One of the top officials at the Federal Reserve made it abundantly clear that the central bank – which is also a powerful financial watchdog – is paying careful attention to the flaws showing up as the crypto sector founders.
“Recent volatility has exposed serious vulnerabilities in the crypto financial system,” Fed Vice Chairwoman Lael Brainard said in a speech in London on Friday, which offered a laundry list of the failings of the digital assets sector. Brainard has been leading the Fed’s work on a potential digital dollar and has been minding the store on crypto policy discussions until the central bank appoints its permanent vice chair for supervision.
Brainard said the Fed has been “closely monitoring recent events where risks in the system have crystallized and many crypto investors have suffered losses,” according to a copy of the speech. And she suggests an answer: “Strong regulatory guardrails will help enable investors and developers to build a resilient digital native financial infrastructure.”
The vice chairwoman contends that the shortcomings of crypto are basically the same as traditional finance, and the sector needs to meet the same safety standards before it gets large enough to become a threat to the rest of the financial system.
“We have seen crypto trading platforms and crypto lending firms not only engage in activities similar to those in traditional finance without comparable regulatory compliance, but also combine activities that are required to be separated in traditional financial markets,” she said at the Bank of England event. “For example, some platforms combine market infrastructure and client facilitation with risk-taking businesses like asset creation, proprietary trading, venture capital and lending.”
TerraUSD’s meltdown has drawn the attention of the Fed and other regulators, and Brainard equated it with other financial runs throughout history.
“New technology and financial engineering cannot by themselves convert risky assets into safe ones,” she said. Brainard argued that stresses throughout the industry have revealed that crypto platforms suffer from classic vulnerabilities and contagions, “illustrated by the freeze on withdrawals at some crypto lending platforms and exchanges and the bankruptcy of a prominent crypto hedge fund.” Last week, hedge fund Three Arrows Capital filed for Chapter 15 bankruptcy in the Southern District of New York federal court.
She suggested that all this reinforces the idea that a central bank digital currency from the U.S. “may be an advantage for future financial stability.” Such a government token could have profound implications for the private stablecoin market.
The Senate is soon expected to confirm Michael Barr, President Joe Biden’s pick to be the next Fed vice chairman for supervision, who will lead the central bank’s regulatory and financial-supervision efforts, including how the U.S. will oversee stablecoins. Barr is widely seen as a consumer advocate who will promote tough regulation. He served for a time on the advisory board of crypto firm Ripple, and so he is familiar with the industry.
Camomile Shumba contributed to this report.