As regulators circle cryptocurrency, acting Comptroller of the Currency Michael Hsu warned that the U.S. could be heading for a new financial crisis if oversight over the industry isn’t tightened.

“If the crypto industry doesn’t evolve or is more responsible, then we will be headed” for a potential rerun of 2008, Hsu told Yahoo Finance in an exclusive interview. The official is one of several crypto skeptics within the Biden administration who have taken more of a hardline on regulating the booming digital coin movement.

Hsu sounded the alarm, but noted there’s still some time to guard against a crisis. He doesn’t expect the sector will blow up in the near term. “But we are at a point where there need to be some adults in the room that guide this industry into a more responsible place,” he added.

Hsu said that cheerleading about crypto and how it will change the world is overshadowing a more responsible conversation that’s needed about how the product works, and how it should be developed in a more responsible way to meet the needs of consumers.

One of those cheerleaders—Tesla (TSLA) CEO Elon Musk – said this week that when it comes to regulating crypto, the U.S. government should do “nothing,” believing that official intervention could hold back growth.

"It is not possible to, I think, destroy crypto, but it is possible for governments to slow down its advancement,” Musk told the Code Conference in L.A.

Hsu appeared to be sending a warning to the industry – regulate yourselves before the government over-regulates you.

“I’m telling the industry today, you know what best practices are. You should impose that on yourselves now before there’s a crisis and people lose money,” said Hsu. “There are real people now putting their money into this industry and if they’re not responsible those people will lose money.”

Memories of the 2008 crisis

Hsu applauded the original premise for bitcoin that creator Satoshi Nakotomta was trying to solve: a system where there can be peer-to-peer electronic exchanges of value to solve those needs in a low cost way without relying on intermediaries.

“I’m all for that,” Hsu said, but argued that’s not what’s being developed right now.

“It’s all trading assets. And trading assets aren’t mediums of exchange,” he added. “You can’t really pay for anything in bitcoin, but you can invest in it, you can lend it and borrow it but it’s moved away from its original purpose.”

Drawing a parallel to the 2008 financial meltdown, Hsu said that Wall Street “had all these products that started in one place and innovation got heaped on top of innovation and created a whole mountain full of things that led to the crisis.

The official added: "We know that happened and it didn’t happen that long ago. So why are we repeating it? Let’s avoid those mistakes.”

Hsu pointed to a couple different areas that could unravel, including high rates of interest consumers can earn on crypto savings accounts. He suggested many people don’t read the fine print, or understand it.

“It looks very attractive versus sticking your money in a regular bank account or even the stock market,” he said. “But peel back the onion and it’s hard to understand where the high return on a crypto savings account comes from.”

Hsu worries that those who could get hurt in the crypto space don’t fully understand the risks they’re taking on, and will be the least able to bear it.

He is concerned that the underbanked – those with a bank account who also depend on alternative financial services to meet their needs like payday lenders – own crypto in significantly higher percentages than the fully banked. According to a recent poll by Morning Consult, 10% of the fully banked owned crypto, while 37% of the underbanked owned crypto.

With respect to regulation, Hsu also stated it’s important for the crypto industry to play a role, pointing specifically to the Blockchain Association.

The official pointed to the development of derivatives in the late 1990s, saying that the industry knew best practices to guard against losses in counter-party credit risk with hedge funds.

However, that industry didn’t implement those standards because it would have hurt its business. Hsu drew a parallel to the circumstances that led to the collapse of hedge fund Long-term Capital Management in the late 90s, which nearly sank the financial system.

Stablecoin fears percolate

Another area that concerns Hsu and many other regulators is the potential for runs on stablecoins, cryptocurrencies whose values are tied to fiat units like the U.S. dollar, precious metals, or short-term securities as a way to mitigate the inherent volatility of cryptocurrencies.

“Once a run starts, you can’t stop it,” Hsu explained. “You want your money back and so that’s why it’s so important to have rules, regulation structure around this because you want people to trust it.”

Stablecoin issuers hold massive amounts of commercial paper or other short-term securities like Treasuries or certificates of deposit. According to Hsu, investors could choose to pull their money out suddenly if cryptocurrencies plunge, leading to losses for investors — or worse, potential runs on the financial system.

There have been stablecoin runs in the past, though they have been relatively small. Hsu warms every week stablecoin runs get bigger and bigger and more integrated into the crypto decentralized finance (DeFi) universe, which is increasingly melded with the traditional banking universe.

“There are more and more connection points and that’s what worries me,” he said. “If these were totally separate universes then I’m not sure I’d care so much. But the fact that these blend together and increasing amounts of linkages of increasing complexity that starts to worry me.”

Meanwhile, the growth of crypto space has been extraordinary: total market cap is over $2 trillion, with stablecoins well over $100 billion and growing.

And according to Hsu, what differentiates crypto from the credit default swaps (CDS) that brought the global financial system to its knees in 2008 is that crypto has gone mainstream. CDSs were instruments used on Wall Street, but just between banks and institutional investors.

The big question facing the crypto industry now is what would regulations in the crypto space look like?

Hsu told Yahoo Finance that regulators can take some principles from the existing regulatory playbook. But given the uniqueness of these digital assets, new rules need to be developed and tailored specifically for the space, and more authority will be required from Congress, he said.

The OCC is working closely with the President’s Working Group on Financial Markets – a group of financial regulators including the Treasury, the SEC and the Federal Reserve – on a proposal for new regulations for crypto – specifically stablecoins – due out imminently.

Hsu says this time around, it’s important that regulators are attacking the problem together so that each agency knows what another agency’s role is. Before the financial crisis, a key critique was that each regulatory agency didn’t know what the other was doing.

“That was part of the problem because industry players could arbitrage between different agencies,” Hsu explained.

“They could and did and that led to gaps and a buildup of vulnerabilities which was part of what amplified the crisis. There’s a keen recognition this time around that we need to lock arms and attack this together,” he added.

The OCC is also currently considering issuing national bank charters for crypto players like Circle, but Hsu stated those are still under review, and no final decision has been made on that yet.

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