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Tighter regulation of digital currencies is needed to protect small investors and to help tame the industry’s volatility as it continues to grow, Lael Brainard, vice-chair of the U.S. Federal Reserve, said in a London speech last week at a conference hosted by the Bank of England.

Cryptocurrencies dangle “the false allure of seemingly easy returns that obscures significant risk,” she noted.

Crypto’s risks “are all too familiar from traditional finance, such as leverage, settlement, opacity, and maturity and liquidity transformation,” she said.

The crypto industry has faced only minor regulation by governments so far.

Europe is studying the issue and U.S. regulators have been pushing for years for Congressional authorization to impose rules on crypto, as we have reported in “SEC Push to Regulate Crypto” (7 Dec 2021), CFTC Chief Seeks Authority to Regulate Crypto (15 February, 2022), and other articles.

As well as protecting investors, the rules should cover trading and lending firms that operate in ways similar to traditional financial institutions “without comparable regulatory compliance,” she said.

“This is the right time to ensure that like risks are subject to like regulatory outcomes and disclosures,” she added.

The U.S. Senate and House of Representatives each are drafting regulatory frameworks for digital assets with a special emphasis on governing stablecoins, which are digital currencies the value of which is tied to a non-digital asset, such as the dollar, euro, or price of gold.

Rules should begin by protecting individual investors from “exploitation, conflicts of interest, and market manipulation—risks to which they are particularly vulnerable, according to a host of research,” Brainard said.

The absence of such protections can lead to investor stampedes, she warned.

“It is important that the foundations for sound regulation of the crypto financial system be established now before the crypto ecosystem becomes so large or interconnected [with traditional financial infrastructure] that it might pose risks to the stability of the broader financial system,” she emphasized.

TREND FORECAST: In May, the European Union proposed a new set of more comprehensive regulations over the crypto industry. If adopted, the rules will take effect in 2024.

Europe’s draft regulations will serve as a template and starting point, as well as a prod, for the U.S. and other nations to begin structuring their own formal oversight of the cryptocurrency industry.

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