If A Crypto Bill Passes this Congress, “It Would Be Fairly Miraculous”: A Q&A with Kathy Kraninger

The former director of the Consumer Financial Protection Bureau on crypto markets, regulation, and the unlikelihood of Congressional legislation any time soon.

Kathy Kraninger attends HOPE Global Forums Cryptocurrency and Digital Assets Summit on May 20, 2022 in Atlanta, Georgia. (Photo by Paras Griffin/Getty Images for Operation Hope) Getty Images for Operation Hope Getty Images for Operation Hope

Kathy Kraninger was the director of the Consumer Financial Protection Bureau from 2018 to 2021. Last year she we went to work for Solidus Labs, a New York-based company that supports transparency in the cryptocurrency and decentralized finance markets. Recently Observer executive editor James Ledbetter interviewed her; this transcript has been edited for length and clarity.

Observer: Tell me what is Solidus Labs and what do you do there?

Kraninger: I’m the vice president of regulatory affairs, coming off of a career 20 plus years, working for the US government, I was looking for a company in crypto because I thought this was a really exciting place to be. Solidus was founded the introduction and enhancement of market integrity in crypto in general. We’re experts in trading behavior and in setting up algorithmic trading, helping the traders understand what the lines are with respect to all of the legal and compliance requirements that exist in traditional finance. The founders were watching what was happening with respect to ICOs in 2017, they said, this industry really is missing market surveillance.

What does that mean “market surveillance”?

Pretty much 90% of trading activity is centralized off-chain, as opposed to being actually on-chain. Our bread and butter started as off-chain market surveillance. So looking for spoofing, front-running, wash trading, and then looking at the relationship between the transactions: fiat coming into the exchange, going out of the exchange, the tokens coming in and out of the exchange.

By way of analogy, just so readers can understand: Who performs that market surveillance function in traditional trading?

The exchanges do. They’re actually required to. There are third-party software service providers that do it for the exchanges in traditional markets. One of the big differences, though, in traditional markets, you have assets that are native to one exchange, and there’s an open and close to the markets. That is definitely not the world of digital assets.

How do you think the recent dramatic drop in crypto prices affects the regulatory environment?

The volatility in general of prices has been a concern to regulators because they can see obviously what that can do to consumers and retail investors. I think there is a general attitude or expectation that manipulation, pump-and-dumps are part of what is driving that volatility. It’s understanding that better and then saying, okay, what controls should be in place in this market, or be enforced?

One aspect of crypto that’s always troubled regulators is the propensity toward fraud and money laundering and other unsavory activity. Are there steps that the mainstream trading platforms can and should take to reduce that?

Absolutely. And in fact that they are taking. We at Solidus created a community of interest trying to highlight what the crypto industry is doing. A lot of attention anti-money laundering and Bank Secrecy Act compliance. Those rules are in place, but there wasn’t a lot of attention to market integrity and fraud beyond the big headlines of this awful event just happened. There are best practices that are followed by broker-dealers and market makers and others in this space to identify manipulation and to comply with codes of conduct that are out there.

The crypto sector has witnessed quite a few bankruptcies and consolidation in recent months. Do you think that helps or hurts the sector in terms of effective, transparent markets?

I think it’s a natural progression and an opportunity to really mature this industry. I think a downturn really gives people the opportunity the incentive to focus on infrastructure, to focus on the right behaviors. You hope and expect that those companies that are acting responsibly are the ones that are going to make it through, and have that be better for investors and consumers. So that’s what I see as a silver lining for the downturn of the moment.

Is there a risk, though, of creating a monopoly or an oligopoly of people who dominate the space, which is counter to the spirit of decentralized finance?

It is a definite paradigm shift here to get to decentralization. I think regulators have a role in that. Regulation is very much about the intermediaries that the regulators can really put a hold on and, enforce market conduct. And when you talk about the way defi is envisioned, uh, even though it’s not necessarily the way defi is operating right now, it really is about peer-to-peer and the elimination of those intermediaries. That’s the challenge that regulators are grappling with.

What is the logic behind having the Commodity Futures Trading Commission (CFTC) and not, say, the Securities and Exchange Commission or another body regulate crypto?

You have a system of securities and capital markets and capital formation that is oversee by the SEC. And then you’re going to have the dynamics around commodities and other assets that are not securities. Derivatives, options, futures, those are regulated by the CFTC. There is a bit of a gap here when you’re looking at this in terms of spot market oversight. That can be filled by Congress and many different bills right now are considering to have the CFTC oversee those spot markets.

That’s essentially what has been happening over time. It happened with foreign exchange. It happened with swaps. These markets look a bit like commodities markets, and they were put under the care of the CFTC.

You mentioned bills in Congress. Do you expect a significant piece of crypto or stablecoin legislation to pass this Congress?

This Congress? No. I spent half my career on Capitol Hill, I really don’t expect it. If it happens, it would be fairly miraculous. There are definitely some narrow issues that in an end-of-year bill could potentially make their way through. In coming years, there is the opportunity for stablecoin legislation. It’s definitely a conversation globally. And I think there are dangers to the US not actually leading, and as I noted, spot market oversight is really only something Congress can solve. If A Crypto Bill Passes this Congress, “It Would Be Fairly Miraculous”: A Q&A with Kathy Kraninger