[Senate Hearing 118-186]
[From the U.S. Government Publishing Office]
S. Hrg. 118-186
CRYPTO CRASH: WHY FINANCIAL SYSTEM SAFEGUARDS ARE NEEDED FOR DIGITAL
ASSETS
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HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE CONCEPTS AND PRINCIPLES OF CONVENTIONAL FINANCIAL
SERVICES REGULATION THAT CAN BE APPLIED TO DIGITAL ASSETS AND RELATED
MARKETS
__________
FEBRUARY 14, 2023
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov /
__________
U.S. GOVERNMENT PUBLISHING OFFICE
54-457 PDF WASHINGTON : 2024
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chair
JACK REED, Rhode Island TIM SCOTT, South Carolina
ROBERT MENENDEZ, New Jersey MIKE CRAPO, Idaho
JON TESTER, Montana MIKE ROUNDS, South Dakota
MARK R. WARNER, Virginia THOM TILLIS, North Carolina
ELIZABETH WARREN, Massachusetts JOHN KENNEDY, Louisiana
CHRIS VAN HOLLEN, Maryland BILL HAGERTY, Tennessee
CATHERINE CORTEZ MASTO, Nevada CYNTHIA LUMMIS, Wyoming
TINA SMITH, Minnesota J.D. VANCE, Ohio
KYRSTEN SINEMA, Arizona KATIE BOYD BRITT, Alabama
RAPHAEL G. WARNOCK, Georgia KEVIN CRAMER, North Dakota
JOHN FETTERMAN, Pennsylvania STEVE DAINES, Montana
Laura Swanson, Staff Director
Lila Nieves-Lee, Republican Staff Director
Elisha Tuku, Chief Counsel
Amber Beck, Republican Chief Counsel
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Pat Lally, Assistant Clerk
(ii)
C O N T E N T S
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TUESDAY, FEBRUARY 14, 2023
Page
Opening statement of Chair Brown................................. 1
Prepared statement....................................... 31
Opening statements, comments, or prepared statements of:
Senator Scott................................................ 3
Prepared statement....................................... 32
WITNESSES
Lee Reiners, Policy Director, Duke Financial Economics Center.... 5
Prepared statement........................................... 34
Responses to written questions of:
Chair Brown.............................................. 99
Senator Fetterman........................................ 110
Linda Jeng, Visiting Scholar on Financial Technology, Georgetown
Institute of International Economic Law, and Adjunct Professor
of Law......................................................... 7
Prepared statement........................................... 67
Responses to written questions of:
Senator Fetterman........................................ 113
Senator Lummis........................................... 116
Yesha Yadav, Vanderbilt University Law School.................... 8
Prepared statement........................................... 88
Responses to written questions of:
Chair Brown.............................................. 119
Senator Lummis........................................... 122
Additional Material Supplied for the Record
Letter submitted by NAFCU........................................ 127
Statement submitted by Chamber of Progress....................... 128
Statement submitted by ICBA...................................... 131
Statement submitted by Prometheum................................ 134
GWU Legal Studies Research Paper, Arthur E. Wilmarth, Jr......... 137
(iii)
CRYPTO CRASH: WHY FINANCIAL SYSTEM SAFEGUARDS ARE NEEDED FOR DIGITAL
ASSETS
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TUESDAY, FEBRUARY 14, 2023
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:34 a.m., via Webex and in room 538,
Dirksen Senate Office Building, Hon. Sherrod Brown, Chair of
the Committee, presiding.
OPENING STATEMENT OF CHAIR SHERROD BROWN
Chair Brown. The Committee on Banking, Housing, and Urban
Affairs will come to order.
I apologize to the witnesses and to the observers today,
both in person and the Committee room and those watching
remote, for the delay. Senator Scott and I were at a briefing
we will not talk about any more than that, on what has happened
with China and what has happened with the balloons that the
military and others have protected us from, if you will. So we
needed to stay and at least hear the generals make their
remarks to us.
What a difference a year makes. Go back to last year's
Super Bowl. The cryptocurrency industry spent a whopping $54
million on eight ads promising Americans untold riches and the
chance to make history. Of course, they did not tell us about
the high fees, the risk of loss, the outright theft that
plagued the crypto industry. But if you watched the Super Bowl
2 nights ago, you did not see a single ad for crypto.
The cryptocurrency industry has imploded. In 2022, the
crypto market lost $1.46 trillion. That is 1.46 million, I am
sorry, thousand billion in value. Hackers and fraudsters, often
tied to the regimes in Pyongyang and Moscow, have stolen over
$3 billion. Crypto firms have slashed over 1,600 jobs. And as
crypto vanishes, crypto values crashed last year, platforms
began collapsing, creating more losses across the rest of the
crypto ecosystem. The crypto firms that are left have had to
halt customer withdrawals, freezing people out from their own
money.
While crypto contagion did not infect the broader financial
system, thank God, we saw glimpses of the damage it could have
done if crypto migrated into the banking system. The handful of
banks with close ties to the crypto industry have needed
liquidity lifelines after they suffered large withdrawals.
This crypto nightmare is not over yet. We are still
learning the full extent of the fallout from the FTX collapse.
In December, this Committee heard about the excessive risk-
taking and misconduct at FTX. The customers who lost money are
only now understanding the reality of the products they were
sold.
As these crypto firms filed for bankruptcy, regulators and
policymakers have also learned how out of control some of those
businesses were. They were overleveraged. They were
undercapitalized. They had no internal risk controls. They were
careless with customers' money. In the case of FTX, they used
it to line their own pockets. Now the money of millions of
Americans is trapped, and they might never get it back.
Last year, I warned that the splashy Super Bowl ads left
out key details. A year ago, I said, as Chair of this
Committee, big crypto companies are looking to make big
profits, are desperate to reach as many Americans as they can,
hence, the $54 million in ads in the Super Bowl. They brought
in celebrities and gimmicks to make crypto sound exciting and
daring and profitable, immensely profitable.
These ads left a few things out. They did not mention the
fraud. They did not mention the scams. They did not mention the
outright theft. The ads did not point out that you can lose big
in crypto's huge price swings. They did not tell you about the
high fees pocketed by the crypto companies, and they sure did
not explain that crypto markets lack basic investor protections
and oversight.
The results were as predictable as they are tragic.
Contrary to crypto evangelists' claims of democratizing
finance, it is not the early adopters or the big money
investors left holding the bag. When it comes to crypto, turns
out fortune does not favor the brave; it favors wealthy
insiders.
It is not just about a few bad actors that did not do
things quite the right way. These crypto catastrophes have
exposed what many of us already knew; digital assets,
cryptocurrencies, stablecoins, investment tokens are
speculative products run by reckless companies--we know that is
true--that put Americans' hard-earned money at risk, not
surprising from an industry that was created to skirt the
rules.
Whether it is Facebook Libra or the explosion of crypto, I
have always been concerned about shiny new products that really
just offer another way to profit off the backs of working
Americans and, at the same time, threaten the real economy. It
is time now to consider how to protect consumers from
unregulated digital assets and, ultimately, whom we want our
financial system to serve.
Last Congress, this Committee examined the risks of crypto
to our economy, explored the mechanics behind stablecoin
companies, looked at how regulators in Congress can protect
consumers. We learned how crypto can be used to commit crimes
like drug running and human trafficking, which threaten our
national security and help fund terrorists and rogue regimes.
We looked at how fraud and speculation in the crypto market
hurt investors and savers.
Recent crypto meltdowns have made clear we need a
comprehensive framework to regulate crypto products to protect
consumers and our financial system.
Today, we will examine how time-tested financial safeguards
can help protect against the harms and the risks of crypto
products. We will start by taking a closer look at these basic
principles of regulation:
Clear disclosures and transparency essential so retail
customers and investors can understand how a token or crypto
platform works.
Prohibitions on conflicts of interest and self-dealing by
insiders is fundamental. Our markets only work when they work
for everyone.
Protecting consumer funds by separating them from company
assets. Investor dollars cannot be a slush fund for the
executives' benefit.
Internal governance and risk management to make sure if a
platform takes customer funds it acts prudently.
Strong consumer and investor rights and protections that
are foundation of trust in any financial system and central to
a functioning market.
Anti-money laundering and fraud prevention to make sure
that malign actors and evil Nation States cannot fund
themselves and evade law enforcement.
Oversight and supervision to hold companies accountable
because access to our financial markets is a privilege, not a
right that can be abused.
These are basic, commonsense principles that have developed
over centuries of financial system regulation--the wildcat
money of the 1800s, the repeated banking panics of the Gilded
Age, the 1929 stock market crash, the savings and loan crisis
in our lifetime, the dot-com bubble, the Great Financial
Crisis.
These crises are the story of speculative bubbles fueled by
investor euphoria and the promise that ``this time it is
different'' even though it really never is. The lessons learned
are the product of hard-earned experience--experience born of
real people losing real money and of real dreams shattered.
Crypto is not special. We can start with these commonsense
principles as we consider a regulatory framework for digital
assets that puts consumers first and, above all, keeps our
financial system safe. I trust this Committee, as the Ranking
Member often says, can find common ground and work together to
protect investors from crypto risks.
Ranking Member Scott.
OPENING STATEMENT OF SENATOR TIM SCOTT
Senator Scott. Thank you, Mr. Chairman, and before I dig
into my opening comments, I want to address the elephant in the
room. If Chairman Gensler is going to take action, enforcement
action, Congress needs to hear from him very soon. The Chairman
had lots of time to do the rounds on the morning talk shows. If
he has time for that, he should be here testifying with us this
morning, and I hope that we see him here very soon. Thank you,
Chairman Brown.
The free market economy was formed by financial innovation.
It is the engine that continues to drive our economy today, but
every engine needs fuel. And, in order to advance as a country,
we must continue to grow and innovate, but we must do so in a
safe and sound manner.
Innovation can increase access to traditional financial
services and may foster new, emergent technologies that promote
financial independence, access to credit, and capital
formation. We all know and understand how technology can
improve our daily lives, from using our iPhones or our phones
to open bank accounts to opening a digital marketplace. If we
foreclose financial innovation, we limit future generations
from growth and opportunity.
That said, financial innovation must be done so in a safe
and sound manner, which, unfortunately, has not been the case
with a number of actors in the digital asset space. For
example, for some time, FTX was considered the darling of the
crypto industry. Unfortunately, instead of protecting
customers' interest and using customer funds in the manner
intended, Sam Bankman-Fried, FTX's owner, stole millions of
dollars of customers' funds and used them to finance risky bets
and to pay for luxury penthouses in the Bahamas.
When I consider this massive failure, I wonder whether our
regulators, when they supposedly already had the authority,
were they using those authorities?
