New York Attorney General Letitia James has announced legislation that would tighten regulations on the cryptocurrency industry to protect investors, consumers, and the broader economy. James says the multi-billion-dollar industry lacks robust regulations, making it prone to dramatic market fluctuations, and has been used to hide and facilitate criminal conduct and fraud. Attorney General James’ program bill would increase transparency, eliminate conflicts of interest, and impose measures to protect investors, consistent with regulations imposed on other financial services.
The bill would require independent public audits of cryptocurrency exchanges and prevent individuals from owning the same companies, such as brokerages and tokens, to stop conflicts of interest. Crypto platforms would also have responsibilities to customers similar to banks under the federal Electronic Fund Transfer Act by requiring platforms to reimburse customers who are the victims of fraud. The bill would also strengthen the New York State Department of Financial Services (DFS) regulatory authority on digital assets.
Overview of the Crypto Regulation, Protection, Transparency, and Oversight (CRPTO) Act:
Millions of investors have lost hundreds of billions in the value of their cryptocurrency investments because of rampant fraud, including market manipulation, hacking, and opaque business practices. Currently, the cryptocurrency industry lacks a robust regulation regime that would prevent or intercept fraud and market failures. While there are millions of investors who have lost significant investments because of these failures, lower-income investors and people of color have been disproportionately harmed by the risks of crypto. A study by the JPMorgan Chase Institute on investments made before the 2022 collapse in cryptocurrency values found that lower-income households bought crypto at substantially higher prices, and as a result, those lower-income households bore a disproportionate share of the losses when the bubble burst.
Additionally, as cryptocurrency investments have been marketed directly to minority communities, the people most susceptible to fraud and losing significant funds due to financial collapses are disproportionately vulnerable and marginalized Americans. Attorney General James’ bill seeks to protect New York investors by bringing regulations and oversight that are applied to other financial services to the cryptocurrency industry and addressing risky practices that are unique to crypto.
1. Stop Conflicts of Interest
The cryptocurrency industry is rife with conflicts of interest that harm investors and reduce competition. In one example, crypto company Terraform Labs created a token, Luna, and also created a lending platform, Anchor, that promised 20 percent interest to customers who invested in Luna on Anchor. But investors could only access the 20 percent returns if they purchased another token created by Terraform Labs called Terra. Because Terraform Labs owned Luna and Terra and promised these unsustainable high interest rates, the actual value of the digital assets was masked from everyday investors and set the table for market disaster. Under current law, there is no regulation or prohibition against these obvious conflicts of interest that put crypto investors at risk.
The bill would stop conflicts of interest in the industry by:
- Preventing common ownership of crypto issuers, marketplaces, brokers, and investment advisers and preventing any participant from engaging in more than one of those activities;
- Preventing crypto brokers and marketplaces from trading for their own accounts;
- Prohibiting marketplaces and investment advisers from keeping custody of customer funds;
- Prohibiting brokers from borrowing or lending customer assets; and
- Prohibiting referrals from marketplaces to investment services for compensation.
2. Require Public Reporting of Financial Statements
Too often investors are unaware of the real risks of investing in cryptocurrencies because crypto companies are not required to make critical public disclosures of their financial condition. As a result, most companies do not make any public disclosures and some companies have even publicly misrepresented their financial condition. For example, Celsius, a cryptocurrency lending platform, bought up its own token, Cel, resulting in an inflated price of Cel and an appearance of demand for Cel, which did not actually exist. When Celsius ultimately froze customer withdrawals and filed for bankruptcy, many investors were caught by surprise, especially in light of repeated statements by the company and its CEO Alex Mashinsky that Celsius had billions of dollars of liquidity.
The bill would increase transparency in the industry by requiring companies to, among other things:
- Undergo mandatory independent auditing and publish audited financial statements;
- Provide investors with material information about issuers, including risks and conflict-of-interest disclosures;
- Require marketplaces to establish and publish listing standards; and
- Require cryptocurrency promoters to register and report their interest in any issuer whose crypto assets they promote.
3. Bolster Investor Protections
Cryptocurrency companies — unlike banks — lack insurance for customer deposits, which makes these companies at significant risk of an old-fashioned “bank run” if they get into trouble. At the same time, crypto companies often lack comprehensive oversight and reserve requirements to ensure they can meet consumer demand or obligations. Multiple cryptocurrency companies have gone bankrupt, losing billions of dollars in investments with no recourse for investors. Additionally, due to inadequate cybersecurity measures, many crypto brokers and marketplaces have lost billions of dollars of customers’ crypto assets. In 2021, cybercriminals raked in at least $14 billion in stolen digital assets. Currently, the law does not protect investors’ cash or provide a means for returning an investor’s crypto holdings if a crypto exchange, broker, or platform fails.
The bill would bolster investor protections by:
- Enacting and codifying “know-your-customer” provisions, meaning brokers would have to know essential facts about their customers, and requiring crypto brokers and marketplaces to only conduct business with firms that comply with KYC provisions;
- Banning the use of the term “stablecoin” to describe or market digital assets unless they are backed 1:1 with U.S. currency or high-quality liquid assets as defined in federal regulations; and
- Requiring platforms to reimburse customers who are the victims of unauthorized asset transfers and transfers resulting from fraud.
The bill would grant the Attorney General jurisdiction to enforce any violation of the law, issue subpoenas, impose civil penalties of $10,000 per violation per individual or $100,000 per violation per firm, collect restitution, damages, and penalties, and shut down businesses engaging in fraud and illegality. The bill would also codify DFS’ authority to license digital asset brokers, marketplaces, investment advisors, and issuers prior to engaging in business in New York and allow DFS to oversee the digital asset licensing regime.
“The cryptocurrency industry is in need of regulation and oversight,” said New York State Comptroller Thomas P. DiNapoli. “As the financial capital of the world, New York must lead these efforts. I applaud Attorney General James for taking decisive action to protect the public.”