Can Congress Actually Regulate Crypto?

Holding dramatic hearings is all well and good. But Congress is hamstrung in a number of ways that make effective legislation unlikely or even impossible. Is there a way to regulate crypto?

CEO of FTX Sam Bankman-Fried testifies during a hearing before the House Financial Services Committee at Rayburn House Office Building on Capitol Hill December 8, 2021 in Washington, DC. (Photo by Alex Wong/Getty Images) Getty Images

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Congressional committees are drawn to financial scandal; it makes legislators look serious, and can occasionally provide excellent political theater. But as the world witnessed in the aftermath of the GameStop/Robinhood tornado, there’s not necessarily much that Congress can do to prevent future scandal, especially in an atmosphere that is allergic to new legislation.

Congressional hearings following the FTX meltdown are evoking a similar pointlessness. Yes, there is a widespread sense that “more regulation” is needed. But in part because the underlying regulatory structure is so rickety, there is little consensus about where and how cryptocurrency regulation could be effectively increased.

Moreover, a hearing about FTX at least implies that Congress can somehow wave a legislative wand to prevent a future Sam Bankman-Fried from bilking customers out of billions of dollars. But it’s far from clear that many of the actors in December 13’s House Financial Services Committee hearing actually believe that. Nydia Velásquez (D-NY) asked John Ray III, the CEO who’s taken over FTX in its bankruptcy period, if there was anything particular he’d learned that he would urge the committee to consider in drafting new legislation. Ray declined to offer any advice beyond an almost tongue-in-cheek: “You need records, you need controls, and you need to segregate people’s money.”

Of course, even if Congress can’t prevent fraud by passing a new law—by definition, everything the US Attorney’s indictment accuses Bankman-Fried of is already illegal—it could in theory require more stringent registration and reporting requirements for companies that want to run exchanges and other crypto transactions. But here, too, satisfaction is elusive.

FTX is based in the Bahamas, and most of its trading activity took place outside the United States. Many within the crypto world argue that stricter US regulation will only push crypto companies offshore, to more relaxed jurisdictions like the Bahamas, and thus encourage fraud. FTX certainly seems like a case in point (as rival Coinbase (COIN) is exploiting in a current ad campaign, touting its US headquarters). The flip side of that: LedgerX, a crypto futures exchange that FTX bought in October 2021, is in fact registered with the Commodity Futures Trading Commission (CFTC); it is said to be solvent and is not part of the FTX bankruptcy, and will likely be sold to help pay off FTX’s creditors.

And yet, the CFTC is no panacea, either. As self-proclaimed crypto enemy Brad Sherman (D-CA) pointed out in the hearing, Bankman-Fried spent a lot of time and money on Capitol Hill advocating for “a patina of regulation, baby regulation, from the CFTC,” a smaller agency than the Securities and Exchange Commission (SEC). Some of that advocacy came in the form of campaign contributions; on December 15, the New York Post compiled a list of donations from FTX to the members of the House Financial Services Committee, and the company’s political influence extended well beyond that. Whether the money achieved its goal is highly debatable. Earlier this year, at least two prominent bills were introduced into the Senate that would give the CFTC official authority over cryptocurrency, first from the crypto-friendly Cynthia Lummis (R-WY) pairing with New York’s Kirsten Gillibrand, and later from Senators Debbie Stabenow (D-MI) and John Boozman (R-AR). FTX’s lobbyists told the Observer several months ago that they favored the latter, less because of the bill’s content than that it seemed more likely to pass, given that the two major sponsors are chair and ranking member of the relevant Senate committee (which is agriculture).

This week, Senator Elizabeth Warren thundered forth with another bill, that would force cryptocurrency companies to play by the same anti-money-laundering rules as traditional banks. That might sound like common sense, yet the crypto industry absolutely loathes the idea. A heated missive from a lobby group said: “While proposed as a solution to potential money laundering and terrorist financing, the bill is in fact a repudiation of liberal values and a move towards the types of surveillance and control prized by authoritarians like Vladimir Putin, Xi Jinping, and Kim Jong-un.”

None of this matters, of course, because no crypto bill is going to become law during what’s left of this Congress. The spate of hearings this month provide little more than posturing. Is there hope for meaningful regulation of cryptocurrency any time soon?

FIN turned to Jenny Lee, currently a partner at the law firm Reed Smith, and a former enforcement attorney at the Consumer Financial Protection Bureau. Lee is skeptical about an effective crypto enforcement bill passing even the next Congress. But that doesn’t mean she thinks that no progress is possible; “muddling through” America’s patchwork regulation seems like the most likely path. She maintains that the FTX debacle illustrates the need for a financial separation akin to the separation of commercial and investment banking enacted by Glass-Steagall in 1933. When legislators focus on this aspect, Lee maintains, it might help them unlock the ongoing debate about whether crypto should be treated as a commodity or a security. “In many areas, banking regulations, from safety and soundness, as well as consumer protection, are relevant places to look,” she said.

Lee also pointed to digital privacy efforts a few years ago. While there were many legislative proposals in recent years, Congress never found a way to consensus. In the meantime, Europe and US states (notably California) moved forward, and most companies implemented stronger privacy provisions without the need for federal legislation. Already there is motion on crypto on the state level. This week New York State’s Department of Financial Services, reacting to the FTX bankruptcy fallout, issued new guidance requiring all banking organizations doing business in the state to seek the department’s approval before engaging in crypto activity.

One more piece of evidence for the “muddling through” thesis: Congress roared and moaned when the GameStop/Robinhood volcano erupted nearly two years ago, yet no legislation emerged to change payment for order flow (PFOF), the controversial method that allows Robinhood and many other brokers to provide commission-free trading. PFOF for equities and options last year amounted to $3.8 billion; it was below a billion dollars as recently as 2019. This week the SEC, while stopping well short of banning PFOF altogether, proposed a new set of rules that seem likely to make PFOF less attractive. The market seems to have received the message: Robinhood stock is near its all-time low, and given how much money Robinhood loses, it’s increasingly difficult to believe that it will survive as a standalone company. Maybe all that political theater does eventually have an impact.

Can Congress Actually Regulate Crypto?