In recent statements, the regulators, the SEC specifically,
have noted that it is the responsibility of crypto firms to
comply with existing regulations, but it is also the
responsibility of regulators to enforce existing regulations
and to conduct appropriate, effective supervision.
The American people deserve to know why no action was taken
prior to FTX's collapse and how millions of dollars of
Americans' hard-earned money just vanished into nothing. And it
was not just FTX. If the SEC had provided even the slightest
bit of guidance, I wonder if we would have been able to protect
investors from the collapse of Terra and Luna in May, Celsius
in June, Voyager in July, and BlockFi in November.
This is particularly alarming when we see the reports that
44 percent of Americans who own and trade digital assets are
new investors or people of color, which means when there is a
$2 trillion drop in the market cap our most vulnerable citizens
bear the significant brunt.
We must hold companies that harm consumers accountable, but
we must empower consumers through financial education so that
they can more accurately understand the risk posed by different
assets classes. Whether it starts in the classroom or in the
boardroom, financial literacy provides an avenue for
individuals to make better decisions and climb the economic
ladder. Nonetheless, regulators have put their misplaced focus
on progressive social issues.
So we have to ask ourselves, where do we go from here?
To date, the SEC has failed to take any meaningful,
preemptive action to ensure this type of catastrophic failure
does not happen again. If they have the tools they need, were
they just asleep at the wheel? If they do not, why aren't they
here to tell us what they need? We would be happy to have
Chairman Gensler testify sooner, much sooner, than later.
Moving forward, we must take a thoughtful, bipartisan, and
balanced approach that protects consumers and promotes
innovation and opportunity. I look forward to hearing our
witnesses' perspectives on how we can continue to drive
innovation and opportunity while ensuring consumers are
protected.
Thank you, Chairman.
Chair Brown. Thank you, Senator Scott.
I will introduce today's three witnesses. We will hear from
Lee Reiners, Policy Director at the Duke Financial Economics
Center and a lecturing fellow at Duke University School of Law.
Welcome, Mr. Reiners.
Professor Linda Jeng is the Chief Global Regulatory Officer
and General Counsel of the Crypto Council for Innovation. She
is also the Visiting Scholar on Financial Technology and
Adjunct Professor of Law at Georgetown University Law Center's
Institute for International Economic Law and a senior lecturing
fellow also at Duke Law School.
Professor Yesha Yadav is the Milton Underwood Chair
Professor of Law and Associate Dean at Vanderbilt Law School.
Professor Yadav, welcome you.
Mr. Reiners, if you would begin.
STATEMENT OF LEE REINERS, POLICY DIRECTOR, DUKE FINANCIAL
ECONOMICS CENTER
Mr. Reiners. Chairman Brown, Ranking Member Scott, and
Members of the Committee. Thank you for inviting me to testify
at today's hearing.
My name is Lee Reiners, and I am the Policy Director at the
Duke Financial Economics Center and a lecturing fellow at Duke
University School of Law. At Duke, I teach courses in
cryptocurrency law and financial regulation, and prior to
entering academia, I spent 5 years examining systemically
important financial institutions at the Federal Reserve Bank of
New York.
Satoshi Nakamoto introduced the first cryptocurrency,
Bitcoin, to the world in a 9-page white paper posted on
Halloween 2008, and the first Bitcoin transaction occurred in
January 2009. Fourteen years, thousands of cryptocurrencies,
and trillions of investor losses later, crypto scarcely
resembles the ``purely peer-to-peer version of electronic
cash'' first envisioned by Satoshi.
By technology standards, crypto is not new. For comparison,
the iPhone was introduced in 2007. Anyone who held a smartphone
in their hand for the first time immediately recognized its
transformative potential. More recently, OpenAI made the
artificial intelligence chatbot, ChatGPT, available to the
public last November. Two months later, ChatGPT had 100 million
monthly active users, making it the fastest growing consumer
application in history.
After 14 years and countless claims that crypto represents
the future of money, finance, or something else, we have yet to
see crypto's killer use case. In fact, only 16 percent of U.S.
adults have invested in, traded, or used crypto. The data is
clear; most people invested in crypto simply because they
thought they could sell it to someone at a higher price in the
future. Sadly, these people were wrong.
Fourteen years have provided ample evidence of the dire
harm cryptocurrency inflicts throughout our society. Beyond the
billions in investor losses due to frauds, hacks, and scams,
crypto undermines our national security by facilitating
terrorists' financing and sanctions evasion. It undermines our
economic security by fueling a surge in ransomware attacks that
have crippled American businesses, health care systems, and
municipal governments. And, it jeopardizes our climate goals by
needlessly consuming massive amounts of energy that contribute
to carbon emissions and electronic waste.
I ask, what benefits do we have to show for these costs?
Even as we stand in the ashes of the FTX implosion, the
crypto industry is spinning new narratives to deflect and
obfuscate the damage that they have wrought. One such line goes
that Sam Bankman-Fried was just a bad apple and that the
problem lies not with crypto's underlying technology but with
centralized crypto intermediaries, but FTX was not an isolated
incident--Terra (LUNA), Celsius, Voyager, BlockFi, Axie
Infinity, Genesis, Mango Markets. How many more must fail
before we conclude that the entire barrel is rotten?
Another self-serving line spun by crypto boosters is that
policymakers must embrace innovation or else the crypto
industry will migrate to other jurisdictions with a more
favorable regulatory climate. Well, this implies that
innovation is an unmitigated good. The truth is that innovation
is value-neutral. It could be used for good or bad. Instagram
for kids is technically innovative, but does anyone think it is
a good idea?
Looking at crypto, it is clear that the costs outweigh the
benefits. So why would we want to embrace it?
The millions of Americans who invested in crypto only to
see their hard-earned money evaporate do not care whether
crypto is classified as a commodity or a security. They do not
care whether the industry is regulated by the SEC, CFTC, or
some other agency. They only care about having the same basic
safeguards they have come to know and expect from the
traditional financial system. Unfortunately, we have let them
down.
The time has come for action--action that only Congress can
provide. While I agree with SEC Chairman Gary Gensler that most
cryptocurrencies are securities subject to SEC registration and
disclosure requirements, some cryptocurrencies, like Bitcoin,
are commodities. While the CFTC regulates commodity
derivatives, they do not regulate commodity spot markets. The
practical effect of this structure is that cryptocurrency
exchanges in the U.S. are presently not regulated at the
Federal level.
In my written testimony, I provide a detailed roadmap for
how Congress can close this gap. I urge Congress to carve out
cryptocurrency from the definition of commodity in the
Commodity Exchange Act and recognize cryptocurrencies as
securities under a special definition to the securities laws.
This would give the SEC exclusive authority to regulate all
aspects of the crypto industry. The SEC simply has more
expertise, more resources, and more appetite for enforcement in
the crypto realm than the CFTC does. Most importantly, unlike
the CFTC, the SEC has a statutory mandate to protect investors.
Whatever Congress decides to do, the status quo is simply
untenable. I look forward to discussing the way forward with
you. Thank you.
Chair Brown. Thank you, Professor Reiners.
Professor Jeng, welcome.
STATEMENT OF LINDA JENG, VISITING SCHOLAR ON FINANCIAL
TECHNOLOGY, GEORGETOWN INSTITUTE OF INTERNATIONAL ECONOMIC LAW,
AND ADJUNCT PROFESSOR OF LAW
Ms. Jeng. Chairman Brown, Ranking Member Scott, and Members
of the Committee, it is a pleasure to be here with you today.
Thank you for the opportunity to testify.
The Banking Committee was where I cut my teeth on financial
policy, working on the response to the global financial crisis.
I have been impressed by, and am thankful for, the
bipartisanship this Committee has long embraced. Today's
hearing is yet another example of its leadership.
With inflationary pressures not seen since the 1970s,
market volatility, and changes to the Fed's longstanding
monetary policies, I have been asked to discuss how best to
strategically think about the regulatory future of our digital
economy. As a former regulator myself, I am particularly
concerned about this area of our shared digital future and how
we can all ensure the best outcomes for American consumers
while promoting innovative.
In this light, I am testifying in my personal capacity as
an academic and researcher. I am a visiting scholar on
financial technology and adjunct professor at the Institute of
International Economic Law at Georgetown and a senior lecturing
fellow at Duke Law. In addition, I am the Chief Global
Regulatory Officer of the Crypto Council for Innovation, a
global industry alliance of companies operating in the digital
assets ecosystem.
Technological innovation enhances people's lives in
meaningful ways. As someone who has spent years working on
financial regulation in a number of roles, I know that in the
financial sector policies should focus on a number of key
areas: empowering consumers, ensuring open markets, increasing
efficiency, and lowering costs for consumers. In short,
technological innovation should be harnessed to improve access,
efficiency, and equity for digital consumers.
To facilitate the growth of a resilient and sustainable
digital future, policymakers should be intentional in their
choice of building blocks. In my experience, these blocks must
address a range of issues, including consumer and investor
protection, digital money, digital identity, decentralized
finance, private commercial law, bankruptcy, accounting, tax,
technology standards, energy, illicit finance, and national
security.
The development of a flourishing digital ecosystem
ultimately relies upon innovators as well as laws, regulations,
and policies that guide policymakers, investors, and businesses
to facilitate long-term value. Currently, companies operating
in the digital asset space in the U.S. are subject to a
patchwork of State and Federal regulatory requirements.
For example, crypto exchanges typically must secure a State
money transmission license or obtain a license through a
tailored regime such as the New York Department of Financial
Services BitLicense, and importantly, at the Federal level,
companies are required to be registered as money service
businesses with the U.S. Treasury's FinCEN and comply with AML/
CFT rules. But the absence of a transparent and consistent
Federal regulatory framework, coupled with successful State
regulatory regimes, causes uncertainty for businesses and
innovators while often failing to protect consumers and
investors.
In the past year, we have seen legitimate projects fail and
outright fraud committed against customers transacting in
digital assets. Both have caused significant harm. These losses
underscore the urgent need to establish formal Federal
regulatory oversight and demonstrate the inadequacy in
regulating solely by enforcement.
To date, and for the purposes of this Committee's
jurisdiction, the SEC has not initiated any formal rulemaking
process to update securities laws that are decades-old to
account for the unique attributes of digital assets that are
determined to be securities. Given this unusual departure from
the normal and well-established process of public rulemaking,
Congress urgently needs to pass thoughtful, comprehensive
legislation that establishes a Federal regulatory framework for
digital assets addressing both securities and nonsecurities. In
this complex and nuanced space, the details matter.
Failure to enact rules, even through rulemaking or
legislation, that protect investors and allow digital assets to
develop in the U.S. would risk offshoring innovation and
putting American business, consumers, and the economy at a
competitive disadvantage with our foreign peers. It could also
jeopardize an important national security lever of the U.S.
