Crypto Policy Experiences Massive Turbulence In Congress Amid TerraUSD And FTX Failures

What Happened In 2022

Even before a months-long winter engulfed the digital-assets market, 2022 was shaping up as the year that Washington began to get serious about regulating the cryptocurrency business. That resolve was bolstered throughout the year by a series of calamities that included a massive stablecoin failure of terraUSD and the associated luna, with contagion effects that impacted BlockFi, Celsius Network and Voyager Digital exchange that called into question the ability of crypto exchanges to be digital asset custodians that would protect investors’ assets.

Essentially, the crypto industry managed to recreate the same risks of the traditional banking system, in which the institutions that were responsible for holding customer’s assets were simultaneously lending funds, leading to leverage, liquidity and capital conflicts. Before the year could end, the third-largest exchange, FTX – previously seen as a white knight lender of last resort for troubled companies in the industry – ended up proving itself to be a house of cards. And just like that, all of the goodwill, power, and swagger of crypto lobbyists throwing their weight around on Capitol Hill was eviscerated, leaving the industry to try to build credibility in 2023 and Congress and the administration to figure out how to control the sector.

Key Statistic

Congress held at least 15 hearings focused on cryptocurrency and blockchain policy in 2022. Of the 15 hearings, Sam Bankman-Fried, the former CEO of FTX that is now awaiting trial in the U.S. after an indictment by the Department of Justice in the Southern District of New York (SDNY), was invited to four of the 15 hearings to testify on crypto policy during 2022, although he only made it to three as his arrest in the Bahamas resulted in his inability to testify before the House Financial Services Committee on December 13th.

The overall tally.

• Senate Banking Committee: 4

• House Financial Services Committee: 3
• Senate Committee on Agriculture, Nutrition, and Forestry: 3
• House Agriculture Committee: 2
• House Committee on Energy and Commerce: 1
• Senate Committee on Homeland Security and Government Affairs: 1
• House Committee on Homeland Security: 1

Key Events In 2022

Legislation doesn’t happen overnight, and very often a final bill is put together using language for policy ideas in other legislation that has been previously introduced. The administration laid out its own roadmap in September, introducing what was billed as a “first-ever” federal regulatory framework for cryptocurrency. However, in a government that relies on checks and balances, there was acknowledgment from the reports done by the White House that certain legislation from Congress would be needed to close some gaps so that U.S. regulators would have a remit covering all of crypto. In the matter of a CBDC, however, the outlook remains murky. It is not clear what kind of legal authority would be required nor if the administration is convinced that a federal digital currency is even necessary.

On March 9, Biden issued Executive Order 14067 on the responsible development of digital assets. This became a whole-of-government effort where the Administration sought to explore how the U.S. should approach digital assets. Leading up to the order, Federal Reserve Chair Jerome Powell shared his own views on CBDCs, noting the introduction would be a huge change but that the U.S. is not yet ready. Concerns relating to illicit finance were also front and center in the context of this executive order, as the Russia-Ukraine war had just sparked the ability of almost anyone with internet access to send cryptocurrency to Ukraine, while the ability of Russia and other countries to avoid sanctions using cryptocurrency became critical points relating to U.S. national security.

In addition, ransomware was (and continues to be) a social hazard that also represented potential national security interests after the 2021 Colonial Pipeline hack was revealed. Meanwhile, the terraUSD and associated luna collapse, followed by the bankruptcy proceedings for Voyager and Celsius, highlighted consumer-protection issues, regarding the types of cryptocurrencies that should be allowed to trade as well as protecting customers from malfeasance at digital-asset exchanges.

Two senators then submitted landmark legislation aimed to provide specific solutions to most of crypto’s quagmires, such as differentiating a security token from a digital commodity and providing clear tax policies. Amid the wreckage in crypto that sparked the current bear market, Senator Cynthia Lummis (R-Wyo.) and Senator Kirsten Gillibrand (D-N.Y.) co-sponsored the bipartisan Responsible Financial Innovation Act of 2022 (RFIA). While there are numerous bills that have been issued on specific issues relating to cryptocurrency, this one represents a comprehensive framework for crypto. However, the bill still crosses four different committee jurisdictions which could lead to a long period of time in seeing the bill move to a vote in the Senate. This proposal has shaped much of the debate on Capitol Hill, and, interestingly, sparked another bill that many experts considered had a strong chance of passing but that ended up mired in controversy.

