• As recent events have underscored, there is an urgent need for policymakers to provide regulatory clarity to the digital asset markets and ensure that all participants are brought inside a regulatory perimeter. In the absence of clear rules of the road, digital asset markets will continue to evolve in ways that could pose risks to investors and potentially even financial stability.
• In particular, regulated financial institutions with strong risk management expertise will remain reluctant to participate in these markets, thereby exacerbating risks in the digital assets’ ecosystem, while the benefits of new blockchain technologies for financial markets and end-users will not be fully realized.
• Given this context, we welcome the ongoing efforts of the Biden Administration and congressional leaders with respect to digital asset policy. We encourage them to consider a few key guiding principles as they make policy in this area, as articulated in our recent letter to key congressional committees.
• Those principles include putting investor protections at the forefront of any policy action; adopting a “technology neutral” approach that follows the “same risk, same activity, same regulatory outcome” principle; distinguishing between “native blockchain” assets^[1] and the use of blockchain technology to facilitate “traditional” asset transactions; and applying, with appropriate modifications, existing and well-understood regulatory frameworks to digital assets.
• Using stablecoins as an example, we discuss how existing regulatory frameworks could be applied based on product attributes and the underlying business model involved.

Introduction

As recent events have demonstrated, there is a clear need for policymakers to take action to regulate all aspects of the evolving market for digital asset products and services.  Without clear rules of the road that apply to all actors in the digital assets’ ecosystem, it will be difficult to build investor confidence in these developing markets or facilitate responsible innovation. Established and regulated financial institutions will be reluctant to participate in digital asset markets or adopt blockchain technology solutions that could provide significant efficiencies and other benefits for market participants. Without clear oversight and the participation of regulated financial institutions that operate robust risk management and compliance systems, digital asset markets will continue to evolve in ways that could pose risks to investors and the stability of the financial system; at the same time, without the participation of mainstream, regulated financial institutions, the benefits of new blockchain technologies for financial markets and end-users will not be fully realized.

That is why it is crucial that policymakers act with deliberate speed to provide greater regulatory clarity and structure to the digital assets’ ecosystem, and bring currently unregulated parts of the market inside a regulatory perimeter. The Biden Administration has taken some steps in this direction, with President Biden signing an Executive Order in March 2022 that directed executive branch agencies to undertake a “whole-of-government” approach to “addressing the risks and harnessing the potential benefits of digital assets and their underlying technology.”^[1] Since then, the U.S. Treasury, Commerce, and Justice Departments, as well as the Financial Stability Oversight Council (“FSOC”), have put out a series of reports that identify potential solutions to address gaps in digital assets policy.^[2] Those solutions are both regulatory and legislative, highlighting the important role of Congress in providing structure and legal certainty for this developing market. Indeed, many members of Congress have either introduced or are considering a variety of bills that would address gaps in the regulation of these markets.^[3]

The Key Principles That Should Guide Digital Assets Policy

We believe that there are a few key principles, as articulated in our recent letter to key congressional committees, that should guide the efforts of members of Congress, the Administration, and regulatory agencies as they consider these issues.^[4] First, as discussed below, investor protection should be at the forefront of digital asset policymaking. Recent events implicating different elements of the novel, but increasingly complex, digital asset ecosystem underscore the importance of prioritizing investor protection to building confidence these markets.

Second, as the recent FSOC report noted,^[5] digital assets regulation should be “technology neutral” and follow the basic principle of “same risk, same activity, same regulatory outcome”; that is, the underlying risk and regulatory treatment of a particular activity should not be affected by the technology used to conduct that activity, and regulatory results should be the same for similar types of risks and activities. This latter principle means that currently unregulated activities should be brought inside a regulatory perimeter. It does not, however, mean that there should be a “one-size-fits-all” regulatory framework: businesses differ in scale, business model, and scope of services, with some regulated as banks and others as broker-dealers or asset managers, while others are regulated at the state rather than the federal level. Similarly, digital asset products will have different underlying attributes and risk-profiles that will affect whether they are regulated as bank-like, securities-based, or commodity-like products. The key is that the regulatory outcome should be similar for similar activities and similar risks, not that the regulatory framework be identical for every business entity and product.

Third, and related to the technology neutrality principle, policymakers should distinguish between blockchain technology used solely to support “traditional” assets and native blockchain assets.  There is a range of opportunities for financial institutions to use blockchain technology to improve the processes supporting traditional assets, from clearance and settlement to asset servicing to information management, all of which can enhance efficiency and reduce risk.  These blockchain-driven enhancements of the infrastructure and processes supporting traditional assets should generally be outside the scope of new digital asset regulations. An example of this would be using blockchain technology to record information as part of a financial institution’s books and records functions. These processes – which are already subject to existing supervisory approval, review, and oversight by the financial institution’s regulators – are using new technology to perform existing functions for traditional assets. As such, they should not be subject to additional digital asset-related regulation.