Government, the preeminence of our financial system.
Thank you again for the opportunity to testify today. I
look forward to answering your questions.
Chair Brown. Thank you, Professor Jeng.
Professor Yadav, welcome.
STATEMENT OF YESHA YADAV, VANDERBILT UNIVERSITY LAW SCHOOL
Ms. Yadav. Chairman Brown, Ranking Member Scott,
distinguished Members of this Committee, thank you so very much
for the opportunity to be here today. It is an extraordinary
honor and a privilege for me. I hope that my testimony today
can be of some help to this Committee as you progress your
review into thinking about the causes of this crypto and the
steps that we need to take to shore up this financial system as
well as, most importantly, to protect those who use it.
Now we have been asked today to consider why financial
system safeguards are needed for the cryptocurrency market, and
I think the evidence is becoming clear for all of us to see.
The digital assets market today is big. It is becoming popular.
It is sophisticated, and it is becoming increasingly
financialized. And the cost of being late to regulation is
becoming obvious to all of us.
Now as we have seen in the case of FTX, for example, a case
that I imagine we will talk about extensively during this
hearing, the bankruptcy court in Delaware is having to deal
with the consequences. We are talking about approximately 9
million estimated creditors, 134 entities, everyday customers,
both retail as well as institutional, that are now clamoring to
get their money outside of the bankruptcy system.
At the same time, these legal processes are extremely
expensive. They are long, and the outcomes are extremely
unclear. But what is becoming straightforward here is that
these customers are likely to become unsecured creditors of the
estate and very likely to be last in line to be paid out when
the recoveries do come.
Now, Senators, this entire episode obviously casts enormous
doubt, reduces trust and confidence, of course, in the
cryptocurrency exchanges as well as the cryptocurrency
industry.
But, Senators, it also casts a lot of doubt on the trust
and confidence of the regulatory system. It is unfortunate that
expert technical determinations about very important matters,
such as how assets in cryptocurrency--for cryptocurrency assets
should be custodied, how those custody arrangements should
work, are now having to be taken--are now getting to be taken
not by our extremely expert, our extremely talented regulatory
agencies but, instead, by the bankruptcy court. Now the
bankruptcy court is, of course, extremely talented and
extremely expert, but it is an expert in distributing scarce
assets across hurt and distressed creditors.
Now, Senators, what I would like to propose to you today is
to create a solution that can help to get a regulatory
framework up and running quickly, one that is useful for, and
able to, integrate quickly into the larger, comprehensive,
Federal oversight system that we have today.
What I am proposing is the creation of a self-regulatory
regime where cryptocurrency exchanges are tasked with oversight
of the market as a whole. This would bring cryptocurrency
exchanges in line with traditional commodities and securities
exchanges where self-regulation by exchanges has been the norm,
essentially, for centuries. What this proposal would do would
essentially task cryptocurrency exchanges with writing rules,
with monitoring the market, and with exercising discipline.
But, really, the goal of this proposal, Senators, is
threefold:
Firstly, it seeks to bring cryptocurrency exchanges within
a framework for Federal oversight. Our agencies would be tasked
with vetting and carefully overseeing these exchanges to make
sure that they are doing their job. They would have to make
sure that these exchanges have the organizational capacity that
they need to do their job.
Second of all, it would seek to make cryptocurrency
exchanges accountable. What that would mean is that if they
fall in their ability to do oversight then they would have to
pay. They would have to pay financial penalties. In addition,
of course, they would suffer loss of reputational damages.
Now third of all, it would make sure that cryptocurrency
exchanges are in fact paying to look after their market. This
means using their resources, using their expertise, using their
knowledge, using their proximity to the technology to make
their marketplace, as well as themselves, much more honest,
much more stable, and much more driven toward protecting
customers.
Now, Senators, to be very, very clear with you, this is not
in any way a substitute for public regulation. Rather, it is
designed to be a complement. This is a solution that is
supposed to integrate seamlessly into a larger Federal
oversight framework, and it is one that we have seen working in
the traditional market for a very long time indeed.
Senators, this is also not a proposal that is without its
faults. There are certainly enormous faults to be had in this
market. Now certainly, in the traditional marketplace, we have
seen exchange oversight by exchanges suffer from various
conflicts of interest.
So this is a really a proposal, Senators, which is designed
to get a market up and running quickly. It seeks to make
agencies--it seeks to make the exchanges responsible. It seeks
to make the exchanges accountable. And, it seeks to force these
exchanges, which are anchor pieces, central parts of this
entire ecosystem--responsible much more formally for bringing
safety, stability, and consumer protection to the heart of the
cryptocurrency market.
Senators, the adage goes that we should not let the crisis
go to waste, and I would urge you to not let that happen here
so that we are not left wondering how we could prevent another
FTX from happening. Thank you so very much, and I look forward
to your questions.
Chair Brown. Thank you, Professor Yadav.
Professor Reiners, start with you. Some in the crypto
industry have complained about recent SEC enforcement actions
against crypto firms for offering unregistered investment
products. Some of these companies entice consumers to put their
crypto to work to earn double-digit returns. Shouldn't a
financial product that takes in billions of dollars in retail
consumer money operate with basic consumer protections?
Mr. Reiners. Yes, it should, Senator, and I would point out
that the crypto industry is very fond of criticizing SEC for
regulation by enforcement, but the truth is that it is just a
catchphrase that the industry uses to deflect from the fact
that they have willingly chosen to operate outside the
regulatory perimeter.
And the SEC has been quite clear, going back to the
chairmanship of Jay Clayton, most cryptocurrencies are
securities that need to be registered with the Commission. And
the SEC has filed over 125 enforcement actions, and they have
not lost a single case related to cryptocurrency, so the judges
think it is quite clear as well. The only people who seem to be
confused about this is the crypto industry.
Chair Brown. Thank you.
Professor Yadav, your testimony discussed how stock
exchanges are regulated, how to extend similar safeguards to
crypto exchanges. What are the established safeguards that can
benefit consumers, that can increase market transparency and
prohibit conflicts?
Ms. Yadav. So, Senator, thank you so much for that
question. Stock exchanges have been providing self-regulation
of this market for a long time, and I think it is important to
consider the counterfactual here, which is that these extremely
powerful, extremely central, extremely important parts of the
institution, what would happen if they were not required to do
so.
And what we have here is essentially a marketplace in which
we are using the private self-interest of these exchanges to
provide a public good. Now in the context of the exchanges
themselves, what they do provide is having extremely sort of--
is having expertise within the marketplace to surveil trading
from a very proximate standpoint. They are responsible for
enforcing, under Section 6 of the Securities and Exchange Act,
standards of preventing fraud, manipulation, and to create a
fair and equitable marketplace. Now certainly this oversight is
not perfect, Senator, but at the same time it is better than
what we would have if we did not have it.
And so in this context--you know, there have been various
steps taken in the context of preventing these conflicts of
interest, so for example, entity separations within these
exchanges. FINRA is another organization that is there to
prevent potential conflicts from occurring. And so overall this
is a system that provides a complement to public oversight
rather than necessarily being any kind of substitute for it.
Chair Brown. Thank you.
Mr. Reiners, again, the collapse of FTX has focused
attention on basic protections like safeguarding customer money
so companies cannot use it for their own personal benefit.
Explain briefly the urgency to us, the urgency to develop
better standards for the custody of consumer assets.
Mr. Reiners. Yes, Senator. So unfortunately, millions of
Americans have found out that if they have used a crypto
exchange and that exchange has failed they are now unsecured
creditors in that bankruptcy estate, so they do not have
control or access to those assets. Of course, that is very
different than the situation we have with banks, which are
FDIC-insured, or with traditional broker-dealers, which are
subject to SIPC insurance.
So if there was going to be one change that I would
recommend Congress focus on, it would be requiring these crypto
platforms to segregate customer assets from firm assets so that
if these firms do get into trouble customers will still have
access to their funds.
Chair Brown. Thank you.
Last question I would ask all three of you to answer. There
are many ways to protect consumers in the crypto market. One
thing is clear, that customers deserve to understand better the
investment they are making. My question for the panel: Without
debating the ways cryptocurrencies are different from stocks or
bonds, is it reasonable to start the conversation with the
investment disclosures that we are familiar with?
So, Professor Yadav, start with her--with you. Let us go
down the line. Each of you briefly explain how we can use
existing disclosure principles for crypto.
Ms. Yadav. Senator, I am so glad you asked that question.
This is an essential part of the process, which is to have
disclosures reveal insight about what exactly are the
governances of the issuers that are providing this technology,
in addition about the blockchains as well as, obviously, the
underlying technologies that are animating these offerings.
Now what we have here today is a disclosure system that
needs to work. As Ranking Member Scott discussed earlier, this
is a technology that has been popularized and is being used by
increasingly younger people, folks in minority communities, and
so it is extremely important not just to focus on disclosure
but also literacy, making sure that these disclosures work.
I have a terrific coauthor that has done work in making
sure that disclosures are readable, making sure that
disclosures are usable, you know, encouraging people in
different ways to engage with the actual information they are
seeing. Otherwise, just having a thick bundle of information
does no good whatsoever if it is not something that is able to
communicate these risks and opportunities effectively.
Chair Brown. Thank you.
Professor Jeng.
Ms. Jeng. This is a very important question. One of the
very interesting issues about this is that it is transparent in
code. Right? But as a former regulator who worked with
blockchain engineers, and I do not code, I need the engineers
to actually explain to me how the product was actually
designed. So white papers that clearly explain how it is
designed, what the risks are, who holds the private keys, the
governance, the voting rights, and then more importantly, where
are the funds held, these are the important issues that need to
be included in the disclosures.
Chair Brown. Thank you.
Mr. Reiners.
Mr. Reiners. Senator, we have had a basic bargain in our
capital markets since the 1930s, and that is that companies
that want to raise money from the public have to disclose the
risk involved in that and then investors are free to choose
what risks they want to take. And so I see no reason why that
principle should not apply to crypto although I will agree with
Professor Yadav's point that maybe the specifics of what gets
disclosed can be debated.
And I think the SEC does have the authority, and I think
Congress should give them the authority, to draft customized
disclosure regimes for certain decentralized crypto products,
and the EU is moving in that direction. But disclosure is
necessary.
Chair Brown. Thank you. I guess the $54 million of Super
Bowl ads a year ago and zero ads this year sort of underscore
that.
Ranking Member Scott.
Senator Scott. Thank you, Mr. Chairman. Just to finish
Professor Yadav's point on disclosures, having sold mutual
funds in a past life, I will say that having a prospectus that
the average person can understand would be really helpful. The
truth of the matter is disclosure sounds great until you try to
read a prospectus and you cannot figure out what in the world
it says. So I think plain English would be very helpful for the
vast majority of our folks who are first-time investors to
understand what it is that they are investing in. I would say,
without any question, this is an area where that is really
important because of the complexity of the actual underlying
asset itself.