Agriculture Chairwoman Debbie Stabenow (D-Mich.) and Ranking Member John Boozman (R-Ark.) subsequently introduced the Digital Commodity Consumer Protection Act of 2022 (DCCPA), which would have the crypto spot market regulated by the Commodity Futures Trading Commission. With broad-based support, including from co-sponsors such as Senator Cory Booker (D-N.J.) and Minority Whip Senator John Thune (R-S.D.), this bill seemed to have a good chance of becoming law. Soon, the DCCPA became the center of attention for the crypto industry, as a result of Bankman-Fried tweeting out his role in the negotiations over the bill. Many experts felt Bankman-Fried’s position could destroy the decentralized finance industry, where the conversation was focused on whether this bill as written was good or bad for the industry.

These discussions occurred in late October, but were derailed when on November 2, the drama of the FTX scandal turned Bankman-Fried from a prestigious CEO of a leading exchange with a controversial policy position to a potential fraudster who had problems in his own backyard. Some soon started referencing the DCCPA as the ‘FTX bill’ in Congress due to Bankman-Fried’s influence; however, Stabenow has doubled down on the bill as a solution to the problems within the crypto market including Bankman-Fried, while Boozman said the office would take a top-down review of the bill, insinuating this as the method to expunge any of Bankman-Fried’s fingerprints on the policy positions in the bill.

Meanwhile, there were also negotiations between Maxine Waters (D-Calif.), who chairs the House Financial Services Committee, the panel’s ranking Republican, Patrick McHenry (R-N.C.). The idea was considered in hearings in early 2022, following recommendations from the President’s Working Group on Stablecoins in late 2021. After the terraUSD and the associated luna collapse, which saw a leading stablecoin becoming worthless almost overnight, some in the industry started considering what regulatory oversight of stablecoin issuers such as the Office of the Comptroller of the Currency (OCC) or state-level banking regulators might look like. The bill specifies the exclusion of “algorithmic stablecoins” such as terraUSD and luna, with a potential two-year moratorium on any new types of these coins. However, these negotiations are still ongoing, and Sherrod Brown (D-Ohio), who chairs the Senate Banking Committee, has taken a frosty position against any kind of stablecoin legislation that makes stablecoin legislation passing the Senate unlikely.

However, with the fall of FTX, Brown seemed to signal a change when he wrote to the Treasury Secretary Janet Yellen seeking inputs on potential legislation and in the goals for the Senate Banking Committee in 2023, crypto policy is listed as the number one priority. As the 2023 Congress begins to formulate in early January, it will almost be like starting over for crypto advocacy and policy on the Hill, as reports of how legislators are struggling to separate Bankman-Fried from the rest of the industry continue.

Key Decision Points For Investors

U.S. Government Advancing CBDCs

The White House formed a working group with the Fed and the Treasury on CBDCs after the White House provided its proposed ‘regulatory framework’ in September for the crypto industry. Recently, the New York Fed announced that the central bank is testing a prototype with a group of banks, in concert with the New York Innovation Center.

While there is no guarantee that the U.S. will ever go ahead with a CBDC, signs that it is progressing could come via a White House request for legislation in Congress to authorize the Federal Reserve to issue a CBDC. A CBDC could be seen as a rival to stablecoins.

U.S. Treasury Rulemaking On Illicit Finance Framework For Cryptocurrencies

The Treasury also submitted a plan to mitigate the use of cryptocurrencies in illicit finance as part of its required response to the executive order on digital development. Given that the department has already provided an opportunity for stakeholders to give comments as to what regulations might look like, it is probable that by February, proposed rules would be introduced. Investors should expect a great deal of pushback from the industry over reduced privacy and adverse effects in areas ranging from the use of off-line storage devices to hold cryptocurrency to bitcoin automated teller machines. On the flip side, investors should consider how certain companies might benefit from requirements such as enhanced know-your-customer regulations, although there should be the expectation that the industry associations will likely sue over new rules and seek to bring the case to the Supreme Court.

