Key Takeaways from President Biden’s Executive Order on Crypto

On March 9, 2022, President Joe Biden signed a much-anticipated executive order (EO) titled “Ensuring Responsible Development of Digital Assets” as well as released an accompanying fact sheet. The order focuses on six key areas — ensuring consumer and investor protection, maintaining financial stability, combating illicit financing activities, establishing U.S. leadership in the global financial system, and securing economic competitiveness, financial inclusion, and responsible innovation.

According to the EO, while developing, designing, and implementing digital asset technologies and digital payment ecosystems, the crypto industry should place increased emphasis on three main things:

• Ensuring that privacy and security remain an integral part of the core architecture
• Crypto businesses must integrate features and controls that provide defense against illicit exploitation
• Reduce environmental pollution and negative climate impacts, which may result from certain activities such as crypto mining

Under the executive order, President Biden directed the U.S. Department of Treasury to work with relevant agency partners such as the Attorney General, the Secretary of Commerce, and Homeland Security amongst others, to produce a report on the future of money and payments systems. The report, which is to be published within 180 days of the release, will analyze the conditions that drive the adoption of digital assets and the extent to which technological innovation may influence the adoption of digital assets. The report will also examine the implications of such adoption on the modernization of payments systems, economic growth, financial inclusion, and national security.

The EO was welcomed by the crypto industry and investors as it attempted to address a long-standing desire for regulatory clarity. Post the announcement, cryptocurrencies such as BTC and ETH experienced a momentary surge in prices. Jerry Brito, the executive director of prominent think tank Coin Center, stated that “the message I take from this EO is that the federal government sees crypto as a legitimate, serious, and important part of the economy and society.” Further, Travis Kling, Founder and Chief Investment Officer of Ikigai Asset Management noted that “it’s easy to lose sight of how much ground this ecosystem has covered in the last two years in terms of legitimacy and stance from the U.S. government, but this EO makes it clear the US government is not banning crypto, it is embracing it.” 

Though the EO garnered mostly positive responses from the crypto industry, some members of the community were disappointed by the lack of specific policy proposals.

Putting consumer and investor protection at the forefront

The EO explained that though some digital asset trading platforms and service providers have grown exponentially in size and complexity in recent years; however, they may not be subject to or in compliance with appropriate regulations. In this situation, investors and consumers may not be provided with the same amount of safeguards that are given to other asset classes, such as derivatives. Further, in the absence of sufficient oversight and standards, firms providing digital asset services may provide inadequate protections for sensitive financial data, custodial, and other arrangements relating to customer assets and funds, or disclosures of risks associated with the investment.

Same business, same risk, same rules: The EO explained that digital asset businesses such as crypto exchanges and trading platforms should, as appropriate, be subjected to the same regulatory and supervisory standards that govern traditional market infrastructures and financial firms.

When it comes to conducting money laundering activities, illicit actors generally use similar types of criminal typologies, whether in fiat or crypto. Technologies such as decentralized finance (DeFi) and non-fungible tokens (NFTs), however, introduce a new layer of complication. For instance, in DeFi and NFTs, smart contracts may serve a function similar to that of coin mixers, making it difficult to track the funds’ origination. In these cases, the regulators should consider refraining from putting a centralized wrapper around new technologies. They must take this opportunity to adapt themselves to the new automated and digital infrastructure.

However, the EO also stated that new and unique uses and functions that digital assets can create additional economic and financial risks requiring a new regulatory approach to adequately address them. In a Merkle Science webinar on DeFi, panelists opined how the crypto industry should come together and propose technical solutions to regulatory problems surrounding new technologies such as DeFi. Since stakeholders like the protocol runners understand the concentration of control, governance structure, and systematic risks existing between different technologies the best, the regulators will hugely benefit from the constructive and technical solutions provided by the protocol runners. Further, panelists thought that regulators should acquire technological expertise and engage with a wider group of stakeholders — such as software developers — to effectively regulate digital assets such as stablecoins or understand new and unique use cases of technologies such as NFTs.

Prioritizing mitigating the illicit use of finance

Though the EO recognized that the rise in digital assets usage may create an opportunity to reinforce the U.S.’ leadership in the global financial system, it also stated that digital currencies may pose substantial illicit finance risks including money laundering, cybercrime, narcotics, ransomware, human trafficking, terrorism, proliferation financing, and ransomware. The EO called for coordinated action across all relevant U.S. government agencies to mitigate illicit use of digital assets.