Right now, the United States has the strongest and most
enviable capital markets in the world. The reason for this is a
very simple reason; the sun never sets on American innovation.
Over decades, we have fostered a financial environment that has
decreased poverty, increased home ownership, and made the
American Dream a reality for more and more of our citizens.
Our goal should not be any different when it comes to
digital assets. Our aim should be to provide rules of the road
that are clear, consistent, and most importantly, foster an
environment that rewards opportunity while ensuring consumers
are informed and protected against fraud and deception. As we
speak here, several countries across the globe are creating
their own framework to address the rise of cryptocurrency.
Unfortunately, our regulators have muddied the waters. We
have been told everything from we need legislation to, more
recently, that regulators have the tools they need to supervise
this industry. That is quite a flip-flop.
Once again, it is really important that we have Chair
Gensler here before September. It is far too far in the future
for us to wait that long before we hear from Chairman Gensler.
The regulators have permitted activity in this space
without providing clear rules of the area, which has
unfortunately led to the multiple failures that bring us here
today. Let us be clear. Had the SEC provided anything besides
hostility to the crypto industry we may have been able to save
investors from losing billions of dollars on FTX, Celsius,
BlockFi, and the list goes on.
So my question, Professor Jeng, what should Congress keep
in mind when it considers developing an approach to the crypto
industry? How do we strike a balance between appropriate and
thoughtful regulation and the tool of innovation that it could
be?
Ms. Jeng. Thank you, Senator, for that very important
question. We are at a pivotal moment in history where the
decisions that you all make as policymakers will affect how our
economy grows in the future, and currently, we are becoming a
data-driven, digital economy. What does that mean? That means
that our activities are increasingly based upon data and on
blockchain technologies. So the kind of guardrails that you put
in place now will affect generations to come.
Many of the issues that you need to think about will
include certainly consumer protection but also consumer rights
and consumer empowerment. Currently, there are countries around
the world who are also looking at how to take advantage of
crypto technologies, China being a good example, but in that
situation it is the Government that wants to actually control
the personal data. Here is an opportunity for you all to create
the framework for consumer empowerment, for consumer data
rights, that serves as a foundation for a digital economy.
Senator Scott. As I noted in my opening statement,
innovation can be a positive driver in expanding access to
traditional financial services and can foster new, additional
technologies that promote financial independence, access to
credit, and capital formation. It is astounding what financial
innovation can do for people when they are given the ability to
make their own choices and allowed the flexibility to innovate.
While we have talked about cryptocurrency a lot, innovation
in the technology space is not limited to crypto. Fintech is
another classic example of things that are moving in a positive
direction.
Question for the whole panel: Can you speak to the benefits
you see for everyday Americans in the digital asset space and
the need to ensure that regulation does not stifle innovation?
Professor.
Ms. Yadav. Great. Thank you so much, Senator Scott, for
that question. Innovation here is something that is moving
extremely fast in terms of trying to improve the efficiency,
for example, of the payment system. Now one thing that is very
clear in the U.S. is that despite us having a state-of-the-art
financial system, our payment system is lagging behind, and
what we have seen, for example, in the context of fintech is
the ability to try and make payments much more usable, for
example, using smartphone technology, for example, trying to
have contactless payments.
The world that we inhabited 10 years ago in terms of
payments is not the world that we inhabit today, and yet, there
are still some problems. For example, you know, these are
things that you have heard in this Committee before. It takes
time, days in fact, for payments to settle. Checks take days in
order to move. In addition, obviously, there are enormous costs
involved with this.
Now this obviously leaves out folks that do not necessarily
have a bank account and do not have access to the full panoply
of financial services. So the question is: How do we make
innovation work for people so that we are able to bring
everyone into the fold in a much more inclusive and cheap and
efficient way?
Now certainly some of the technologies that are being
proposed, even in digital assets, are trying to do that, and so
certainly that is something, a potential use case, that could
be worth exploring provided that it is, you know, substantively
and properly regulated.
Senator Scott. Thank you.
Professor Jeng.
Chair Brown. Thank you, Senator Scott.
Senator Scott. Let me hear from the professor real quick.
Chair Brown. Oh, I am sorry. That is OK.
Ms. Jeng. Thank you for the opportunity. So one of the very
important issues to take into account is consumer rights and
property rights. We need a clear set of rules.
And what do I mean by that? My husband is from Ireland.
When I am in Ireland, I have to drive on the left side of the
road. If I am not told that, I would get into a car crash.
Similarly here, we--as a professor looking at the system, there
is an urgent need for a regulatory framework that clearly
states what are the consumer rights and also what are the
responsibilities of crypto participants.
Senator Scott. Thank you. I am out of time.
Chair Brown. Thank you, Ranking Member Scott.
Senator Menendez from New Jersey is recognized.
Senator Menendez. Thank you, Mr. Chairman. Last fall, the
Financial Stability Oversight Council released its 2022 report
on Digital Asset Financial Stability Risks and Regulations, and
one of FSOC's recommendations was that Congress pass
legislation providing rulemaking authority to financial
regulators over the spot market for nonsecurity digital assets.
Mr. Reiners, why is it important that Congress address this
gap, and how would you propose that we do it?
Mr. Reiners. So, Senator Menendez, for the past 10 years or
so, the big debate when it comes to crypto regulation is, you
know, are these things commodities or securities, and of
course, the Howey Test is principally what is used to determine
whether or not a given token is an investment contract and,
therefore, a security. Now I happen to agree with Chair Gensler
that most cryptocurrencies are securities, that they meet the
Howey Test, but there are some cryptocurrencies--and I will
just use Bitcoin as an example--that are decentralized enough
that they are commodities.
And the CFTC regulates commodity spot markets, but they do
not--or, they do not regulate commodity spot markets. They only
regulate commodity derivatives markets although they do have
fraud and manipulation enforcement authority in commodity spot
markets.
So that is the gap that needs to be addressed, and so what
I recommend--and I have this detailed in my written testimony--
is that Congress carve out cryptocurrency from the definition
of commodity in the Commodity Exchange Act and include
cryptocurrency as a new category of security under our
securities laws so that it is clear to everyone, to the market
and everyone else, that the SEC has exclusive rulemaking
authority and jurisdiction over cryptocurrency.
Senator Menendez. Professor Jeng and Professor Yadav, any
views on this?
Ms. Yadav. Thank you so much, Senator Menendez. I think one
of the main things that we have to figure out how to do, at
least in my proposal, is to make the private industry
accountable and to make the private industry responsible. So as
set out in my written testimony, some of the major--arguably,
the most important institutions in this economy are the
exchanges, and we have to find a way to make them play their
part in making sure that this market becomes a safer and much
consumer-protected market.
Now in this context, what I propose is to create this
framework for exchanges to become self-regulatory organizations
very clearly under a framework of oversight that could be
administered by agencies jointly. I think this is a gap here--
in other words, that we are allowing exchanges to become very
big, we are allowing them to become sophisticated, we are
allowing them to have governance structures that are extremely
centralized and subject to conflicts of interest, and we need
to bring that under control because exchanges are providing on-
ramps into the cryptocurrency market for really the vast swath
of the population.
Senator Menendez. Mm-hmm.
Ms. Jeng. There are many different types of digital assets,
some of which are like Bitcoin, native cryptocurrencies; others
are like fiat-backed stablecoins which will act as digital
money.
And so for example, if I give you a green paper dollar
bill, you know when you take it from me that nobody has an
interest or title to that dollar bill. That is why it acts so
well as a medium of exchange. To ensure that we will have a
digital economy that can run on digital money, we need to make
sure that fiat-backed stablecoins and other types of digital
money--that could include CBDC as well--are also going to be
free of interest or title.
And hence, why putting it under the SEC framework was
problematic? Because again, you know, I cannot pay you with a
security.
Senator Menendez. Mm-hmm. Well, we are trying to figure
this out. The key element I will be looking for in digital
asset legislation is a clear prioritization of transparency and
investor protection, which is also providing for stability--
while also providing for stability and safe innovation. These
are values that make our current financial system strong and
effective and should equally apply, I believe, to the digital
assets.
Let me just ask you, Professor Jeng and Yadav, for decades,
the United States has been a leader in the global financial
system, which has had an immeasurable asset to American
consumers and, in my role as the Chairman of the Foreign
Relations Committee, our foreign policy goals as well. We
should look to continue that leadership as we work to develop
digital assets regulations.
Can each of you talk about some of the global trends we are
seeing on crypto regulation? Is the U.S. ahead or behind the
curve?
Ms. Yadav. Senator Menendez, unfortunately, the U.S. is
extremely behind the curve at this point. One thing that we
have done, as you mentioned, extraordinarily well over the last
10 years is have leadership in standard setting. We have been
incredibly powerful exporters of our financial markets
regulation abroad, and this is so important because it means
that other countries have adopted key principles that we use in
our markets to make our markets work and make our markets safe.
One example here would be the leverage ratio, for example, that
we use in our banking system that has now become an export that
is being used more broadly abroad.
In the case of digital asset regulation, unfortunately,
however, we really do not have anything to export at present.
Unfortunately, other countries have taken a lead, and in
particular, the EU here has set out a very comprehensive
framework in the form of the market and the marketing crypto
assets regulation. Now this likely to come in force in April,
perhaps later this--you know, April or later this year, and
this is a very comprehensive framework that has set the stage
for the U.S. essentially to become a potential second there in
terms of coming up with a plan for, and an agenda for, digital
assets regulation.
So here, it does not feel like we are leading. It feels
like we are potentially following others where they have taken
a lead and have set the standards and are using their framework
to say what rules are good and what rules are bad.
Ms. Jeng. To add to Professor Yesha's remarks, it is not
just that other countries are adopting regulations; other
countries are pursuing very thoughtful, national, digital
strategies. And you look at the EU, which has in place not just
MiCA but GDPR and other regulations, like the Digital Markets
Act. It is all part of a comprehensive strategy that they are
pursuing.
The U.K. is in the process of consulting its proposal on
regulating crypto assets. Australia has been pursuing a long-
term national data strategy and has just come out with its
proposal on taxonomies of crypto assets. Hong Kong is about to
come out with a consultation. Singapore just finished its
consultation in December. As you can see, the list just goes on
and on, and not to mention China, which has been pursuing a
multiyear crypto strategy.
Mr. Reiners. Senator Menendez----
Chair Brown. Senator Menendez--oh, I am sorry. You wanted
Mr. Reiners, too. OK.
Mr. Reiners. So I do not think the U.S. is falling behind.
I think the important thing is that we get regulation right,
not that we necessarily be the first.