Stablecoin Regulation

Stablecoin regulation seems likely, since the consumer-protection aspects are not controversial. With managers of USD Coin, the conservative No. 2 stablecoin behind Tether, likely to push for such an outcome on Capitol Hill, it seems safe to say that there may be a place for an instrument backed on a one-to-one basis by the dollar, although exotic algorithmic versions like the failed terraUSD would probably be excluded. A key part of this debate would be the impact on the dollar, which also ties into the idea of CBDCs.

Legislation Giving The CFTC Leadership In Crypto Spot-Market Oversight

While it is fair to say the DCCPA – snidely referred to as the FTX bill, given SBF’s promotion of it– will need to be reintroduced and possibly rebranded, the commonsense need to have a day-to-day regulator of the spot crypto market may be too strong to ignore. Investors should look to see when the expected Digital Commodity Exchange Act (DCEA) is introduced by Representative Glenn G.T. Thompson (R-Pa.). Thompson will chair the House Agriculture Committee in the new Congress. If it seems clear this bill would be generally acceptable to Stabenow in the Senate, then investors should expect her bill to regain the momentum it had prior to the FTX fallout.

Legislation Giving Regulators Oversight Of Crypto Exchange Affiliates

This is the type of legislation that would directly respond to the FTX scandal. If Brown and the Biden administration could come to terms on this matter, that would give a lot of credibility to this kind of bill. A possible broader outcome for crypto is for Brown to not only introduce this aspect to regulating affiliates, but to also win support in stablecoin bill language from the House and to coordinate with the Senate Agriculture Committee to give the CFTC oversight of the spot market. This will place a substantial amount of the crypto marketplace within the regulatory perimeter of U.S. federal regulators.

Key Regulatory Timeline

• January 22: Freedom convoy starts in Canada, sparks concern for how many turned to crypto donations.

