A new report by the Financial Stability Oversight Council (FSOC) identified three regulatory gaps in the current oversight of cryptocurrency, stablecoins, and other digital assets and recommended steps Congress and federal regulators should take to close them.

FSOC’s Report on Digital Asset Financial Stability Risks and Regulation, released Monday, was developed in response to President Joe Biden’s Executive Order 14067, “Ensuring Responsible Development of Digital Assets.”

The FSOC report concluded crypto-asset activities “could pose risks to the stability of the U.S. financial system” if they are not “paired with appropriate regulation.”

“Many crypto-asset activities lack basic risk controls to protect against run risk or to help ensure that leverage is not excessive,” FSOC said. The report noted crypto-asset prices “appear to be primarily driven by speculation rather than grounded in current fundamental economic use cases,” leading to wild fluctuations in value.

In addition, because the nearly $3 trillion digital asset market is mostly unregulated, digital assets lack the transparency and accountability that is afforded to investors who choose to place their bets on more traditional securities.

The report and accompanying fact sheet identified three regulatory gaps in the U.S. regulation of the “crypto-asset ecosystem.”

  • One gap is the lack of regulation of the spot markets for crypto assets that are not securities, namely bitcoin. The report said trading in these digital assets does not “feature robust rules and regulations designed to ensure orderly and transparent trading, prevent conflicts of interest and market manipulation, and protect investors and the economy more broadly.” The report recommended Congress pass legislation granting rulemaking for federal financial authorities over the spot market for crypto assets that are not securities.
  • Another gap is what FSOC called crypto asset’s “regulatory arbitrage,” in that some crypto businesses have affiliates and subsidiaries operating under different regulatory frameworks (i.e., state but not federal regulatory frameworks). The result leaves no single regulator with “visibility into the risks across the entire business.” The report recommended more coordination between state and federal regulators to better supervise and provide visibility into the activities of crypto-asset affiliates and subsidiaries. The report also recommended legislation to address risks posed by stablecoins.
  • Some crypto-asset trading platforms have begun offering customers direct access to markets through broker-dealers or futures commission merchants, creating a regulatory gap that has financial stability and investor protection implications. The report suggested further study of the issue is needed while recommending regulators increase their capacities “related to data and to the analysis, monitoring, supervision, and regulation of crypto-asset activities.”

“This report provides a strong foundation for policymakers as we work to mitigate the financial stability risks of digital assets while realizing the potential benefits of innovation,” said Secretary of the Treasury Janet Yellen in a press release. “… The report concludes that crypto-asset activities could pose risks to the stability of the U.S. financial system and emphasizes the importance of appropriate regulation, including enforcement of existing laws. It is vital that government stakeholders collectively work to make progress on these recommendations.”

SEC Chair Gary Gensler said in a statement in response to the FSOC report he believes the “vast majority” of crypto assets are securities and should be required to register with the SEC. The same applies to “crypto intermediaries” like crypto trading platforms, he said. Gensler added, “[I]n the crypto market there is a lot of noncompliance with the securities laws.”

“I look forward to working with colleagues to enhance the investor protection and resiliency of the crypto market,” he said. “We can’t let this market undermine our broader capital markets or the economy.”

Acting Comptroller of the Currency Michael Hsu said coordination between regulators should be improved to break through the currently disjointed regulatory oversight of crypto assets.

“[W]e at the OCC are committed to ensuring that the nexus between crypto and the federal banking system does not become a channel for cross contagion while also supporting innovation and progress,” he said.