And many other jurisdictions that Professor Jeng was
mentioned, you know, they are embracing crypto because
essentially they are gambling that it can help juice their
economy. But look at the situation in the Bahamas, where they
embraced crypto. They rolled out the red carpet for Sam
Bankman-Fried, you know, and obviously it did not turn out so
well.
So as I said in my opening testimony, you know, crypto is
doing more harm than good to our society. As you mentioned, it
is undermining U.S. national security by facilitating sanctions
of Asian terrorist financing. The dollar and New York status
for dollar clearing is an instrument of foreign policy, and
crypto undermines all of that. So we should not be embracing
something that is undermining our sovereignty.
And so I think the important thing is getting financial
regulation right in this space with what I call a dual
mandate--one, protecting investors, and two, preserving
financial stability.
And that is an upside to the most recent crypto winter--is
that it has not spilled into the traditional financial system,
and it is largely due to actions of the SEC and the Federal
banking agencies who have had clear rules in place for the
better part of a year that basically say, if you are a
regulated bank and want to engage in crypto activity, you need
to get permission from us first. And that really prevented a
lot of banks from engaging more heavily in crypto activity, and
this story would be very different if we had banks engaging in
crypto activity.
Chair Brown. Thank you.
Senator Vance of Ohio is recognized.
Senator Vance. Thank you, Mr. Chairman, and thanks to the
witnesses here.
I am going to pose this first question to all three of you
but maybe give you some background where I am coming from. So I
am probably one of the few Members of the Committee that
actually owns cryptocurrency. I have been fascinated for it, or
by it, for a long time. But I also, you know, recognize that
there are downsides to it, that there are risks that come along
with it.
My basic bias here is that we do not really know what it is
yet, meaning not just cryptocurrency but a lot of the other
underlying related Web3 technologies and that our regulatory
approach should basically be to protect consumers while
ensuring that we do not destroy the dynamic upside of this.
And here is what I mean by the dynamic upside. Mister--is
it Reiners? What you just said is fascinating to me in that,
you know, I can tell, you know, you are sort of skeptical of
the role that crypto is playing in society right now, and look,
after what happened with Sam Bankman-Fried, there obviously--
there is a lot of cause for skepticism.
What I wonder is how people would have described the
internet in the 1970s and the 1980s, before it was commercially
available, before it was a major part of the way that we did
commerce, and that if we had taken an overbearing approach then
we might have destroyed a lot of the upsides that have come
over the last three decades.
So I want to put this question to each of you, maybe just
going from left to right: How do you think about that, about
regulating crypto not just in a way that protects consumers and
also protects the upsides of the technology right now, in
February of 2023, but ensures that the innovation that is going
to happen on this platform, which is really how I think of it,
actually happens in a way that is relatively free, relatively
fair, and preserves, as Senator Menendez said, the fact that
this could become a tool in America's foreign policy and
economic arsenal?
Mr. Reiners. Yeah, thank you for that question, Senator. So
I respond by saying that crypto is not new. The first Bitcoin
transaction was in 2009, so we have a 14-year track record to
look back and assess this. It did not take the internet 14
years to prove its worth.
And so when you look at cryptocurrencies, I would just ask,
what is the fundamental value? Why are they worth anything?
Normal financial assets are someone else's liability. Right?
There is an issuer. Otherwise, where would the returns come
from?
There is no reason to think that cryptocurrency is going to
generate returns indefinitely into the future. It is clear that
people are just buying it because they think they can sell it
to someone else at a higher price in the future. There is no
fundamentals.
Now that does not mean necessarily that blockchain does not
have value, and I think there is a way to regulate the risk
associated with crypto and to the consumer protections point
that you raise, while still allowing, you know, traditional
financial services to experiment with blockchain as they are.
And I think our existing financial regulatory framework is more
than capable of keeping up with the traditional financial
system using blockchain.
But, unbacked crypto assets? There is no ``there'' there,
and we have plenty of history to prove it.
Senator Vance. Professor Jeng.
Ms. Jeng. Thank you, Senator. I like very much your analogy
to the internet. I was just speaking with a colleague of mine
at Wharton who had begun his legal career at the FCC, and he
told me, at that time--and I am dating his age very clearly,
but he said one the big fights at the FCC was whether to
license internet charters. I do not even know what that means,
but the question was: Should internet providers have to
register with the FCC? Should page providers, site providers,
et cetera? And if they had decided yes, I think the internet
would be very different today, and we may not even have
blockchain technologies.
So why am I bringing this up? It is extremely important
that we have open interoperable standards, and what I--that is
the spirit of blockchain technology. The idea is that these
technologies produce stacks that are composable, almost like
Legos. And so with the iPhone you can then build apps on top,
GPS locators, and then be able to use Uber on top of that and
then maybe your finances.
Why we need to think in terms of pushing for open
interoperable standards is to prevent monopolies of the future.
So digital identity is going to be the cornerstone of the
digital economy, and right now there are some companies--and I
am not going to name them right now, but they are digitizing
our driver's licenses in closed-wallet solutions. And that
means these companies--and you can probably guess who they
are--are going to have an advantage over who are using their
wallets whenever they are trying to transact and are required
to share their personal data, including their driver's license.
And so down the road, you end up with digital transactions
that are viewable only by these companies, and other companies
are not allowed to actually build on top of the digital
identities. So we have to actually set the guardrails in the
right balance to allow for innovation but not have companies or
bad players take advantage of that openness.
Senator Vance. Great. Ms. Yadav.
Ms. Yadav. Thank you so much, Senator, for that question.
We have had innovation for as long as we can remember in this
economy, so for example, from the ATM to all the financial
engineering that we saw precrisis. We have had a ton of
innovation that is, you know, constantly and consistently a
part of the American financial system. The way in which we have
tackled it is by having a dialogue amongst regulators to
approach this in a smart way that includes, obviously,
contributions from the industry.
Now certainly, as Professor Reiners mentioned, Bitcoin has
been there for 14 years, but what we have seen in the crypto
economy, for example, is a real uptick in activity,
particularly in the last 3 years. So for example, DeFi
transactions have increased almost 900 percent in 2021. We have
seen extraordinary transaction volumes in crypto exchanges,
almost 689 percent gains from 2020 to 2021. So we have seen
more people coming into this economy to sort of try out new
products and so forth.
Now that has obviously created risks, and it means that we
need to understand them. It means that we need to use the tried
and tested rules, the tools that we had to understand and
regulate innovation, to think about innovation, and to
encourage innovation through, for example, tools like
disclosure as was discussed earlier in addition to making sure
that the entities that are engaging in innovation are doing so
safely, for example, keeping minimum capital buffers, for
example, making sure that those people are providing products
and taking money from other people are doing so in a way that
has proper internal controls. These are things that we have
used before, we have tried before, that have encouraged
innovation before.
I think the need for this now is urgent given the expansion
and sophistication of the crypto framework, and I think we can
continue to balance the need for market integrity and consumer
protection, as well as making sure that we can do innovation
but provided we can get regulators on board, as well that
industry contributes to that dialogue in a systematic way.
Senator Vance. Great. Thank you.
Ms. Yadav. Thank you.
Chair Brown. Thank you, Senator Vance.
Senator Van Hollen of Maryland is recognized.
Senator Van Hollen. Thank you, Mr. Chairman, and thank all
of you for your testimony here today.
Mr. Reiners, in your testimony, you argue that bank
regulators should learn from previous incidents where crypto
failures impacted the banks that they worked with, and I agree.
Earlier, back in December in this Committee, we heard from
Professor Hilary Allen, and she made a case for a Glass-
Steagall 2.0 model separating banking entirely from crypto
asset activities.
In your testimony, you indicate that that is probably
beyond the agencies' power or authority to do even if they
wanted to do it, and you urge that we look at other
alternatives to develop a comprehensive framework that
clarifies--and I am quoting from your testimony here now--
``comprehensive framework that clarifies the type of crypto
asset activities banks can engage in and the prudential
requirements, capital, and liquidity required to engage in such
activity.'' Could you expand on that and provide a little more
detail as to what you are thinking?
Mr. Reiners. Yeah, thank you, Senator. I am a friend and
admirer of Professor Allen's work, and I certainly agree with
the sentiment that we should do everything we can to restrict
crypto from entering the banking system. But as long as crypto
is legal, you know, then these firms are entitled to banking
services. So I think the challenge is: Where do you draw the
line? What specific crypto activity can be done in a safe and
sound manner?
And so I think the banking agencies have started off on the
right foot in having guidance in place that says, if you are a
regulated bank--so this is the FDIC, OCC, and Fed all have
guidance in place that says, if you are a regulated bank and
you want to engage in crypto activity, you have to let us know
first.
But again I think more is needed, and so what I recommend
is that banking agencies do a horizontal exercise where they
understand all the different ways that banks are exposed to
crypto and then release that information to the public so that
not only bank customers but bank investors as well are aware of
the risks because, you know, the guidance has not been perfect
and we have seen a few banks that unbeknownst to regulators
were more exposed to crypto than previously realized.
And I would just point to Silvergate as a perfect example.
Over 90 percent of their deposits were from crypto-related
firms, and in the fourth quarter of last year they saw over $8
billion in deposits leave. That was over 60 percent of their
deposit base, and it looks likely that they would have failed
if they did not get emergency liquidity from the Federal Home
Loan Bank of San Francisco, which, of course, is not the reason
that we have Federal Home Loan Banks. They exist to support
home ownership, not to bail out banks that gamble on crypto.
So you know, again I think the challenge is: Where do you
draw the line? The Basel Committee finalized their guidance in
2000--in December. You know, the U.S. has a history, of course,
of gold plating, as they say, Basel Standards, and I think that
is certainly warranted in this case as well because if crypto
had been more integrated with the banking system the fallout of
FTX would have been much, much worse.
Senator Van Hollen. Right. No, I think that is a really
important point. I guess, just to ask you to expand a little
bit more on this, do you think our banking regulators are
taking all the steps that they are authorized to do under
current law to try to prevent crypto from sort of making its
way into the banking system in a way that puts consumers at
risk? Is there any additional measures that they should be
taking? And, if they have exhausted their authorities, do you
support legislation along the lines that Professor Allen
suggested?
Mr. Reiners. So banking agencies have a broad legal
authority to prohibit banks from engaging in any activity that
cannot be conducted in a safe and sound manner. So I do think
that they can be--they can do more and be more prescriptive
around what specific crypto-related activities can and cannot
be done in a safe and sound manner.
For instance, there is absolutely no reason why banks
should hold cryptocurrency as a principal on their balance
sheet. Now the joint statement that the banking agencies
released at the beginning of January alludes to the fact that
they would look--that the agencies would look very askance at
banks that wanted to do that, but I think certainly clear
guidance that just says, you cannot do this, is warranted.