Finally, for these new classes of assets, policymakers should leverage or apply existing and well-understood regulatory frameworks, rather than creating an entirely new regulatory architecture. Our existing regulatory frameworks, particularly their strong investor protections, have helped make the U.S. financial markets the strongest and most resilient in the world, and they have proved adaptable to prior waves of innovation and the introduction of new types of assets. As discussed below, there is no reason they cannot be applied, with some thoughtful modifications to account for the unique features of blockchain technology and the still-developing nature of this novel class of assets, to most digital asset products.

The Importance of Ensuring Robust Investor Protections

Protecting investors needs to be the cornerstone of any legislative or regulatory action related to digital assets. Without robust investor protections, it will be impossible to build confidence in the integrity of digital asset products and markets, inhibiting their growth, and diminishing the potential benefits that these new technologies can offer investors, and ceding leadership in these markets to other jurisdictions around the world. Although the underlying attributes of digital assets will affect how they are treated for legal purposes and the type of supervision they will be subject to (see below), U.S. securities regulation offers a guide to the types of protections that should be applicable broadly to digital asset products and markets.

Robust investor protections are at the forefront of U.S. securities regulation across the securities lifecycle, from securities issuance to trading to clearance and settlement. Investors are protected by a mature and tested disclosure-based regulatory regime that gives investors access to timely and updated information on issuers and other market participants. In addition, investors are protected by a broad set of safeguards that require market participants to, among other things, “know their customers,”^[6] protect vulnerable individuals from financial exploitation,^[7] protect investor privacy and data, put their investors’ best interests first when recommending a transaction,^[8] comply with robust regulatory requirements regarding custody and segregation of customer assets,^[9] and abide by a range of rules governing markups, commissions, and fees.^[10]  Moreover, investors are protected by a strong regulatory oversight regime that continually reviews for compliance with these investor protection rules.

As policymakers consider legislative and regulatory actions to support the development of the digital asset marketplace in the U.S., they must remember that the strength of our financial markets is rooted in the strong protections our current regulatory regime provides to investors. We should lean into and build upon this strong investor protection regime so that the U.S. can continue to lead in the digital assets and infrastructure space.

Extending Existing Regulatory Frameworks to Digital Assets: Stablecoins as an Example

As noted above, new entities and digital asset products should generally be accommodated within existing regulatory frameworks, albeit with modifications that reflect the unique ways in which blockchain technology functions and that recognize these assets and markets are still evolving. In determining which regulatory framework should apply to a particular digital asset product, it is vital to consider its underlying attributes and business model(s) involved.

Take stablecoins as an example. Stablecoins are not a single category of instruments; they have a wide range of different attributes, including whether they pay interest, the mechanisms used to maintain stable value (i.e., whether fiat currency-backed, commodity-backed, crypto-backed, or algorithmically-backed), and how they are offered, sold, and used within the crypto asset ecosystem.  It is precisely such attributes of a stablecoin and the related business model(s) that should inform how it is regulated.  For example, a stablecoin that is backed by cash and cash-like instruments may, in appropriate circumstances,^[11]  be treated in a similar manner to a bank deposit – that is, subject to banking laws and regulations and oversight by bank regulators. Alternatively, a stablecoin that meets the definition of a “security” as defined by the federal securities laws and interpreted by Supreme Court precedent^[12] should be subject to the federal securities laws and regulation and oversight by the Securities and Exchange Commission (“SEC”).^[13] In short, the attributes of a product, not its label, should determine whether it is a security, commodity, or bank-like instrument, and therefore inform the appropriate regulatory framework under which it should be governed.

As policymakers continue to consider legislative and regulatory action, they should also bear in mind the full range of non-bank and state regulatory frameworks that currently apply to products, activities, and entities involved in the digital asset marketplace. While still nascent, many digital asset brokerage and derivatives activities should be regulated at the federal level under existing SEC and Commodity Futures Trading Commission (“CFTC”) frameworks (i.e., they should be subject to regulation at a “functional” or business model level). Other developing activities, such as issuing a reserve-backed “payment stablecoin” could be governed under federal or state regulatory regimes, providing that both sets of regimes lead to comparable regulatory outcomes. In short, the existing regulatory frameworks at both the functional federal and state level should generally be extended to digital assets and the entities working with them. This would bring unregulated parts of the market into a regulatory perimeter but permit appropriate diversity in regulatory approaches according to the underlying business model and type of product.

Conclusion

We welcome the important work that the Administration and members of Congress have undertaken to date in this important area and encourage them to move with deliberate speed to fill regulatory gaps in the digital assets ecosystem.  As they undertake this important work, we believe that they should apply the principles outlined here. It is crucial that investor protection is at the forefront of any legislative or regulatory action in order to build confidence in these still evolving markets; that our existing regulatory regimes and their robust investor protections should, with appropriate modifications, be applied to digital asset products, activities, and businesses; that regulation be technology neutral and follow the principle of “same risk, same activity, same regulatory outcome”; and that regulation clearly distinguish between the treatment of “native blockchain” assets and the use of blockchain technology to facilitate transactions of “traditional” assets.

