October 11, 2018

Senate Committee on Banking, Housing, and Urban Affairs “Exploring the Cryptocurrency and Blockchain Ecosystem”

Key Topics & Takeaways

  • Cryptocurrency Regulation: Van Valkenburgh explained that the cryptocurrency exchanges in the U.S. are regulated by FinCEN for anti-money laundering purposes, but for consumer protection purposes they are regulated by the states, but state-by-state regulatory regimes is not “entirely rational.”
  • Illicit Uses of Cryptocurrency: Multiple Senators asked about the illicit uses for cryptocurrencies. Van Valkenburgh agreed that criminals are often the earliest adopters of new technologies, but cryptocurrencies have a “mostly positive” story. Van Valkenburgh noted that the Financial Crimes Enforcement Network (FinCEN) was the first agency to say the cryptocurrency exchanges needed to know their customers and file suspicious activity reports (SARs).
  • Initial Coin Offerings: Sen. Elizabeth Warren (D-Mass.) noted that Securities and Exchange Commission (SEC) Chairman Jay Clayton has suggested the best approach would be to regulate ICOs like securities offerings. Van Valkenburgh agreed, saying the SEC has done an “excellent job” trying to better inform investors about ICOs and undertaking targeted enforcement actions, which has “chilled” markets and made them more rational.

Witnesses

Opening Statements

Sen. Mike Crapo (R-Idaho), Chairman, Senate Committee on Banking, Housing, and Urban Affairs

In his opening statement, Crapo highlighted that although Bitcoin has existed for more than a decade, cryptocurrencies have gained notoriety in recent years due in part to their recent “meteoric rise” and subsequent fall. He said that although cryptocurrencies have transformed access to capital in the financial system, much of the media coverage has been negative, focusing on enforcement actions, hacks, and concerns raised by regulators and market participants. Crapo said regulatory questions remain, including on price volatility, that need to be better understood in order to give these innovations room to develop in a safe and sound way. 

Sen. Sherrod Brown (D-Ohio), Ranking Member, Senate Committee on Banking, Housing, and Urban Affairs

In his opening statement, Brown said that Bitcoin and other cryptocurrencies were developed to provide faster, easier transactions and eliminate reliance on traditional financial institutions. He said that while there is a need for innovation in the financial sector, cryptocurrencies have few real-world applications and an “alarming number of scams.” He noted value of investments have fallen, and few initial coin offerings have registered with the Securities and Exchange Commission (SEC).

Testimony

Dr. Nouriel Roubini, Professor of Economics and International Business, New York University Stern School of Business

In his testimony, Roubini critiqued blockchain and cryptocurrencies, saying cryptocurrencies are the “mother of all scams” and blockchain is “no better than a glorified database.” He highlighted that most coin offerings are scams, few are traded on exchanges, and they should not be considered currencies or means of payment. Roubini conceded that while there is an evolution in financial services, this evolution is in Fintech, not cryptocurrencies. He noted that mining and trading are done on insecure, centralized networks that are regularly hacked. He added that corporations are utilizing privately controlled ledgers with trust permitted authorities, not blockchain technology.

Mr. Peter Van Valkenburgh, Director of Research, Coin Center

In his testimony, Van Valkenburgh advocated for cryptocurrencies, saying they make it possible for any person to send and receive value using nothing more than a computer and an internet connection, without the need for a corporation to act as a “middleman.” He noted cryptocurrencies are available to all, and not owned by any single entity. He said that while blockchain is not yet perfect, it is a technological breakthrough as “significant to prosperity” as the internet.  He highlighted that corporate intermediaries are becoming fewer, larger, more powerful, and susceptible to losses by hacks, and urged “light touch,” innovation-friendly regulation.

Question & Answer

Cryptocurrency Market Volatility

Crapo noted that Bitcoin has had a volatile price flux in the last year, and asked about the outlook for the coming year and if its market value is stabilizing. Van Valkenburgh said the ongoing volatility is similar to that seen in dot com companies in the 90s. He said that as institutional investment increases, sell-side research will improve and will help rationalize the market, noting there are already Commodity Futures Trading Commission (CFTC)-regulated derivatives in this space. He continued that a nationally chartered bank that custodies cryptocurrencies would help bring more rationality to the market. Roubini said that cryptocurrencies are not scalable, centralized, or secure, have no deposit insurance, and have no security if hacked. He called this “very risky” and said this status will not change.

