CFTC Nominations; FSB on DeFi Risks; Sanctions

1. CFTC Nominees

What happened?

On Wednesday, the Senate Committee on Agriculture, which oversees the Commodity Futures Trading Commission (“CFTC”), held a hearing to consider the nominations of four new CFTC commissioners.

If confirmed, these four commissioners would join Chairman Rostin Benham on the Commission. The Commission has been operating with only two commissioners for months.

Cryptocurrencies were front and center at the hearing. Nominees Christy Goldsmith Romero, Kristin N. Johnson, Summer Kristine Mersinger, Caroline D. Pham unanimously expressed their support for an expanded role for the CFTC in regulating digital asset spot markets. Each of the nominees mentioned that they believed financial markets were at an inflection point and discussed their desired approach to regulating digital asset markets.

Goldsmith Romero emphasized pursuing a thoughtful and pragmatic approach to regulating cryptocurrency markets; Johnson expressed concerns about risks to consumers presented by cryptocurrencies; Mersinger emphasized a need to allow innovation to flourish while implementing safeguards to properly manage risk; Pham noted that this was a moment to build and reshape global markets and stated she would take a pragmatic approach to regulating these new markets.

In an important question, Senator Boozman (R-AR) noted that ETH and BTC are commodities and asked the nominees whether they believed it was a good idea to create a list of which digital assets the CFTC considers commodities. None of the nominees thought this was a good idea because a list would not be able to keep up with innovation in the market. However, each emphasized the need to provide clarity to the markets and noted the importance of interagency cooperation to create principles based standards.

How does this impact DeFi?

Just like the last time the Senate Ag committee held a hearing on digital assets, the short answer is: TBD. DeFi was not specifically mentioned in the hearing. However, overall, it was a productive hearing. The senators and nominees evidenced well-reasoned assessments regarding the utility of further regulation in digital asset spot markets.

Creating regulatory clarity around custodial digital asset spot markets may positively impact DeFi by increasing access and acceptance, and the CFTC will be better able to effectively promulgate reasonable regulation with a full cadre of Commissioners.

Expect these nominees to be confirmed without too much controversy. Once confirmed, we’ll work with the commission and congress as it considers increasing the CFTC’s mandate to cover custodial digital asset spot markets.

2. FSB Report Assessing Risks to Financial Stability from Digital Assets

What happened?

The Financial Stability Board (“FSB”) issued a report on digital assets and the potential risks that digital assets pose to broader financial stability.

What is the FSB, you may ask? The FSB is an international organization that monitors and makes recommendations about the global financial system. The FSB is composed of representatives from all of the G20 economies and has institutional members that include the Bank for International Settlements, the European Central Bank, and the International Monetary Fund, the Basel Committee. The FSB is one of the main institutions responsible for setting standards for global economic governance.

The report released by the FSB examines developments in the digital asset space, and analyzes vulnerabilities relating to three segments of the crypto-asset markets: unbacked crypto-assets (such as Bitcoin), stablecoins, and DeFi.

In particular, the FSB considered a number of potential risks associated with DeFi markets. One of these risks was decentralized governance itself, since decentralization makes it challenging for regulators to identify an entity or individual accountable for meeting existing regulatory requirements—requirements predicated on permissioned and centralized systems. In addition, the FSB pointed out that it is complicated to determine which legal jurisdictions cover DeFi protocols because of DeFi’s “global scope.” Finally, the FSB identified a lack of KYC information as a risk that has the potential to attract users that seek to exploit DeFi protocols to engage in illicit transactions.

What does this mean?

While there aren’t immediate implications, the report further evidences many multilateral organizations’ general suspicion of DeFi and decentralization more broadly.

Nevertheless, a clear understanding of how international financial regulators view DeFi paves the way for productive dialogue. For example, the idea that decentralization is a risk because it is unclear what entities regulatory requirements should apply to is an issue with the regulatory framework, not with DeFi. The current regulatory regime was created to accomplish policy objectives in intermediated financial markets. By design, this regulatory regime does not work in disintermediated markets.

More fundamentally, regulation exists to accomplish policy outcomes, many (but not all) of which decentralized finance protocols vindicate. And while regulatory requirements designed for intermediated markets do not map onto DeFi, that doesn’t mean it's impossible to pursue existing policy goals in DeFi markets!

3. Senators Warren, Warner, Brown, Reed Send Letter to Treasury Regarding *Potential* Use of Cryptocurrency to Evade Sanctions

What happened?

United States Senator Elizabeth Warren (D-Mass.), Senate Intelligence Committee Chairman Mark Warner (D-Va.), Senate Banking, Housing, and Urban Affairs Chairman Sherrod Brown (D-Ohio), and Senate Armed Services Committee Chairman Jack Reed (D-R.I.) wrote a letter to Treasury Secretary Janet Yellen raising concerns regarding the potential use of cryptocurrency to evade sanctions.

The Democratic Senators’ letter came after multiple Treasury and National Security Council officials publicly stated this week that the crypto doesn’t have the potential to seriously undermine sanctions controls right now. According to a Politico article, Treasury officials “aren’t overly worried about crypto undermining the effort to choke off the Kremlin’s access to capital.” Counselor to the Deputy Treasury Secretary Todd Conklin said, “the scale of what they have to move, and where they have to move things from, [crypto’s] not necessarily going to be that concerning.” (Notwithstanding these officials’ cited comments, the article is entitled “Russia's hidden tool to undermine sanctions”.)

The Senators inquired about the Treasury Department’s progress in monitoring and enforcing sanctions compliance in the cryptocurrency industry and expressed their concern that criminals, rogue states, and other actors could use digital assets and alternative payment platforms as a new means of hiding illicit transactions.

What does this mean?

After this week, one wouldn’t be at fault for thinking that crypto is the root of all that is evil in the world. We’ve seen no evidence that people are using cryptocurrencies or DeFi to skirt sanctions on Russian entities or that sanctions dodgers have the intent or ability to use them for that purpose, and we’ll continue to try to correct the record on this issue.