October 11, 2022

Acting OCC Comptroller Urges Limits on Integration between TradFi and DeFi

Steven Lofchie Commentary by Steven Lofchie

Acting Comptroller Michael J. Hsu urged regulators to monitor the nature of the relationship between TradFi and DeFi warning that applying traditional finance regulations and concepts to a decentralized cryptocurrency industry may downplay and disguise significant risks associated with cryptocurrencies.

In remarks at the 2022 DC Fintech Week, Acting Comptroller Michael J. Hsu said that a "skeuomorphic" approach (i.e., modeling new technologies after existing ones to decrease resistance to novel tech) may be beneficial if the old and new technologies are similar. But the same comparison cannot apply to digital assets, he said, because the underlying technologies of TradFi and DeFi that govern core concepts like custody and ownership are quite different.

Additionally, Mr. Hsu argued that integrating TradFi and cryptocurrencies would not enhance the stability of cryptocurrencies without proper guardrails in place. Mr. Hsu urged regulators to be cautious when developing regulations that facilitate the integration of DeFi platforms with traditional financial institutions until a more solid regulatory framework for cryptocurrency is implemented and the cryptocurrency industry matures. He said that the potential convenience and efficiency of integrating TradFi and DeFi should not outweigh the financial stability risks posed by such integration.

Mr. Hsu proposed collecting data on commingled activities among crypto firms, arguing such data would provide regulators with a clearer picture of the broader industry, which will allow regulators to more effectively surveil for financial stability risks. He called for strong international coordination given the "borderless" nature of cryptocurrencies, and he committed to continue working to identify potential risks to the crypto space.

Commentary

Mr. Hsu's observation that crypto assets are very different from non-crypto assets contradicts SEC Chair Gary Gensler's position that crypto assets are no different from other securities and that "like must be treated as like." Mr. Hsu warns, quite rightly, that there really are differences and that financial regulators should be thinking through those differences.

That said, Mr. Hsu's statement that crypto assets must be absolutely separated from the traditional banking systems seems overdone. As with any business, there are risks, but there is no reason to believe that traditional financial organizations are fundamentally incapable of managing these risks. Repeated and overemphasized attention to only the risks of digital assets and technology - with almost daily statements by one regulator or another associating the technology with criminal conduct or systemic risk - is an unbalanced approach to regulating the developing market. It is often difficult to account for the vehemence of some of these regulatory pronouncements. Unless, of course, one were to believe that the administration is trying to clear the field of stablecoins for a launch of a central bank digital currency.

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