Does the Federal Reserve regulate cryptocurrency?

The central theses

  • The Federal Reserve regulates banks, meaning it only oversees cryptocurrencies held by banks in the United States.
  • The top US banking regulator is considering introducing a Central Bank Digital Currency (CBDC), a cryptocurrency version of the dollar.
  • Cryptocurrency exchanges and businesses may be regulated by other state and federal agencies.

Cryptocurrencies made big headlines as prices skyrocketed, turning investors into millionaires overnight. When something big happens in a financial market in the US, you can rest assured that regulators won’t be far behind. Among other authorities, the crypto revolution caught the attention of the Federal Reserve and a leading financial regulator.

Here’s what you need to know as a crypto trader and investor considering how regulations may affect your cryptocurrency in the future.

Cryptocurrency 101

If you are new to crypto, here is a brief introduction to how it works. Cryptocurrencies are a form of digital money managed by distributed computer networks. Each works differently, some are made by volunteer programmers, others are built by corporations – Fortune 500 companies, startups and everything in between.

Cryptocurrencies are digital assets that are not backed by any government. National currencies, known as fiat currencies, are backed by loans from their national government or government agency such as the Federal Reserve or the European Central Bank. Cryptocurrencies only have value from the communities that use them.

While cryptocurrencies can increase in value by 10x or 100x, they could also go down to zero. The industry is riddled with scams, so it’s important to remain cautious and avoid investing more than you can afford to lose.

How the Federal Reserve regulates cryptocurrency

The Federal Reserve focuses on regulating banks and the US dollar, leaving cryptocurrencies generally outside of their sphere of influence. Crypto and the Fed overlap when banks hold cryptocurrency as an asset on their balance sheets.

Banks make money from the funds raised by customers’ bank deposits to facilitate home loans, credit cards, business loans, and investments. The Federal Reserve requires banks to hold a certain percentage of deposits in secure assets and cash so customers can easily access funds when withdrawals spike.

The Federal Reserve has ruled that banks must disclose cryptocurrency-related assets separately. New cryptocurrency activity requires Federal Reserve notification. Banks are being urged to consider the risks of crypto to their asset portfolios.

A new digital dollar?

The Federal Reserve recently popped into crypto news to explore a central bank digital currency (CBDC), or digital dollar. In this case, the Fed plans to create a digital version of the US dollar managed by blockchain technology. Other countries, including China, are also exploring the use of a CBDC.

At that point, the Fed released a paper examining the pros and cons of creating a new CBDC and asked for public feedback. Currently, banks and credit unions keep digital books for our money. With a digital dollar, dollars would become part of a more transparent system, but there are still many risks and issues to address before we can expect the Fed to move forward.

Other authorities and cryptocurrency regulation

The Federal Reserve is not the only government regulator dealing with cryptocurrencies. Here’s a snapshot of our other agencies and their relationships with crypto:

  • Securities and Exchange Commission (SEC): The SEC regulates the stock market and other securitized investments. Cryptocurrency is arguably a security in some cases, and the SEC specifically chose Ripple XRP currency as an example. It is investigating more cryptocurrency rules in the future.
  • Financial Crime Enforcement Network (FinCEN): FinCEN works to prevent and detect financial crime. They investigate cryptocurrencies specifically working to uncover financial crimes such as money laundering.
  • Commodities Futures Trading Commission (CFTC): The CFTC regulates futures and commodity trading. Several cryptocurrencies are available for trading under these asset class umbrellas, bringing them under the supervision of the CFTC.

The regulations could be expanded in the future. A Congressional proposal would direct the Federal Energy Regulatory Commission to investigate the cryptocurrency’s energy impact.

State regulators are also on the case, particularly in New York, where certain currencies must be registered to be available to local residents and bitcoin mining is effectively banned. A high-profile case involved Tether (USDT) and related exchange Bitfinex, which agreed to fines from the New York State Attorney General related to misleading investors.

bottom line

Cryptocurrencies are a unique asset class that is currently only loosely regulated. Many in government and the crypto industry would like additional cryptocurrency regulations to create guidelines and guard rails that would prevent missteps, rather than the Wild West we’ve inhabited for the past decade.

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