Headline:  What is the responsibility of the Federal Reserve to regulate cryptocurrency?

Body:  The Federal Reserve is so important to the financial transactions of this nation.  It is vital to the underpinning of banking, as it ensures a lender of last resort and it ensures that a run on one bank will not translate to a run on multiple banks that could be a major shock to the financial system.  So, it makes sense that if cryptocurrencies are really important to financial well-being, the Federal Reserve would be involved.  But, despite all of the readings I have done, I have not yet found a reference to what portion of the governance they would have to do.  So, let’s look at this.

How the Federal Reserve regulates cryptocurrency

The Federal Reserve is focused on regulating banks and the United States dollar, so cryptocurrencies are generally outside its sphere of influence. Crypto and the Fed overlap when banks hold cryptocurrency as an asset on their balance sheets.  And given the performance of Bored Apes, cryptokitties, Bitcoin and Etherum, this collection of digital assets is immense.  (Are you flashing back to Silicon Valley Bank, Signature Bank or Silvergate?   Yes, digital assets can form an outsized portion of the holdings in a bank.)  In this regard, it makes sense that the Federal Reserve would become important in the governance of digital assets.

The Federal Reserve decided that cryptocurrency-related assets must be disclosed separately by banks. New cryptocurrency asset activities require notifying the Federal Reserve. Banks are urged to consider the risks of crypto to their asset portfolios.

A new digital dollar?

The Federal Reserve popped up in crypto news recently to explore a Central Bank Digital Currency (CBDC), or digital dollar. In this case, the Fed is looking at creating a digital version of the US dollar that’s managed by blockchain technology. Other countries, including China, are also exploring using a CBDC.  At this point, the Fed issued a paper looking at the pros and cons of creating a new CBDC and solicited public feedback. Currently, banks and credit unions hold digital ledgers for our money. With a digital dollar, dollars would become part of a more transparent system, but there are still plenty of risks and issues to iron out before we can expect the Fed to move forward.

The Fed made it clear that it does not intend to proceed with a CBDC without clear support from the executive branch and Congress, ideally in the form of a specific authorizing law. On February 7, the Fed’s Board of Governors issued a policy statement clarifying permissible activities by member banks which would “presumptively prohibit” member banks from holding most crypto assets as a principal. Member banks wishing to issue dollar tokens will need to prove certain security measures and receive formal approval prior to their use in banking transactions.

The Federal Reserve is putting together a “specialized team of experts” to help it supervise the crypto sector, Michael Barr, the central bank’s vice chairman for supervision, said Thursday.  The Fed’s top regulatory official said the digital-assets specialists are needed to “help us learn from new developments and make sure we’re up to date on innovation in this sector.”

 “While crypto assets are hyped as decentralized, there has been an emergence of new, quite centralized intermediaries that are either not subject to or not compliant with appropriate regulation and supervision, which has perpetuated harm to consumers,” said Barr, who once worked as an adviser for Ripple, the issuer of the XRP token. “Our overall stance is that, at this stage of the development, banks should take a careful and cautious approach to engaging in crypto asset-related activities and the crypto sector.”

 An Aug. 8 announcement by the Federal Reserve Board established the Novel Activities Supervision Program, which aims to limit certain crypto-related activities and facilitate a more fair playing field for banks involved in servicing the digital asset industry.  While the program looks to provide stricter oversight on U.S. banks, the Federal Reserve implied that it isn’t discouraging state banks from cutting ties with industry, presumably including the digital asset firm sector.

The Verdict

This is interesting because the Federal Reserve is not a government agency, so their approach appears to be slightly different.  Instead of staking out their portion of cryptocurrency to regulate, they seem to be more interested in getting Congress to act and provide legislative solutions.   At the same time, they seem to want to educate consumers as to the real risk of cryptocurrencies, as much of their attention appears to be on stablecoins.  I hope their approach wins the day.


Does The Federal Reserve Regulate Cryptocurrency? (forbes.com)

The (somewhat lively) state of crypto regulation – Thomson Reuters Institute

Federal Reserve Setting Up New Squad of Crypto Specialists (coindesk.com)

US Fed steps up oversight of banks’ involvement with crypto firms (cointelegraph.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.


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