Senator Van Hollen. Got it. Thank you.
Thank you, Mr. Chairman.
Chair Brown. Thank you, Senator Van Hollen.
Senator Britt is recognized, from Alabama. Welcome.
Senator Britt. Thank you, Mr. Chairman. So countless
Americans confidentially participate in our financial system
and markets every day. They are informed of the risks
associated with the decisions they make, and they choose what
they want to pursue, for example, whether it is stocks or
bonds, or whether we are talking about mutual funds or
traditional savings accounts.
However, what we have seen now is that our current laws and
regulations do not speak to the recent innovations within our
financial sector, and in fact Congress has a responsibility to
act to establish rules of the road to ensure robust
transparency and protection for consumers and investors.
However, we have seen this past year alone show the
consequences of what happens when Congress fails to do that.
My question is for Ms. Jeng. Just like the rest of the
financial sector, we must ensure that appropriate, commonsense
guardrails are in place so consumers have transparency in the
digital asset space. I have heard you talk about these
commonsense guardrails. You have mentioned protecting
consumers, their rights, and empowering them. Can you tell me
from your perspective what Congress needs to keep in mind while
developing these types of guardrails?
Ms. Jeng. Thank you, Senator, for this opportunity to
expound upon what I think are key foundational building blocks
that Congress needs to consider. Consumer and investor
protection, that is crucial, and having clear legal rights in
the property that they purchase when part of the problem with
the bankruptcies is that the bankruptcy court had really
nothing to work with in terms of legal rights. And so here is
an opportunity for Congress to make very clear that when
consumers purchase digital assets that they have a property
right in that digital asset, and then that will be respected in
a bankruptcy proceeding.
The other really important concern to keep in mind is that
this kind of technology is about democratizing financial
services, and that means when I, for example, moved back to the
U.S. from Europe I had to pay $4,000 to my European bank to
move my own savings back to the U.S. and then I also had no
profit from the spread the bank made when it converted from
Swiss francs to U.S. dollars.
This is the type of opportunity that blockchain technology
can help with. I look forward to that day when I will be able
to transfer money cross-border to myself and actually also make
part of that profit in the spread, and that kind of equitable
interest in financial services is what makes Web3 different
from, say, Web2.
And so we have to think about how can we empower consumers,
give them consumer data rights, while also protecting them
through disclosures and legal protections in bankruptcy.
Senator Britt. Staying on that same line of thought of
empowering consumers, I was struck in your testimony here about
who the actual purchasers of digital assets are. You have here
55 percent do not have a college degree; 44 percent of crypto
traders are not White; 41 percent of traders are women. And
knowing that, do you believe that if we put in proper
guidelines and guardrails that there is an opportunity for more
people across this Nation to achieve the American Dream through
the use of digital assets?
Ms. Jeng. Currently, in the U.S., 4 percent are unbanked,
14 percent are underbanked. I think that is a huge amount for a
country as rich and advanced as ours. They feel that they are
excluded from the traditional financial system. Here is an
opportunity where we can lower the costs and improve access to
financial services.
Senator Britt. And as we work to do that, there is a lot of
talk about overregulation, stifling the market, essentially
taking jobs and innovation and offshoring them to places like
China, to our adversaries. Do you share that line of thinking,
that if commonsense guardrails move to overregulation that we
may do just that?
Ms. Jeng. Regulatory uncertainty causes market uncertainty,
and when the market is uncertain they will go to where there is
regulatory clarity. So if there are other countries with clear
frameworks, that is where they are going to head or they will
go into the shadow banking sector where our regulators would
have very little insight and oversight.
And so regardless, either way, we will end up bifurcating
our U.S. financial system in ways that will have unintended
consequences. A bifurcated system would in fact be part
traditional banking and then one part that is in the shadows,
if that is where crypto is going. I do not think that would
help with our leadership in digital innovation. If anything,
this will actually just drive our innovation to other countries
that very much want to be the leadership in this space, and
they are actually quite jealous of our ability right now of
being the leader in coming up with the most innovative products
and services in crypto.
Senator Britt. Absolutely. Thank you.
Chair Brown. Thank you, Senator Britt.
Senator Smith from Minnesota is recognized online.
Senator Smith. Thank you, Chair Brown, and thanks to our
panelists for being with us today.
My first question is for Mr. Reiners. So some people, I
think, mistake crypto for sort of this niche, enthusiasm-driven
market, and while that might have once been the case, it is
important to realize that it is now--last year, $2 trillion in
market value was lost. And I think that demonstrates how
mainstream this has been, and I think it is also a good reason
to be wary about the risks that this growth poses to consumers
and to our economy.
And this is why Senator Warner and I questioned Fidelity's
decision to offer Bitcoin in 401(k) plans and we recently have
been pressing regulators about banks' exposure to crypto risks.
I start from the place that people are free, pretty much
free, to invest their money or to bet wherever they want to,
and that includes crypto, but I am really concerned about the
potential for these highly volatile assets and risky assets to
get into our financial system and what impact that might have
if there is a collapse, for future crypto collapses.
So, Mr. Reiners, in your written testimony, you said that
``The failure of crypto to fully integrate into mainstream
finance is due to a combination of luck and prudent action by a
handful of regulatory agencies.'' Could you talk a bit more
about that? Just how lucky were we, and what should we be doing
as policymakers to avoid relying on luck as we look at future
crises?
Mr. Reiners. Yeah, thank you for that question, Senator,
and before I address it, I want to quickly touch on the
financial inclusion element that has been talked about in this
hearing. There is no evidence whatsoever to suggest that crypto
promotes financial inclusion, and in fact there is overwhelming
evidence that suggests the exact opposite is happening. Most
people who have invested in cryptocurrency have lost money. Of
those people, a plurality are minorities and low-income
Americans. OK? So this is an example of predatory inclusion.
We saw the same thing with subprime loans leading up to the
2008 financial crisis, where low-income and minority
communities are being specifically targeted with very, very
risky products, and unfortunately, they have lost in many cases
everything.
Now to your point, Senator Smith, about limiting the
connections between crypto and the traditional financial
system, you know, we did luck out to a certain extent.
I would point back to the fall report from the Financial
Stability Oversight Council and where they said, listen, the
crypto market can be systemically risky given two things. One
is size. Obviously, the bigger the market the bigger risk it
poses to the rest of the economy. And then two is the
connections between that sector and the traditional financial
system. And crypto has been--the industry has been trying very,
very hard to integrate into mainstream finance so that the two
are essentially indistinguishable, which I find ironic given
that the whole premise of cryptocurrency was to bypass banks
and the traditional financial system.
Now they are desperately trying to get access and make
themselves seem as if they are legitimate, and they use the
same terminology that we are accustomed to with traditional
financial institutions. Right? So, broker, exchange, bank. But
they are not. These things have meaning, and they are using
these words intentionally because they want you to think that
they are regulated and just as safe as these traditional
institutions. OK?
And in some cases, for instance, Voyager, they were lying
about the fact that they were FDIC-insured, and then they had a
cease and desist order sent to them by the Fed and FDIC.
So I would just, you know, run through the list. You
mentioned Fidelity attempting to put Bitcoin into 401(k)s. You
know, would we think it is OK if they just let Powerball end up
in our 401(k)s? Again, crypto is just gambling.
So thankfully, the Department of Labor has sent out a
letter saying that it would be a violation of fiduciary duty
for plan administrators to offer--that they think it would be a
violation of an administrator's fiduciary duty, and that again
restricted, I am sure, a lot of employers from allowing their
employees to invest in crypto.
Look at FTX. They had an active proposal in front of the
CFTC that would allow them to offer retail traders 24/7 access
to crypto derivatives on margin, directly, without the need of
going through a broker or futures commission merchant. Again,
if the CFTC had granted that proposal, as it appeared likely
that they would have, the FTX situation would have been very,
very different.
Again, multiple attempts to list an ETF that tracks
Bitcoin, in fact, Grayscale has sued the SEC for not granting
them that permission. Again, just think of how many investors
would have lost money, more money, if there had been a Bitcoin
spot ETF on the market.
So we kind of lucked out here a little bit, Senator,
because we had agencies, at least some agencies, that were
willing to do the right thing even though in many cases it was
not popular.
And I think going forward we need to have a clear
regulatory framework, as I address in my written testimony, to
make sure that crypto does not integrate into the traditional
financial system because they are continuing to try and they
will not stop.
Senator Smith. Well, you just laid out, I think, so many of
the concerns that I have with this whole field. And as you say,
there is sort of this imprimatur of reasonableness and
trustworthiness because of the terms that are used and because
of the ways--you know, as you say, the very typical financial
terms that people are sort of familiar with.
Yet, you take this thing that is supposedly--we have been
calling it a digital asset, but it is not clear to me whether
many of these so-called assets are not just a bet because this
will just like go back to this for 1 minute. I mean, if there
is no underlying value, then you are really just betting on
whether it is going to go up or go down, whether you are going
to win or you are going to lose. And that, I think, is my great
concern.
And I appreciate your comments on how it does seem to me
that in this field there are people that are being--you know, a
lot of people that are losing money and are being taken
advantage of when they should be--know that in this category
that there are some basic consumer protections that are going
to protect them.
Thank you, Mr. Chair.
Chair Brown. Thank you, Senator Smith.
Senator Tillis from North Carolina is recognized.
Senator Tillis. Thank you, Mr. Chairman. Welcome to all of
you for being here.
If we take a look at this Congress, you have to kind of
sort of out what the art of the possible is. Every Congress is
a little bit different. We have a divided Government here. And
while I hope we can look at some big things, I am really
wanting to get down into some singles and doubles.
Professor, I heard you talk about an idealized framework
from your perspective. That is a big lift and not likely to
occur. What I am also worried about is with the lack of
information that we could overreach.
And, Professor Jeng, you mentioned GDPR. I followed that
fairly closely. It was a good, broad regulatory construct that
has met with some challenges. They have to go back and refine
it. So I think we need to get it right.
So I tend to be more on the lean, singles and doubles
approach to addressing some of the problems in building over
time. I thought that Senator Vance's analogy on the internet
was a good one.
Now we have a hearing downstairs right now talking about
protecting our children on the internet. We have got a lot of
work to do in that space, but I think overreaching could have
set us back by a decade or generation of innovation.
So one of the things that we have looked at that I do not
think would be particularly controversial but what I would put
in the single or double category is a proof of reserves
requirement. If we saw that in the FTX world, we could have
avoided some of that.
So, number one, what is your thought, if we can be quick? I
want to at least get two questions in, but--you know. What are
your thoughts on things like proof of reserves and other things
that Congress can act on?