Factors Hindering Blockchain Adoption

Crapo asked what factors are hindering wider adoption of blockchain technology. Roubini said that no government, corporation, or bank will use a public, decentralized, permission-less system. Roubini said that while there is potential for innovation, many systems used by corporations are private, permissioned, not distributed, and have trusted, authorized transaction; they are databases, not blockchain. Roubini stipulated that the revolution in Fintech would be in digital payment systems that already see billions of transactions daily, not in blockchain technology.

Cryptocurrency Regulation

Van Valkenburgh explained that the cryptocurrency exchanges in the U.S. are regulated by the Financial Crimes Enforcement Network (FinCEN) for anti-money laundering purposes, but for consumer protection purposes they are regulated by the states. He said that because these are global networks, state-by-state regulatory regimes is not “entirely rational,” and there should be further discussion about federal regulation, policing for market manipulation, and making the U.S. a leader in protecting consumers in this space.

Illicit Uses of Cryptocurrency

Sen. Doug Jones (D-Ala.) asked about the dangers of cryptocurrencies as they relate to law enforcement, human trafficking, money laundering, drug trafficking, and other illicit uses. Van Valkenburgh agreed that criminals are often the earliest adopters of new technologies, but cryptocurrencies have a “mostly positive” story. Van Valkenburgh noted that FinCEN was the first agency to say the cryptocurrency exchanges needed to know their customers and file suspicious activity reports (SARs). He added that transactions on the Bitcoin network are not anonymous, and law enforcement has become “extremely adept” at identifying criminals on exchanges. Roubini said that cryptocurrencies are used for a variety of criminal activity and have become a toll for individuals to avoid declaring their income, wealth, and capital gains.

Sen. Catherine Cortez Masto (D-Nev.) asked if cryptocurrency exchanges have protocols in place to detect when they’re being used for criminal activity, mentioning her bill, S. 3179, the FIND Trafficking Act, which would require the Government Accountability Office (GAO) to study how virtual currencies are being used for illicit activity. Van Valkenburgh explained it is a peer-to-peer network run by people around the world, so there is no way to set policies across all users. He added that there are several intermediaries building their systems on top of Bitcoin, and those firms do have policies in place to address criminal activity, including registering with FinCEN and filing SARs. Roubini added that because it is a global, decentralized system, it is hard to crack down on criminal activity happening outside of U.S. jurisdiction, which has created a “massive loophole” for criminals.

Sen. Elizabeth Warren (D-Mass.) asked about cryptocurrency thefts. Van Valkenburgh explained that these thefts were primarily of new cryptocurrencies with “massive” price increases being secured overseas where security was not scaled in line with their rising value. He noted that Bitcoin was not involved in those thefts.

Initial Coin Offerings

Sen. Pay Toomey (R-Pa.) said that initial coin offerings (ICOs) have experienced “incredible scams” and volatility. He noted that anything can become currency if its acceptable to enough people, asking if cryptocurrencies can achieve wide enough use to achieve the characteristics we use to define a currency. Roubini explained the “impossibility trinity,” wherein a cryptocurrency cannot have scalability, decentralization, and security at the same time. Van Valkenburgh agreed that it is difficult to have scale, decentralization, and integrity of data simultaneously, and it is something that should be worked on.

Warren said ICOs allow companies to raise money by creating and selling currencies, but 80 percent of ICOs in 2017 were found to be scams. She noted that SEC Chairman Jay Clayton has suggested the best approach would be to regulate ICOs like securities offerings. Van Valkenburgh agreed, saying the SEC has done an “excellent job” trying to better inform investors about ICOs and undertaking targeted enforcement actions, which has “chilled” markets and made them more rational. Van Valkenburgh said it is possible to undertake a token sale and comply with securities laws, selling only to accredited investors.

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