How new rules will define the next phase of crypto’s growth
Morgan Stanley Research04/10/23
Summary: Crypto regulation will have broad implications throughout the financial sector, affecting everything from asset managers to overseas payments. Here’s what investors should know.
To say the future of the cryptocurrency industry in the US is uncertain would be an understatement.
Recent meltdowns of several high-profile crypto players have raised concerns for lawmakers and underscored the need for government oversight to protect investors, the economy, and the government itself from risk. While legislators from both sides of the aisle see the need for regulation, there's been little bipartisan consensus on how and where.
Still, with a significant percentage of American households holding cryptocurrency in some form, Morgan Stanley Research sees “a viable path to fresh crypto regulations” before the next US presidential and congressional elections, and maybe even in the current Congressional term.
“Legislators are likely to get serious about stablecoin regulations first, as conversations have been underway for some time,” says policy strategist Ariana Salvatore.
Finding common ground on crypto
At the moment, it's not clear how digital assets should be categorized under US law, or for that matter, what federal agency should oversee them. Designating that power lies with Congress.
“Lawmakers and regulators are asking themselves, ‘Is cryptocurrency a security, commodity, currency, or something else?’” says Sheena Shah, Morgan Stanley’s lead cryptocurrency strategist. “Significant regulatory implications depend on the answer.”
The answer to that question will determine, for example, if the US Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), or another body leads the effort.
Previous legislative attempts at regulating crypto have been proposed, but not enacted. Because of this, Salvatore and Shah think legislators in the near term will take a measured approach, focusing on stablecoins rather than the full scope of the crypto space. This is because stablecoins are viewed as an area where bipartisan consensus appears more achievable.
“This could involve requiring issuers to be defined like banks and therefore maintain adequate reserves and possibly be Federal Deposit Insurance Corporation (FDIC)-insured says Shah. “In addition, stablecoin issuers may be subject to rules and restrictions on commercial entity affiliation, as well as federal risk-management standards.”
Another possibility would put the Federal Reserve in charge of developing standards to promote robust risk management and the safety and soundness of assets, reduce systemic risks, and support the stability of the broader financial system. Also, considering recent bank failures, alternative bank providers have become wary of serving crypto companies in case their business models come under scrutiny. Moreover, there are only a few smaller banks providing crypto services, and it's unsure how long those offering will continue.1
Other, less likely but eventual, policy scenarios include maintaining the status quo—and the patchwork of agencies overseeing the crypto assets.
Many lawmakers have expressed concerns that regulation is overdue. Last March, President Joe Biden issued an executive order directing a "whole-of-government" approach to crypto regulation, meaning it is unlikely that legislators will opt to do nothing.
“At the same time, the split Congress almost guarantees a lighter touch on regulation, all but ruling out a comprehensive crypto rulebook,” says Salvatore.
Expanding the crypto ecosystem
Some industry players fear regulation will limit profits—and that may be the case, especially if less leverage can be created in the crypto ecosystem.
However, there's a strong case that more products will come online once there's more clarity around cryptocurrency. Traditional players in the finance industry may also want to participate once there are guidelines in place.
Of course, whatever happens on Capitol Hill will have broad implications throughout the financial sector, affecting everything from asset managers to overseas payments.
- Regulatory clarity could continue to promote product expansion as traditional asset managers increase their offerings, including cryptocurrency exchange-traded products (ETPs).
- Cross-border payments could see relatively rapid change enabled by faster clearing, which could lower transaction costs and potentially bring meaningful growth of stablecoins. Meanwhile, building out new systems based on stablecoins could be the primary entry point into the broader payment ecosystem.
- Alternative asset managers may further expand their fund offerings and even create bespoke products as regulatory clarity on crypto mitigates risks.
“Though the industry is still quite nascent and there’s lot of room to grow, Congressional action and the regulatory path will likely influence how—and where on a state and national level—growth and innovation occur,” says Salvatore.
The source of this article, How new rules will define the next phase of crypto’s growth, was originally published on February 28, 2023.
1. Source: Who is Still Banking Crypto Companies, Morgan Stanley Research, April 4, 2023.
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