• February 8: The House Financial Services Committee holds a hearing to consider the right kind of stablecoin policy.
• February 9: The Senate Agriculture Committee holds a hearing on digital assets risks, regulation and innovation. Sam Bankman-Fried, CEO of FTX at the time, testifies as one of the witnesses from industry.
• February 15: Senate Banking Committee holds hearing on stablecoins to evaluate stablecoin policy as well.
• February 17: First director appointed to the National Cryptocurrency Enforcement Team and FBI Starts a virtual-assets unit.
• February 24: Russia invades Ukraine.
• March 3: Ukraine supporters announce $54 million has been raised in cryptocurrency to support the country’s war and humanitarian efforts.
• March 7: U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) alerts financial institutions of their Bank Secrecy Act obligations related to virtual currencies, such as to provide quick reporting of suspicious activity associated with potential sanctions evasion, conduct appropriate customer due diligence, share information with respect to the USA PATRIOT Act and consider how innovative tools and solutions may assist in identifying hidden Russian and Belarusian assets.
• March 9: President Joe Biden signs an executive order on digital assets that calls for a whole-of-government approach to determine what policy in the U.S. should be for the crypto industry. The efforts make multiple U.S. agencies responsible for providing specific reports to the White House over the next several months in 2022, with the White House National Economic Council and National Security Council responsible for compiling the information in the reports. Specific policy concerns include protecting consumers, investors and businesses, providing safe, affordable financial services, fostering financial stability, advancing responsible innovation, reinforcing the global financial leadership and competitiveness, fighting illicit finding and exploring a central bank digital currency (CBDC).
• March 10: U.S. Department of Labor (DOL) cautions 401(k) plan fiduciaries to exercise extreme care as they consider cryptocurrencies.
• March 10: The Commodities Futures Trading Commission (CFTC) seeks public comment on a FTX request for derivatives clearing organizations to eliminate intermediaries and settle crypto within exchanges.
• March 11: Treasury’s Office of Foreign Assets Control (OFAC) reminds the public that sanctions extend to virtual currency with respect to Russia, stating that all U.S. persons are required to comply with OFAC regulations, regardless of whether a transaction is denominated in traditional fiat currency or virtual currency.
• March 17: The Senate Banking Committee holds a hearing on illicit finance and cryptocurrency.
• April 28: Digital Commodity Exchange Act of 2022 is introduced in the House with Representative Glenn G.T. Thompson (R-Pa.), Ranking Member of the House Agriculture Committee, as sponsor. This bill allows for the regulation and registration of digital commodity exchanges subject to oversight by the CFTC. The bill establishes the conditions for the sale of digital commodities and the registration of exchanges, and sets forth other requirements.
• May 12: The House Agriculture Committee holds a hearing on the FTX proposal and new clearinghouse models regarding digital assets. Sam-Bankman Fried is one of the witnesses during the hearing.
• May 26: House Financial Services Committee holds hearing on digital assets and the future of finance.
• June 7: Lummis-Gillibrand Responsible Financial Innovation Act is introduced in the Senate, introducing a comprehensive regulatory framework for digital assets including parsing the SEC and CFTC regarding which digital tokens are ‘digital commodities’ and ‘securities’, as well as creating the concept of ‘ancillary assets’ that would protect tokens – initially sold through an Investment Contract – from being considered securities themselves. The bill also seeks to address tax policy for digital assets, among other items.
• June 23: The House Agriculture Committee holds a hearing on the future of digital-asset regulation.
• July 21: SEC charges insiders at Coinbase with front running the listing of tokens, nine of which are identified by the agency as securities.
• August 3: The Digital Commodities Consumer Protection Act of 2022 is introduced in the Senate by the chair and ranking minority member of the Senate Agriculture Committee, providing the CFTC as regulatory and bringing the spot markets of crypto within the regulatory perimeter in the U.S., including as mandatory for all U.S. crypto exchanges a registration with the CFTC to engage in spot trading.
• August 8: OFAC sanctions Tornado Cash, a smart contract that increases the difficulty of tracing blockchain financial transactions. Soon thereafter, the crypto industry responds with outrage and lawsuits.
• September 16: The White House introduces the first federal framework for digital assets that compiles the reports on cryptocurrency required by the Executive Order in March, and establishes next steps that the administration will do based on the findings. Examples include establishing a CBDC Working Group with the Treasury, White House and Federal Reserve, and tasking the White House Office of Science and Technology Policy (OSTP) and the National Science Foundation with establishing a research and development (R&D) agenda for digital assets for the United States.
• September 22: CFTC files a complaint against the Ooki Decentralized Autonomous Organization (DAO), raising questions about the liability of governance token holders.
• November 1: Alameda Research balance sheet leaked to the press, raising questions about the ties to FTX and the reliance on the FTT token created by the exchange. Soon thereafter, FTX – the third largest exchange at the time, files bankruptcy. As the fall of FTX unfolds, further details are revealed regarding the issue of how FTX and Alameda treated customer assets.
• December 1: The Senate Agriculture Committee holds a hearing on lessons learned from the FTX collapse such as calling for stricter regulation and clarity over the cryptocurrency markets and for the regulation of spot markets. Issues discussed included whether a bill such as the DCCPA would have helped stop the FTX fall.
• December 2: Ripple and SEC file briefs in what is expected to be a landmark decision from the judge that could affect how cryptocurrencies are treated as either securities or commodities going forward.
• December 12: FTX CEO Sam Bankman-Fried is arrested in the Bahamas as U.S. agencies file criminal and civil charges against him.
• December 13: SEC and Department of Justice (DOJ) release complaints against Bankman-Fried.
• December 13: The House Financial Services Committee holds a hearing on the FTX collapse. Forbes obtains and releases an exclusive draft of the written testimony planned to be given by Bankman-Fried
• December 14: The Senate Banking Committee holds a hearing on the FTX collapse, including testimony from paid spokesman and Shark Tank star Kevin O’Leary who reported he received $15 million from FTX, as well as an actor from the OC, Ben McKenzie Schenkkan who is an outspoken crypto skeptic.
• December 21: SBF is extradited to the U.S., while Caroline Ellison, CEO of Alameda and Gary Wang, Co-Founder of FTX, plead guilty to DOJ fraud charges and settle with the SEC and CFTC.
• December 22: SBF is released on $250 million dollar bail, with a $25 million bond posted by his parents. against their Palo Alto home.