In remarks before the Blockchain Association, Acting OCC Comptroller Michael Hsu identified lessons from the 2008 financial crisis that regulators and the crypto industry should apply to "avoid repeating the mistakes of the past."
Mr. Hsu warned of similarities between the trajectory of (i) the crypto and decentralized finance ("DeFi") industries and (ii) the derivatives business leading up to the 2008 financial crisis. He drew a distinction between innovation used to solve a problem and "innovation for innovation's sake," explaining that the latter lacks a clear purpose. Mr. Hsu likened the proliferation of synthetic collateralized debt obligation-squared deals and negative amortization mortgages to the creation of stablecoin savings accounts, asserting that these products lack straightforward explanations as to their function and how returns are generated. Mr. Hsu stated that most crypto/DeFi innovations do not appear to be addressing issues in the real economy.
Mr. Hsu also pointed out that the percentage of the underbanked who own a cryptocurrency is higher than the percentage of the fully banked. Citing these statistics, he raised concerns that a crypto or DeFi financial crisis would impact the individuals who are least likely to endure it.
Mr. Hsu also cautioned that the crypto/DeFi industry's ability to withstand previous destabilizing events is not an indication that the industry will withstand future events as crypto markets open up more and more to mainstream investors rather than just "hardcore believers."
Noting the similarities between the innovation leading up to the 2008 financial crisis and the rapid developments in the crypto/DeFi space, Mr. Hsu recommended that regulators and the crypto/DeFi industries:
- root financial innovation in a clear purpose to ensure that its advent is actually helping to solve an issue, such as reducing the expenses associated with poverty and improving access to credit, banking services and affordable housing;
- advocate for and address scrutiny of crypto innovations to ensure that they better serve the public and are more sustainable; and
- ensure that the profit and loss mechanisms of a crypto innovation can be explained without jargon.
OCC Comptroller Hsu's speech leaves little doubt as to his skepticism of crypto/DeFi markets. His comparison of current crypto/DeFi innovations as similar to the credit default swaps that, in significant part, precipitated the 2008 global financial crisis, will not go unnoticed by market participants and financial regulators. Beyond tone, the content of Comptroller Hsu's speech is largely consistent with his previous remarks expressing caution on technological innovations outside of the traditional banking system.
The speech raises a number of interesting questions as to the "purpose" of financial innovation, to use Comptroller Hsu's terms. For example, if financial innovation should be "anchored in purpose," as he posits, what should that purpose be? Who or what should determine such purpose or evaluate whether that purpose is appropriate or satisfactory? Isn't one of the fundamental purposes of any business, crypto or otherwise, to satisfy consumer demand? Should such decisions be left to financial regulators or to the market itself?
Further, Comptroller Hsu argues that all financial innovation can be subject to "perversion" at one point or another. However, his remarks are silent as to how to determine and prevent such "perversions" in innovation. He criticizes innovations in crypto/DeFi markets as inappropriately "focused on enhancing trading" rather than providing "solutions to problems in the real economy." Yet, are all innovations that are focused on enhancing trading necessarily perversions? What role do financial regulators have in mitigating or managing such "perversions"?
While these questions do not have any obvious answers, they should be considered, particularly as crypto/DeFi markets continue to develop and move into banking sector activities.
Cadwalader's Steven Lofchie contributed to this comment.
- OCC Speech, Michael Hsu: Cryptocurrencies, Decentralized Finance, and Key Lessons from the 2008 Financial Crisis
- OCC Press Release: Acting Comptroller Discusses Innovation in Digital Assets
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