The EO warned that the digital assets may also be used as a tool to circumvent the U.S. and foreign financial sanctions regime. Recently, Financial Crimes Enforcement Network (FinCEN) issued an alert urging financial institutions to remain vigilant against potential efforts by Russia to evade the U.S. sanctions.

The EO also pointed out that, while the U.S. has been a leader in regulating digital assets and setting AML/CFT standards for them, the poor or non-existent implementation of those standards in some jurisdictions is presenting significant illicit financing risks. The continued availability of digital asset service providers in jurisdictions where international AML/CFT standards are not effectively implemented enables financial activity without illicit finance controls. For example, bad actors may use non-compliant exchanges and peer-to-peer (P2P) exchanges situated in jurisdictions with weak AML/CFT controls to liquidate proceeds from illicit activities such as ransomware payments.

The EO warned that the rapid growth of DeFi ecosystems, P2P exchanges, privacy coins, and mixers and tumblers could also create national security risks. These privacy-enhancing technologies can facilitate complete anonymization and privacy in blockchain transactions by obscuring the origin and destination of funds. 

Therefore, to promote high standards for transparency, privacy, and security, the EO seeks to establish appropriate controls and accountability frameworks that have to be put in place for current and future digital assets systems — including through regulatory, governance, and technological measures.

Policy actions related to Central Bank Digital Currency

Acknowledging the merit in showcasing the U.S.’ leadership and participation in international summits such as G7 and G20, and in multi‑country conversations and pilot projects involving CBDCs, the Biden administration is placing urgency on the research and development of potential U.S. CBDC.

The EO directs the U.S. government to assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects the interests of Americans. The EO has listed the promotion of safe and affordable financial services as one of its primary objectives. The EO seeks to promote financial inclusion and provide equitable access to financial services, particularly to those Americans who are underserved by the traditional banking system. The EO directs the Chairman of the Federal Reserve to prepare a report determining the extent to which CBDCs could improve the efficiency and reduce the costs of existing and future payments systems

Further, the EO has given the Attorney General, the Secretary of the Treasury, and the Chairman of the Federal Reserve a 210-day deadline to prepare a legislative proposal focusing on CBDC development. In the future of money and payments systems report, the U.S. Department of Treasury will specifically examine the potential implications that a U.S. CBDC may have on democracy, economic growth and stability, financial inclusion, future of CBDCs and stablecoins developed globally. The report will also analyze the extent to which foreign CBDCs could displace existing currencies and alter the payment system in ways that could undermine the U.S. dominance in the global payment system. Additionally, the report will also examine illicit financing, sanction, and other law enforcement risks.

Increased focus is placed on reinforcing the U.S. leadership in the global financial system

The EO stated that the U.S. derives significant economic and national security benefits from the central role that the U.S. dollar and U.S. financial institutions and markets play in the global financial system. Therefore, to sustain the U.S. financial power and promote its economic interest, the EO observed that the U.S. must remain at the forefront of responsible development and design of digital assets and the technology that underpins new forms of payments and capital flows in the international financial system. To drive U.S. competitiveness and leadership in technology and economic competitiveness and for leveraging digital asset technologies, the EO directed the Department of Commerce to work across the U.S. government to establish a framework. This framework has to be established within the next 180 days.

Stating that uneven regulation, supervision, and compliance across jurisdictions creates opportunities for arbitrage and raises risks to financial stability and the protection of consumers, investors, businesses, and markets, the EO also emphasized the importance of improving international coordination. Therefore, the EO urged the U.S. federal agencies to work with international partners and come up with standards for the development and appropriate interoperability of digital payment architectures and CBDCs. The EO reiterated that the U.S. remains committed to expanding engagement with critical infrastructure partners through forums such as G7, G20, the Financial Action Task Force (FATF), and Federal Security Service (FSB)

How can Merkle Science help?

Fuelled by the increased focus on consumer and investor protection, the Biden administration is looking to strengthen its crypto regulatory regime. Merkle Science’s highly customizable and easy-to-use platform provides near real-time detection of blockchain transactional risks. Our predictive cryptocurrency risk and intelligence platform set the standard for the next generation of financial safeguards and criminal detection. 

Merkle Science’s proprietary Behavioral Rule Engine allows crypto businesses to tailor the tool according to their risk policies based on the recent changes so that businesses may stay ahead of emerging illicit activities and fulfill their local compliance obligations.