Digital Assets Amongst Vulnerabilities Within The US Financial System – Report

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The Financial Stability Oversight Council (FSOC) released its 2022 Annual Report following approval by its voting members on December 16, 2022. According to the report, digital assets were amongst the vulnerabilities identified within the United States (U.S.) financial system.

The FSOC is a federal government organization charged with identifying risks to the financial stability of the United States, promoting market discipline by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the U.S. government will shield them from losses in the event of failure, and for responding to emerging threats to the stability of its financial system.

An October 2022 FSOC Report on “Digital Asset Financial Stability Risks and Regulation” found that financial stability vulnerabilities with respect to digital assets arose firstly from the interconnections between the digital asset ecosystem and the traditional financial system and secondly from the digital asset ecosystem. The report recommended that members continue to enforce existing laws by applying following the principle of “same activity, same risk, same regulatory outcome”.

The FSOC 2022 Annual Report identified gaps in the regulation of crypto-asset activities within the U.S. and made recommendations to address the gaps.

The first gap that the annual report noted was that the spot markets for crypto-assets that are not securities were subject to limited direct federal regulation. The council recommended that Congress pass legislation that provides for explicit rulemaking authority for federal financial regulators over the spot market for crypto-assets that are not securities. 

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The second gap identified was that crypto-asset market businesses did not have a consistent or comprehensive regulatory framework and could engage in regulatory arbitrage. To reduce the risk of regulatory arbitrage, the Council recommended continued coordination, legislation addressing the risks posed by stablecoins, legislation relating to regulators’ authorities to have visibility into and supervise the activities of all of the affiliates and subsidiaries of crypto-asset entities, and appropriate service provider regulation. 

The third gap identified was that a number of crypto-asset trading platforms have proposed offering retail customers direct access to markets by vertically integrating the services provided by intermediaries such as broker-dealers or futures commission merchants. The Council recommended that member agencies assess the impact of potential vertical integration by crypto-asset firms.

Finally, the Council recommended that Council members continue to build capacities related to data and the analysis, monitoring, supervision, and regulation of crypto-asset activities.

Crypto asset prices have declined in 2022, with the total crypto market cap dropping from a US$ 2.3 trillion at the start of the year to around US$ 900 million, as at press time. A number of crypto companies have also wound down, with FTX making the news headlines when it filed for bankruptcy in November 2022. The crypto events of 2022 are likely to have a significant impact on the future of crypto.