On October 3, 2022, the Financial Stability Oversight Council (“FSOC” or “Council”) released a report outlining the risks posed by digital assets to the financial stability of the United States. The FSOC is charged broadly with identifying emerging threats to financial stability, and is comprised of the heads of each major federal financial regulator, chaired by the Secretary of the Treasury. The FSOC’s initial position in 2015 was that digital assets generally do not pose a significant financial stability risk due to limited use and a lack of ties to the traditional financial system. President Biden asked the FSOC to reconsider their position in his “Executive Order on Ensuring Responsible Development of Digital Assets.”

The FSOC’s report partly reaffirmed its 2015 position by concluding that digital assets do not currently pose a great risk to the US financial system. However, the report did emphasize that digital assets could pose risks if their interconnectedness with the traditional financial system or overall scale grows substantially, unaccompanied by appropriate regulation. The FSOC noted that interconnectedness with the traditional financial system remains limited, but overall scale is increasing rapidly.

The FSOC refrained from advocating for an omnibus federal law regulating digital assets like some members of Congress have advocated for. Instead, the report concluded that existing regulations already cover the vast majority of the digital asset space. To that end, the FSOC merely published a list of recommendations advising regulators how to better oversee digital asset activity.

Perhaps of more consequence than the overarching conclusions, the FSOC identified three specific gaps in the current regulatory framework of digital assets and made a series of recommendations outlining how to address them. The three identified gaps are:

• the spot markets for crypto-assets that are not securities, like Bitcoin, are subject to limited direct federal regulation;

• crypto-asset businesses have the opportunity to engage in regulatory arbitrage due to the fragmented nature of the regulatory system; and

• the possibility of direct retail access to markets by vertically integrating traditional intermediary services such as broker-dealers, which is not a reality in the US yet but has been proposed by a number of crypto-asset trading platforms.

On the spot markets issue, the FSOC made an explicit recommendation to Congress to pass legislation granting some federal agency regulatory authority over the spot markets for non-security crypto-assets. The FSOC called for broad rulemaking, enforcement, and examination authority in this space. The Council did not make a concrete recommendation as to which federal agency should be granted this authority, but it did note that the Commodity Futures Trading Commission (“CFTC”) already has broad authority over derivative transactions in non-security crypto-assets, just not spot markets.

As far as regulatory arbitrage goes, the FSOC split its list of concerns into two categories of entities: stablecoin issuers, which tie the value of crypto-assets to a reference, such as the US dollar; and crypto-asset platforms. For both of these, the FSOC is concerned that companies can take advantage of the fact that no single regulator has a comprehensive overview of the whole firm or its relationships. Thus, companies may be able to engage in regulatory arbitrage by understating the risks the entire firm is bearing or by having different subsidiaries simply report to different regulators. The FSOC report made four specific recommendations to remedy this risk:

• first, that Congress pass comprehensive legislation specifically for stablecoin issuers;

• second, that Congress pass legislation granting regulators authority to supervise the affiliates and subsidiaries of crypto-asset entities;

• third, a generic recommendation that regulators coordinate across agencies in these spaces; and

• fourth, a call on bank regulators to use their existing authorities in the crypto-asset arena.

The FSOC made no specific recommendations or calls-to-action regarding the possibility of vertical integration granting retailers direct (sometimes called “non-intermediated”) access to digital asset markets. Instead, the issue was simply flagged for future consideration for member agencies.

Lastly, the FSOC called for a government-wide approach to data collection in the crypto-asset sphere to gain further insights into potential financial stability risks, and for member agencies to continue to build their digital asset expertise.