Push to regulate crypto could test limits of CFPB's power

Many in the regulatory community believe the Consumer Financial Protection Bureau is gearing up to launch enforcement actions against cryptocurrency firms. But that could revive a debate about the limits of CFPB power.

As crypto evolves into a mainstream consumer product, complaints to the CFPB about the sector have already exceeded 1,700 this year, compared with 982 all of last year and 488 in 2019. With the industry's growth have come calls for regulatory checks.

Speculation has mounted that Rohit Chopra, President Biden’s choice to lead the CFPB, will take an expansive view of the bureau’s authority by penalizing crypto companies for "unfair, deceptive, or abusive acts or practices," a federal prohibition under the Dodd-Frank Act that is the basis for many enforcement actions.

“The CFPB sees themselves as protecting the vulnerable,” said Katherine Kirkpatrick, a partner in the special matters and government investigations practice at King & Spalding. “The CFPB also was muzzled under the Trump administration and now the muzzle is going to be taken off and the bounds of what it's going to do are really untested.”

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The CFPB's purpose in its young history is focusing on consumer products not otherwise subject to federal oversight. Dodd-Frank gave the CFPB broad enforcement powers over nonbanks through UDAAP, and authorized the agency to supervise "larger participants" in nonbank sectors.

But conservatives argue that the CFPB's enforcement authority over cryptocurrency firms is not automatic, in part because policymakers are still trying to define digital assets.

“Consumer protection actually is the heart of the matter" with crypto, "but there are jurisdictional questions about what products actually fall in and out of [the CFPB’s] purview,” said former CFPB Director Kathy Kraninger.

In July, Kraninger joined crypto monitoring firm Solidus Labs as vice president of regulatory affairs. At the CFPB, she supported the views of her predecessor, former director of the Office of Management and Budget Mick Mulvaney, who claimed the CFPB should not “push the envelope” of its jurisdiction.

“There are parameters around the CFPB's responsibilities and consumer financial products," Kraninger said. "I think the key issue here is really the fundamental one as we look at all these digital assets: How are they defined, how are they being used, and what are they."

Many expect Chopra will want to take on some aspect of the crypto industry given his close ties to Sen. Elizabeth Warren, D-Mass. She has warned of the dangers that cryptocurrencies pose to consumers.

But other regulators have been more vocal on the need for regulatory involvement.

Treasury Secretary Janet Yellen has urged regulators to develop a framework for stablecoins. Under Dodd-Frank, the Financial Stability Oversight Council can recommend regulatory requirements for nonbanks firms and appoint one of the council's member agencies to lead oversight. Some have also called for FSOC to designate certain crypto firms as "systemically important financial institutions," which would subject them to banklike supervision.

Securities and Exchange Commission Chair Gary Gensler has called cryptocurrencies “the Wild West,” and last week compared stablecoins to poker chips at a casino gaming table. The SEC has been the most active regulator on crypto issues, in large part because of speculative trading of digital assets.

Meanwhile, acting Comptroller of the Currency Michael J. Hsu said last week that cryptocurrency scams have flourished and that underbanked consumers in particular are more likely to hold digital assets.

The Federal Reserve Board is also poised to issue a report soon dealing with stablecoins and whether the central bank plans to issue its own digital currency.

But some observers believe the CFPB would be a natural fit considering its focus protecting vulnerable consumers from relatively unregulated providers.

"The SEC will continue to exercise dominant jurisdiction, but I would expect the CFPB to become involved given the remit of the agency and its genesis," said Alan Konevsky, interim CEO at tZero, a trading platform subsidiary of Overstock.com, and a former senior vice president at Mastercard.

Though complaints about cryptocurrencies to the CFPB remain fairly low relative to other financial products, observers say Chopra's experience serving on the Federal Trade Commission has likely furthered his interest in cracking down on high-profile crypto firms found to be in violation of the UDAAP prohibition.

A recent report by the FTC found that nearly 7,000 consumers have reported losses of more than $80 million to cryptocurrency scams in the six months ended March 31. The median loss was $1,900 per consumer, the FTC found.

Some crypto investors are embracing regulation and expect a focus on consumer harm will lead to an industry shakeout.

"There definitely needs to be more regulation and some consumer protection," said Steven McClurg, co-founder and chief investment officer at Valkyrie Investments, a Nashville asset manager. "Some of these projects make claims that they're going to do something, and then they never do the thing that they said they're going to do. And that's where consumer harm comes in."

Regulators also are questioning the premise, promoted by many crypto firms, that digital assets are a tool to help solve problems for underbanked consumers. Black and Hispanic adults are more likely to be Bitcoin owners than white adults, according to research by Morning Consult.

The OCC’s Hsu questioned how such products aid low-to-moderate-income consumers.

“I find it both concerning and ironic that the crypto ... space is replete with scams,” Hsu said in a Sept. 21 speech to the Blockchain Association, an industry trade group. “To the extent there is fool’s gold in the crypto space, some of those who are going to be hurt most are going to be those least able to bear it.”

Many crypto experts think that while the CFPB will flex its muscles under its UDAAP authority, state regulators also could play a role.

“For the industry to continue to grow, it must be regulated and it will be regulated,” said Konevsky. "We shouldn't discount state agencies as well, either wearing their securities-regulator hat or money- services-regulator hat over consumer protection."

Currently, most crypto exchanges are regulated at the state level through money transmitter licenses. They also follow anti-money-laundering rules issued by the Financial Crimes Enforcement Network, or Fincen. In May, the OCC, Federal Deposit Insurance Corp. and the Fed announced an “interagency policy sprint team” focused solely on crypto.

The Commodity Futures Trading Commission has jurisdiction over derivatives and spot markets for cryptocurrencies, but the Biden administration has yet to get all of its Democratic appointees confirmed to the CFTC.

Kraninger said Dodd-Frank excludes products with an investment component from the CFPB's authority.

"It is explicit in the Dodd-Frank Act, that is, if it's a security or commodity then it's outside of the CFPB purview when it comes to the definition of a consumer financial products," Kraninger said. "That's part of the dynamics that are really challenging in terms of talking about these things."

But Kirkpatrick countered that Dodd-Frank gave the bureau broad powers when dealing with any consumer financial product, and that could include crypto exchanges and digital tokens.

"Dodd-Frank gave the CFPB consumer protection jurisdiction over any company involved in offering or providing a consumer financial product or service — and that can be broadly interpreted," said Kirkpatrick. “There's no narrow definition of what is a consumer financial product or service. And that clearly has not been defined in the crypto space. The only difficult part right now is that all of this has been untested.”