------------------------------------------------------------------
__________
Response from Mr. Peter Van Valkenburgh to Question for the Record
submitted by Senator Cassidy
``Discussions around cryptocurrency, especially at this hearing,
focus on what the Federal Government's role in cryptocurrency
regulation should be. While the Federal Government considers its
approach, states are starting to take action. Some examples include
Wyoming setting up regulations allowing for cryptobanks, while New York
has introduced its BitLicense. From the different approaches taken by
states toward digital currency, what lessons can the Federal Government
take away?''
The greatest lesson that the Federal Government can take from the
states is that we don't need new regulatory systems or even new rules
to effectively regulate activities performed using these technologies.
If a company is performing money-transmission-like services using
bitcoins rather than dollars, there's no reason to regulate that entity
any differently than a traditional money transmitter. When states have
attempted to create cryptocurrency-specific regulatory structures the
result has been both (a) disruptive and (b) ultimately not particularly
dissimilar from the existing regulatory systems in place for equivalent
activities performed using non cryptocurrency assets. It ends up being
much ado about nothing.
Take, for example, the New York BitLicense. The New York Department
of Financial Services went through an exhaustive process of creating a
new license type soliciting multiple rounds of comments and several
drafts of new regulations.\12\ Ultimately, however, ambiguous terms and
uncertain language in those rules made New York a less welcoming
environment for new cryptocurrency businesses.\13\ Meanwhile, the
nature of the license was, nonetheless, not much different from a
typical money transmission license as far as protections afforded the
customers of licensees. More recently, the DFS has been chartering
trust companies to deal in cryptocurrencies just as they would charter
any trust company irrespective of the assets in which they deal.\14\
This technology-neutral approach has, it seems, borne more fruit from
an innovation and investor protection standpoint than the de novo
BitLicense approach.
---------------------------------------------------------------------------
\12\ ``Regulation and History,'' New York Department of Financial
Services, accessed December 3, 2021, https://www.dfs.ny.gov/
apps_and_licensing/virtual_currency_businesses/regulation_history;
Peter Van Valkenburgh and Jerry Brito, ``New York BitLicense Comment,''
Coin Center, October 14, 2014, https://www.coincenter.org/new-york-
bitlicense-comment/; Peter Van Valkenburgh and Jerry Brito, ``Comments
to the New York Department of Financial Services on the Revised Virtual
Currency Regulatory Framework,'' Coin Center, March 27, 2015, https://
www.coincenter.org/app/uploads/2020/05/Coin-Center-BitLicense-Comment-
March-2015.pdf.
\13\ Peter Van Valkenburgh, ``Our thoughts on the BitLicense:
California is Winning,'' Coin Center, June 3, 2015, https://
www.coincenter.org/our-thoughts-on-the-bitlicense-california-is-
winning/.
\14\ See e.g. ``NYDFS GRANTS FIRST CHARTER TO A NEW YORK VIRTUAL
CURRENCY COMPANY,'' New York Department of Financial Services, Press
Release, May 7, 2015, https://www.dfs.ny.gov/reports_and_publications/
press_releases/pr1505071.
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