Mounting Concern, As Cryptocurrency Outgrows Its Clothes

A number of articles about the cyryptocurrency industry highlight recent trends, some of which are found alarming. Some see a potential crisis in the works for investors, and possibly for the wider economy. We are seeing explosive growth, increasing involvement of high-profile former players in the traditional financial industry, and vocal public resolve by regulators to address the phenomenon, but with warnings by critics that their approach isn’t up to the task.

An article from Reuters notes that the cryptocurrency exchange Coinbase has hired the former general counsel/executive vice president of Fannie Mae. This appointment comes on the heels of increasing regulator attention to cryptocurrency markets, including a report this month from the New York attorney general’s office, stating that “several cryptocurrency exchanges are plagued by poor market surveillance, pervasive conflicts of interest and lack of sufficient customer protections.”

Recent regulator interest in cryptocurrencies is further detailed in an article from CCN. (The acronym stands for CryptoCoinsNews, an Oslo, Norway-based site “providing news coverage around cryptocurrencies including bitcoin.”) The CCN article cites a speech earlier this month by SEC co-director of enforcement Stephanie Avakian, in which she alludes to “more substantial remedies” in the works, specifically to target parties that don’t follow proper initial coin offering (ICO) registration requirements.

From Forbes, we get an account of a recent letter to the SEC by some key players in cryptocurrency finance. The letter writers, who include a bitcoin developer, a former Morgan Stanley managing director and a founder of the Ernst & Young blockchain team, warn against what they say are practices of one of the largest international currency exchanges, ICE, which is said to be about to launch its own cryptocurrency exchange. (ICE, or the Intercontinental Currency Exchange, is the parent company of the New York Stock Exchange.) The letter specifically warns against a practice called “commingling,” where assets are grouped together instead of being “natively segregated” in a way that exploits a core strength of cryptocurrency. The letter argues that “maintaining this natural segregation at all times would best protect investors by conforming to the architecture of digital asset technology,” and that failure to do so would create excess liquidity of unbacked assets, one of the problems (presumably a reference to securitized mortgages) that led to the economic crisis of 2007-2008. A second practice the letter warns against is termed “”rehypothecation.” It refers to a protocol that allows both the owner of an asset and an entity that borrows it to list it as an asset on its balance sheet. The letter urges the SEC to partner with those who really understand how cryptocurrency works – “cryptographic engineers, software developers, Bitcoin exchanges, smart-contract designers, blockchain developers, and existing digital-asset managers”- to devise effective regulation protocols.

Another Forbes article, by reporter Caitlin Long, takes an even closer look at the concepts of rehypothecation and commingling, and she doesn’t necessarily like what she sees. She calls them “inside baseball” terms that describe entrenched Wall Street practices that “enable the financial system to create more claims to an underlying asset than there are underlying assets.” With the entry of ICE, she says, these practice are almost certainly coming to the world of cryptocurrency.