Dr. Peter Ryan Managing Director and Head of International Capital Markets

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^[1] A native blockchain asset is a blockchain’s inherent digital currency or base token of a blockchain.

^[1] See, e.g., Exec. Order No. 14067, 87 Fed. Reg. 40881 (July 8, 2022); White House, Fact Sheet: White House Releases First-Ever Comprehensive Framework for Responsible Development of Digital Assets (2022).

^[2] U.S. Department of Treasury, Report on The Future of Money and Payments (2022); U.S. Department of Treasury, Report Crypto-Assets: Implications for Consumers, Investors, and Businesses (2022); U.S. Department of Treasury, Action Plan to Address Illicit Financing Risks of Digital Assets (2022); Press Release, Janet Yellen, Sec’y, U.S. Department of Treasury, on the Release of Reports on Digital Assets (Sept. 16, 2022); U.S. Department of Justice, Office of the Attorney General, The Role Of Law Enforcement In Detecting, Investigating, and Prosecuting Criminal Activity Related To Digital Assets (2022); Press Release, U.S. Department of Justice, Justice Department Announces Report on Digital Assets and Launches Nationwide Network (Sept. 16, 2022); U.S. Department of Commerce, Responsible Advancement of U.S. Competitiveness in Digital Assets (2022); Press Release, Statement from Gina M. Raimondo, Sec’y, U.S. Department of Commerce, Responsible Advancement of U.S. Competitiveness in Digital Assets Report Release (Sept. 16, 2022); Financial Stability Oversight Council (FSOC), Report on Digital Asset Financial Stability Risks and Regulation (Oct. 3, 2022).

^[3] A number of digital assets bills have either been introduced or have been reported on in the media. House Financial Services Committee Chair Rep. Maxine Waters (D-CA) and Ranking Member Rep. Patrick McHenry (R-NC) have been reported to be considering a draft bill focused principally on payment stablecoins; Sen. Pat Toomey (R-PA) has also introduced stablecoin legislation in the form of the “TRUST Act.” Other bills include the Responsible Innovation Act, introduced by Sen. Cynthia Lummis (R-WY) and Sen. Kirstin Gillibrand (D-NY), which would create a comprehensive regulatory framework for digital assets; the Commodities Consumer Protection Act, introduced by Sen. Debbie Stabenow (D-MI) and Sen. John Boozman (R-AR), which would give CFTC exclusive jurisdiction over digital commodities trades and make it the primary regulator of cryptocurrencies; the Virtual Currency Tax Fairness Act, introduced by Sen. Toomey and Sen. Gillibrand, which would simplify the use of digital asses for everyday purchases by creating a de minimis tax exemption; and the Digital Trading Clarity Act, introduced by Sen. Bill Hagerty (R-TN), which would provide exchanges with a safe harbor from SEC regulation under specified circumstances.

^[4] SIFMA, Prioritizing Investor Protection and Existing Regulatory Frameworks in Digital Asset Legislation, Letter to Senate Banking Committee, Senate Agriculture Committee, House Financial Services Committee, and House Agriculture Committee (Oct. 11, 2022).

^[5] FSOC Report, Section 5.1 Consideration of Regulatory Principles, pp. 111-112.

^[6] FINRA Rule 2090.

^[7] FINRA Rule 2165.

^[8] SEC Regulation BI. See also FINRA suitability rule (FINRA Rule 2111).

^[9] SEC Rule 15c3-3 (securities broker-dealer customer protection rule) and SEC Rule 206(4)-2 (securities investment adviser custody rule).  The SEC’s net capital rule (15c3-1) and customer protection rule (15c3-3), for example, form the foundation of the securities industry’s broker-dealer financial responsibility framework. The net capital rule focuses on liquidity and is designed to protect securities customers, counterparties, and creditors by requiring that broker-dealers have sufficient liquid resources on hand at all times to satisfy claims promptly. SEC Rule 15c3-3, or the customer protection rule, which complements rule 15c3-1, is designed to ensure that customer property (securities and funds) in the custody of broker-dealers is adequately safeguarded and segregated.

^[10] FINRA Rules 2121 and 2122.

^[11] For example, where the stablecoin does not promise or provide exposure to the investment return on the underlying instruments in the reserve.

^[12] See Section 2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange Act of 1934. See also SEC v. W.J. Howey Co., 328 U.S. 293 (1946) and Reves v. Ernst & Young, 494 U.S. 56 (1990).

^[13] As a result, the treatment of different types of stablecoins may, depending on their attributes, be analogous to the way that bank sweep programs operate today, where cash may be swept into either a deposit account at a bank (subject to bank regulation and oversight) or invested in a money market mutual fund (a security) at a financial services firm (subject to SEC regulation and oversight).

Related Resources

• Comment Letter

  Prioritizing Investor Protection and Existing Regulatory Frameworks in Digital Assets Legislation

• Issue Page

  Digitization