We Must Protect Investors and Our Banking System from the Crypto Industry

The crypto boom and crash of 2020-22 demonstrated that (i) cryptocurrencies with fluctuating values are extremely risky and highly volatile assets, and (ii) cryptocurrencies known as ‘stablecoins’ are vulnerable to systemic runs whenever there are serious doubts about the adequacy of reserves backing those stablecoins.  Crypto firms amplified the crypto boom with aggressive and deceptive marketing campaigns that targeted unsophisticated retail investors.  The crypto crash accelerated due to the failures of several prominent crypto firms and accompanying scandals, which inflicted devastating losses on investors and undermined public confidence in crypto-assets.

Federal and state regulators committed serious errors by allowing banks to become significantly involved in crypto-related activities.  Several FDIC-insured banks that provided financial services to crypto firms suffered substantial losses and incurred extensive legal, operational, and reputational risks during the crypto crash.  The failures of three of those banks in early 2023 threatened to ignite a systemic banking crisis.  Federal regulators rescued uninsured depositors (including Circle, one of the largest stablecoin issuers) at two of those banks and established an emergency lending program to help other troubled banks.  Meanwhile, stablecoins issued by nonbanks and uninsured depository institutions threatened to become a new form of ‘shadow deposits’ that could undermine the integrity of our banking system and require future bailouts.

My article (which was completed in May 2023) presents a three-part plan for responding to the risks posed by fluctuating-value cryptocurrencies and stablecoins.  First, policymakers must protect investors by recognizing the Securities and Exchange Commission (SEC) as the primary federal regulator for most fluctuating-value cryptocurrencies.  Federal securities laws provide a superior regime for regulating such cryptocurrencies.  In particular, the SEC has broader powers (including a more robust investor protection mandate) and a stronger enforcement record than the Commodity Futures Trading Commission (CFTC).

Second, federal bank regulators must protect the banking system by prohibiting all FDIC-insured banks and their affiliates from investing and trading in fluctuating-value cryptocurrencies, either on their own behalf or on behalf of others.  In addition, federal bank regulators should bar FDIC-insured banks and their affiliates from providing financial services to crypto firms unless those firms are registered with and regulated by the SEC and/or the CFTC. 

Third, Congress should mandate that all issuers and distributors of stablecoins must be FDIC-insured banks.  That mandate would ensure that all providers of stablecoins must comply with the regulatory safeguards governing FDIC-insured banks, their parent companies and other affiliates.  Those safeguards provide crucial protections for our banking system, our economy, and our society.  

Arthur E. Wilmarth, Jr. is the Professor Emeritus of Law at George Washington University Law School.