In the wake of the collapse of FTX, the third largest digital cryptocurrency exchange in the world that also operated as a kind of crypto hedge fund, a letter addressed to Congress by New York State Attorney General Letitia James is one of the latest to call for increased regulation on cryptocurrency investments.
James’ letter focuses on retirement funds, and asks that measures be adopted to prevent IRAs and defined contribution plans from being invested in high-risk digital assets such as cryptocurrency and digital tokens.
Concerns mentioned include the high risks of fraud, theft and loss involved when investing in cryptocurrencies, as well as a lack of equity interest or debt obligations and the non-transparent market forces at play.
For many Americans, the majority of their retirement savings will come from an IRA or 401(k) plan. AG James’ letter warns that allowing these types of funds to be invested in digital assets means many Americans could find themselves at retirement age without enough savings for their basic expenses.
“Most issuers of cryptocurrencies are not examined by any regulator, state or federal,” James wrote. “They neither operate pursuant to net capital requirements, nor do they maintain minimum reserves to meet liabilities and prevent a run.”
New York’s Attorney General is not the first to raise concerns about the prospect of mixing cryptocurrency and retirement fund investments.
Earlier this year, the U.S. Department of Labor released a statement warning plan fiduciaries to exercise “extreme care” when considering the addition of cryptocurrency options to 401(k) plans. The department cited a list of “serious concerns” about crypto being used for retirement investments, particularly the high risks of fraud, theft and loss.
With this letter, AG James joins a growing list of names calling in recent weeks for increased oversight on the largely unregulated cryptocurrency industry in general. Janet Yellen, current US Treasury Secretary and former chair of the Federal Reserve, also released a recent statement calling for tightened regulations on crypto.
“The recent failure of a major cryptocurrency exchange [FTX] and the unfortunate impact that has resulted for holders and investors of crypto assets demonstrate the need for more effective oversight of cryptocurrency markets,” said Yellen, warning that “further interconnections of the traditional financial system and crypto markets could raise broader financial stability concerns.”
However, some are urging caution when considering broad legislation in this early stage of the nascent crypto industry.
Omid Malekan, a professor at the Columbia Business School and author of several crypto-related books including Story of the Blockchain, told The Crime Report he supports introducing new regulations on crypto but states that a law forbidding the investment of any part of citizens’ retirement funds in crypto would be “draconian.”
Malekan, however, agrees that tighter regulation is needed around crypto—the controversies lie in the details of exactly how to regulate it. He states that a modified version of James’ proposal, restricting the availability of crypto in retirement funds to only the most established coins (e.g. Bitcoin), might make sense.
“Everyone, even in the industry right now, agrees there are aspects of crypto that need to be regulated, but there’s very little agreement on how and whom,” Malekan said.
“We have a landscape of many different regulators at the state and the federal level, and they are right now in the middle of a turf war about who gets to regulate crypto.”
Malekan argued that in some ways, the cryptocurrency industry may actually be easier to regulate than traditional financial institutions because of the technology involved.
“There are aspects of blockchain technology that makes it a lot easier to regulate crypto companies than what it takes to regulate traditional financial services,” he said.
“Because everything is ultimately traced on this transparent global ledger…it’s a lot easier to make sure that, if customers send their coins to an exchange, the exchange is not misappropriating them.”
One way of introducing more oversight to the cryptocurrency industry, then, could come in the form of a law formally requiring “proof of reserves.”
“There is this idea called proof of reserves…if done right, what happens is on a periodic basis the exchange releases information that can be used to prove that they have the assets they’re supposed to have,” Malekan explained, “[The FTX failure] happened because the industry, their customers, did not demand this.”
Exchanges would release information verifying that they control a certain wallet and confirming the quantity of cryptocurrency in the wallet.
Because this information would be available to anyone, there would in theory be no need to rely on an outside auditor to assure investors that coins are not being misappropriated or lent out.
This proof of reserves concept could potentially address the issue mentioned in James’ letter about failure to adhere to net capital requirements.
“We all agree crypto should be regulated, but you don’t want to regulate it the same way you do Wall Street. It’s a fundamentally different thing,” Malekan said. “
With regulations this early in the process, you want to [use] as light a touch as possible while preventing something like FTX from happening again. You want to be forward-looking.”
Kay Bontempo is a TCR Contributor.