I do not find a lot of comfort in knowing that Mr. Gensler
thinks he has full authority to implement a regulatory regimen
because I think he has been going a little bit too fast and a
little bit too expansive on rulemaking, which is why I hope
that Congress will act so that we get this right. So give me
some ideas on singles and doubles.
Mr. Reiners. Yeah, so I appreciate the question, Senator.
You know, frankly, proof of reserves are not worth the paper
that they are written on, and I would just point to the so-
called proof of reserves that Binance had for Mazars until
Mazars pulled it off of their website and stopped doing any
work for crypto.
Senator Tillis. Is proof of reserves not a worthwhile
pursuit or is----
Mr. Reiners. So audits are a worthwhile--so I think--no. So
I think audits are a worthwhile pursuit, and I think that is a
single certainly that this Congress should look at. There is no
reason that crypto intermediaries, exchanges, should not have
full audits, but proof of reserves are not full audits.
Senator Tillis. We were talking about an independent third
party reporting to the Treasury, so I think that may address
the point you were making about worth the paper that they are
written on.
Mr. Reiners. Yeah. Now I would say one other sort of single
is requiring these crypto platforms to segregate firm assets
from customer assets.
Senator Tillis. Yep. Professor Jeng.
Ms. Jeng. Proof of reserves can be defined a number of
ways. At its simplest, it is like balancing your checkbook. And
you could do that either through gap accounting disclosures or
on-chain confirmations or supervisory exams, and so whatever
method is chosen, it is just about verifying what is on-chain
as well as what is off-chain.
Senator Tillis. Yeah. And by the way, maybe we need to get
your opinion, but on the proof of reserves bill that we are
working on in our office, we are trying to deal with comingling
of customer funds. I think the things that you are getting at,
so really making it have teeth.
But I will go to you, Ms. Yadav.
Ms. Yadav. Thank you so much, Senator. Proof of reserves is
something that is ones and twos here, to make sure that the
methodology is clear, to make sure that the methodology is
robust. What that means is that the liabilities are being fully
disclosed. One of the problems right now is that it is not
clear whether the liabilities that are being disclosed are in
fact comprehensive, and so the ability to have third-party
audits, as you suggest, that are robust and that are done
systematically.
In addition, also, we need to make sure that we have the
internal controls that go into and underlie the proof of
reserves. For example, it is not enough simply just to
disclose. It is important that the actual exchange has internal
controls that can make sure that these assets are properly
segregated, that the valuation of these assets is done as mark-
to-market on a very regular basis, and that the proof of
reserve disclosures are done regularly. Giving us a snapshot
once every 3 months is not going to be enough. These are things
that are changing every day.
In addition, also, it is not just proof of reserves. It is
proof of solvency. Now one of the things that is emerging in
these different exchanges is that many of the balance sheets
are made up of these, you know, coins that essentially they are
minting themselves and the valuation there is not clear. In the
case of FTX, for example, the FTT token has fallen
precipitously in value. The exchanges' own tokens in the case
of Binance and others are constantly volatile.
And so making sure that we have not just the disclosure of
the reserves but also making sure that the assets that are
being held are liquid and tradable. One of the issues with
these assets that is happening here, you know, is that the
market for trading them is extremely thin, and so the ability
for folks to cash out is, you know, is limited by the fact that
the actual exit is much, much, much less liquid than a proof of
reserve by itself might suggest. So that is another thing that
would be important to take into consideration.
Senator Tillis. Thank you all.
Chair Brown. Thank you, Senator Tillis.
Senator Warren of Massachusetts is recognized.
Senator Warren. Thank you, Mr. Chairman. So big time
financial criminals love crypto. Just last year, just in 1
year, crypto was the payment method of choice for international
drug traffickers who raked in over a billion dollars through
crypto, North Korean hackers who stole $1.7 billion and
funneled that money into their nuclear program, and ransomware
attackers who took in almost $500 million. The crypto market
took in $20 billion last year in illicit transactions, and that
is only the part we know about. You know, that is a lot of
fentanyl and heroin, a lot of help for Iran and Russia, and a
lot of money leaking out to terrorists, and that is precisely
what anti-money laundering rules are designed to stop.
Now, Mr. Reiners, you have studied financial technologies,
including crypto, for many years now, and before that you
worked as a regulator. Why do drug lords and human traffickers
and countries like North Korea and Iran use crypto instead of
banks and credit unions or even Western Union?
Mr. Reiners. Thank you, Senator. So crypto's pseudonymity
makes it ideally suited for bad actors, and when you couple
that with the fact that crypto transactions are not subject to
the same AML and countering the financing of terrorism----
Senator Warren. AML, meaning anti-money laundering.
Mr. Reiners. Anti-money laundering and countering the
financing of terrorism statutes that traditional financial
transactions are subject to. Again, that just, you know, makes
it ideally suited for people that want to do bad things.
Senator Warren. So in other words, crypto helps those drug
traffickers and rogue States launder money nearly
instantaneously. Is that right?
Mr. Reiners. That is correct.
Senator Warren. All right. And if they could not use
crypto, would ransomware gangs even exist?
Mr. Reiners. No.
Senator Warren. And why is that?
Mr. Reiners. Because ransomware is the exclusive payment
method of choice for ransomware hackers.
Senator Warren. You mean crypto?
Mr. Reiners. Sorry. Crypto is the exclusive payment method
of choice for ransomware hackers.
Senator Warren. A hundred percent. Wow. So we have money
laundering rules that cover banks and credit unions and stock
brokers and gold dealers and even Western Union, but the
current rules do not cover big parts of the crypto industry,
and crypto likes it that way. In fact, the crypto industry
claims that applying anti-money laundering laws to the whole
crypto industry is ``not only unnecessary, but it is all but
impossible.''
By the way, this is not a new claim. In 1970, Congress
decided it was time for financial institutions to do their part
to prevent money laundering, so it passed the Bank Secrecy Act
or BSA. The banking industry objected, claiming that complying
would be ``a tremendous expense as well as a pain the neck.''
The banks resisted. They brought legal challenges. They
complained that it would be impossible to comply. And then
after the law went into effect, they made it work.
Now the crypto industry explains that they are amazingly
innovative and creative, but they just could not possibly
figure out a way to comply with the same anti-money laundering
rules that everybody else follows.
So, Mr. Reiners, do you buy the industry's argument that
crypto is simply too special to follow anti-money laundering
rules and that it would be too hard for them to even try?
Mr. Reiners. I do not, Senator.
Senator Warren. All right. Some in the crypto industry say
that anti-money laundering rules can work so long as they
exempt so-called decentralized entities--the crypto exchanges,
lenders, and other financial intermediaries that run on code.
In other words, they want a giant loophole for DeFi written
into the law so they can launder money whenever a drug lord or
a terrorist pays them to do so.
Now that is exactly what Colorado-based crypto exchange
ShapeShift did when it deliberately restructured itself as a
DeFi platform, and here is what it told its customers: They
said, we are making this shift ``to remove itself from
regulated activity.'' Translation: Launder your money here.
Mr. Reiners, should Congress be in the business of creating
loopholes for money laundering?
Mr. Reiners. They should not.
Senator Warren. All right. Look, the rules should be
simple. Same kind of transaction, same kind of risk means the
same kind of rules. And that is why Senator Roger Marshall and
I are reintroducing our anti-money laundering bill, to clamp
down on crypto crime and to give regulators the tools they need
to stop the flow of crypto to drug traffickers and places like
North Korea and Iran.
Chair Brown. Thank you, Senator Warren.
Senator Hagerty of Tennessee is recognized.
Senator Hagerty. Thank you, Mr. Chairman, and I want to
thank our witnesses for being here today, including Professor
Yadav, who is from my home State of Tennessee and also from my
alma mater of Vanderbilt. Welcome to all of you.
I think it is imperative that we continue to discuss
digital assets because America's national and economic security
are greatly enhanced by the preeminence of our financial
system, and in order to maintain this immense competitive
advantage, we have got to stay abreast of innovation. This
involves embracing technological advancements, as unusual as
they may seem, in order to preserve our economic strength and
our strength as an ally and an enforcer on the global stage.
Blockchain technology represents one of these areas of rapid
innovation, and rather than incentivize their movement
offshore, we should work to foster a safe and certain
environment for them to flourish here in the United States.
So, Professor Jeng, I would like to start with you. In your
testimony, you highlighted the importance of payment tokens,
like stablecoins, to the digital asset ecosystem. And I agree
with this characterization as not only will these tokens help
usher in faster and cheaper payments for Americans, but if
allowed to develop they will also advance the role of the U.S.
dollar abroad.
However, as you also mentioned, trust in the assets backing
such tokens is crucial. Unless users are confident in what is
backing these tokens, their adoption will be severely
constrained. That is why I introduced a straightforward and
light-touch bill last year to set the standards for assets
backing stablecoins and to require their issuers to publish
audited reports of their reserves.
So, Professor Jeng, do you believe, like many of those who
are hostile to the technology, that only a Central Bank Digital
Currency issued by the Fed can serve the function of a payment
token?
Ms. Jeng. Thank you, Senator, for this important question
because there are certainly different types of ways to transfer
value. CBDCs definitely could be one of them.
Senator Hagerty. But not exclusively then.
Ms. Jeng. But not exclusively. What is----
Senator Hagerty. I agree. I want to keep moving because I
have a lot to cover today. What kind of legal clarity would be
necessary to help encourage the adoption of stablecoins other
than the one that we just spoke about issued by the Fed?
Ms. Jeng. I think it is very important that we have a clear
regulatory framework that utilizes public feedback. What we
have been missing has been rulemakings through the public
process, and we need public input. Regulators need to better
understand the technology and also gather the best ideas out
there on how to oversee the industry.
Senator Hagerty. Yes. No, you made this clear when you
cited the fact that there have only been two sort of minor
rulemaking activities by each of the SEC and the CFTC while
there have been 30 of these retroactive litigation cases at the
SEC and 18 at the CFTC. That is not the way to run things--in a
hindward-looking, piecemeal basis.
Let us turn on now to something that is concerning me very
much. In the past few weeks, there has been a coordinated
chorus of regulators talking about severing crypto from our
financial system. To me, this really feels reminiscent of
Operation Choke Point, an exercise under the Obama
administration that I strongly, strongly disagreed with. In
Operation Choke Point, politically disfavored entities,
although legal, were cutoff from banking services in order to
achieve partisan gains.
At the same time, I have heard from some of my colleagues,
particularly on the other side of the aisle, that they are fine
with not regulating crypto, just let it go overseas, and not
legitimize it.
But to that, I say, what happens to the hundreds of
thousands of users from Tennessee that are already transacting
in crypto? Are we simply not going to create safeguards to
protect these consumers? And, where do U.S.-based crypto
innovators go?
To that end, Congress needs to write legislation to
properly regulate this industry so we can protect consumers and
remain at the cutting edge of a rapidly evolving space. It is
becoming increasingly apparent that the SEC is not going to do
its job. So it is on us, now more than ever, to make sure that
we have proper safeguards in place and to make certain that
another FTX-like event never happens again.
So, Professor Jeng, what effect would a wholesale debanking
of the crypto industry have on the industry's activity here in
the United States and globally?
Chair Brown. Professor Jeng, please be brief in your
answers. We have one more witness, and Senator Scott and I are
late to vote. So that is our fault, not yours, but be brief
with your answer if you could. Thank you.
Ms. Jeng. The crypto industry is an industry that needs
access to banking services. If it does not have access to
banking, it will either go offshore or into shadow banking,
again bifurcating the U.S. financial system, to which our own
U.S. regulators would not be able to see and monitor and
regulate those parts of that system where they have fled to,
and then if it were to be offshored to other countries, those
countries would end up having leadership in digital innovation.
Senator Hagerty. Just like Binance, and Binance will laugh
all the way to the bank. Thank you.
Chair Brown. Thank you, Senator Hagerty. I apologize for
doing that.
Senators who wish to--thank the witnesses.
Senators who wish to submit questions, those questions are
due 1 week from today, Tuesday the 21st. Witnesses will have 45
days to respond to any questions.
Thank you again. The hearing is adjourned.
[Whereupon, at 12:05 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIR SHERROD BROWN
What a difference a year makes.
Go back to last year's Super Bowl. The cryptocurrency industry
spent a whopping $54 million on eight ads, promising Americans untold
riches and the chance to make history. Of course, they didn't tell us
about the high fees, risk of loss, and outright theft that plagued the
crypto industry.
But if you watched the Super Bowl 2 nights ago, you didn't see a
single ad for crypto.
The cryptocurrency industry has imploded. In 2022, the crypto
market lost $1.46 trillion in value. Hackers and fraudsters--often tied
to the regimes in Pyongyang and Moscow--have stolen over $3 billion.
Crypto firms have slashed over 1,600 jobs.
And as crypto values crashed last year, platforms began collapsing,
creating more losses across the rest of the crypto ecosystem. The
crypto firms that are left have had to halt customer withdrawals,
freezing people out from their own money.
While crypto contagion didn't infect the broader financial system,
we saw glimpses of the damage it could have done if crypto migrated
into the banking system. And the handful of banks with close ties to
the crypto industry have needed liquidity lifelines after they suffered
large withdrawals.
This nightmare isn't over yet--we are still learning the full
extent of the fallout from the FTX collapse. In December, this
Committee heard about the excessive risk taking and misconduct at FTX.
The customers who lost money are only now understanding the reality of
the products they were sold.
As these crypto firms filed for bankruptcy, regulators, and
policymakers have also learned how out-of-control some of those
businesses were.
They were over-leveraged and undercapitalized. They had no internal
risk controls. They were careless with customers' money. In the case of
FTX, they used it to line their own pockets. Now the money of millions
of Americans is trapped and they might never get it back.
Last year I warned that the splashy Super Bowl ads left out key
details. A year ago, I said:
Big crypto companies are looking to make big profits and
are desperate to reach as many Americans as they can. They
brought in celebrities and gimmicks to make crypto sound
exciting and daring . . . and profitable.
But the ads left a few things out.
They didn't mention the fraud, scams, and outright theft.
The ads didn't point out that you can lose big in crypto's
huge price swings. They didn't tell you about the high fees
pocketed by the crypto companies.
And they sure didn't explain that crypto markets lack basic
investor protections and oversight.
The results were as predictable as they are tragic. And contrary to
crypto evangelists' claims of democratizing finance, it's not the early
adopters or big money investors who are left holding the bag. When it
comes to crypto, it turns out fortune doesn't favor the brave--it
favors wealthy insiders.
This isn't just about a few bad actors that didn't do things the
right way.
These crypto catastrophes have exposed what many of us already
knew: digital assets--cryptocurrencies, stablecoins, and investment
tokens--are speculative products run by reckless companies that put
Americans' hard-earned money at risk. Not surprising from an industry
that was created to skirt the rules.
Whether it's Facebook Libra or the explosion of crypto, I've always
been concerned about shiny new products that really just offer another
way to profit off the backs of working Americans while threatening the
real economy.
It's time now to consider how to protect consumers from unregulated
digital assets, and ultimately, who we want our financial system to
serve.
Last Congress, this Committee examined the risks of
cryptocurrencies to our economy, explored the mechanics behind
stablecoin companies, and looked at how regulators and Congress can
protect consumers.
We learned how crypto can be used to commit crimes like drug
running and human trafficking, which threaten our national security and
help fund terrorists and rogue regimes. We looked at how fraud and
speculation in the crypto market hurt investors and savers.
Recent crypto meltdowns have made clear that we need a
comprehensive framework to regulate crypto products to protect
consumers and our financial system.
Today, we'll examine how time-tested financial safeguards can help
protect against the harms and risks of crypto products.
And we'll start by taking a closer look at these basic principles
of regulation:
Clear disclosures and transparency that are essential so
retail customers and investors can understand how a token or
crypto platform works.
Prohibitions on conflicts of interest and self-dealing by
insiders is fundamental. Our markets only work when they work
for everyone.
Protecting customer funds by separating them from company
assets. Investor dollars cannot be a slush fund for the
executives' benefit.
Internal governance and risk management to make sure that
if a platform takes customer funds it acts prudently.
Strong consumer and investor rights and protections that
are foundation of trust in any financial system and central to
a functioning market.
Anti-money laundering and fraud prevention to make sure
malign actors and evil Nation States can't fund themselves and
evade law enforcement.
Oversight and supervision to hold companies accountable,
because access to our financial markets is a privilege not a
right that can be abused.
These are basic, commonsense principles that have developed over
centuries of financial system regulation--the wildcat money of the
1800s, the repeated banking panics of the Gilded Age, the 1929 stock
market crash, the savings and loan crisis, the dot-com bubble, the
Great Financial Crisis.
These crises are the story of speculative bubbles--fueled by
investor euphoria and the promise that ``this time is different''--even
though it never is. The lessons learned here are the product of hard-
earned experience--experience that is born of real people losing real
money and of dreams shattered.
Crypto isn't special. We can start with these commonsense
principles as we consider a regulatory framework for digital assets
that puts consumers first and keeps our financial system safe.
I trust this Committee can find common ground and work together to
protect investors from crypto risks.
______
PREPARED STATEMENT OF SENATOR TIM SCOTT
Before I dig into my opening comments, I want to address the
elephant in the room. If Chairman Gensler is going to take enforcement
action, Congress needs to hear from him very soon. The Chairman had
lots of time to do the rounds on the morning talk shows. If he has time
for that, he should be here testifying with us this morning. I hope
that we see him here very soon.
The free market economy was formed by financial innovation. It's
the engine that continues to drive our economy today. But every engine
needs fuel, and in order to advance as a country, we must continue to
grow and innovate in a safe and sound manner.
Innovation can increase access to traditional financial services
and may foster new, emergent technologies that promote financial
independence, access to credit, and capital formation. We all know and
understand how technology can improve our daily lives, from using our
phones to open a bank account to opening a digital marketplace. If we
foreclose financial innovation, we limit future generations from growth
and opportunity.
That said, financial innovation must be done so in a safe and sound
manner, which, unfortunately, has not been the case with a number of
actors in the digital asset space. Unfortunately, instead of protecting
customers' interests and using customer funds in the manner intended,
Sam Bankman-Fried, FTX's owner, stole millions of customer funds and
used them to finance risky bets and to pay for luxury penthouses in the
Bahamas.
When I consider this massive failure, I wonder, where were our
regulators when they supposedly already had these authorities?
In recent statements, the regulators, the SEC specifically, have
noted that it is the responsibility of crypto firms to comply with
existing regulations, but it is also the responsibility of regulators
to enforce existing regulations and to conduct appropriate, effective
supervision.
The American people deserve to know why no action was taken prior
to FTX's collapse and how millions of dollars of Americans' hard-earned
money just vanished into nothing. And it was not just FTX. If the SEC
had provided even the slightest bit of guidance, I wonder if we could
have protected more investors from the collapses of Terra and Luna in
May, Celsius in June, Voyager in July, and BlockFi in November.
This is particularly alarming when we see reports that 44 percent
of Americans who own and trade digital assets are new investors or
people of color. Which means when there is a $2 trillion drop in market
cap, our most vulnerable citizens bear the significant brunt.
We must hold companies that harm consumers accountable, but we must
empower consumers through financial education so that they can more
accurately understand the risk posed by different asset classes.
Whether it starts in the classroom or in the boardroom, financial
literacy provides an avenue for individuals to make better decisions
and climb the economic ladder.
Nonetheless, regulators have put their misplaced focus on
progressive social issues. So, we have to ask ourselves, where do we go
from here?
To date, the SEC has failed to take any meaningful, preemptive
action to ensure this type of catastrophic failure does not happen
again. If they have the tools they need, were they just asleep at the
wheel? If they don't, why aren't they here to tell us? We'd be happy to
have Chairman Gensler testify sooner than later.
Moving forward, we must take a thoughtful bipartisan and balanced
approach that protects consumers and promotes innovation and
opportunity.
I look forward to hearing our witnesses' perspectives on how we can
continue to drive innovation and opportunity while ensuring consumers
are protected.
Thank you, Mr. Chairman.
______
PREPARED STATEMENT OF LEE REINERS
Policy Director, Duke Financial Economics Center
February 14, 2023
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PREPARED STATEMENT OF LINDA JENG
Visiting Scholar on Financial Technology, Georgetown Institute of
International Economic Law, and Adjunct Professor of Law
February 14, 2023
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PREPARED STATEMENT OF YESHA YADAV
Vanderbilt University Law School
February 14, 2023
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RESPONSES TO WRITTEN QUESTIONS OF CHAIR BROWN
FROM LEE REINERS
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RESPONSES TO WRITTEN QUESTIONS OF
SENATOR FETTERMAN FROM LEE REINERS
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RESPONSES TO WRITTEN QUESTIONS OF
SENATOR FETTERMAN FROM LINDA JENG
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR LUMMIS
FROM LINDA JENG
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RESPONSES TO WRITTEN QUESTIONS OF CHAIR BROWN
FROM YESHA YADAV
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR LUMMIS
FROM YESHA YADAV
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Additional Material Supplied for the Record
LETTER SUBMITTED BY NAFCU
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STATEMENT SUBMITTED BY CHAMBER OF PROGRESS
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STATEMENT SUBMITTED BY ICBA
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LETTER SUBMITTED BY PROMETHEUM
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GWU LEGAL STUDIES RESEARCH PAPER, ARTHUR E. WILMARTH, JR.
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