How to Start Regulating Crypto Markets Immediately

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This risk is partly the result of the widely divergent and often emotional responses that the crypto has triggered since its inception. Charlie Munger has called crypto tokens partly fraudulent and partly a delusion, “while many successful venture capitalists believe that tomorrow’s financial infrastructure will be based on crypto technology. Each camp believes the government should act in the direction of their point of view.

The unique genesis of crypto assets has also complicated the regulatory challenge. Unlike other financial innovations, bitcoin was launched globally and directly to retail consumers, with the claim that it would make traditional intermediaries obsolete. Given that financial regulation is implemented domestically and largely through intermediaries, this path to the emergence of global retail has challenged regulators, as traditional tools are less efficient. an investment opportunity, access to goods or services, or a banking-type product?

Securities or commodities?

These factors, coupled with our fragmented financial regulatory system, in which multiple regulators have overlapping roles, have slowed down the application of basic, consumer-focused prudential regulation. Crypto proponents have sought to exploit the situation by arguing that a large portion of digital assets should not be treated as securities, but rather as commodities where the cash market has no federal regulator. .

Doubling down, they characterized their choices of not voluntarily complying with existing regulations due to regulatory uncertainty,” when the real motivation is to avoid compliance and its costs. They are right that US financial regulation is often onerous, in some cases even unreasonably. yes, and there are areas where regulations should be updated to accommodate new technologies. But that has never been an excuse for non-compliance, especially full and fair disclosure that makes the rules uniform of the game between insiders and buyers.

Legislative proposals have recently attracted attention, but the question is whether consensus can be reached in the wake of FTX. Crypto critics are likely to resist any legislative action that could be seen as legitimizing an industry they distrust and wish to die of its own weight. Many crypto enthusiasts believe that FTX shows that the problem lies with centralized entities “that do not live up to the promise of decentralized cryptos and will oppose any assertion of our traditional and rigorous approach. Some intermediate proposals to create safe harbors in some areas and tighter regulation in others could be tainted by association with the now disgraced Sam Bankman-Fried, founder of FTX and proponent of moderate change.

We, two market regulators, one who served under President Obama and the other under President Trump, believe that government action should not be based on one view of the future or another, but on the hard-won lessons of the past. We also know that looking for a comprehensive plan carries a significant “Waiting for Godot” risk. The fact is that billions of dollars a day of transactions continue to take place, while fraud and theft in forms as old as the bazaar and as young as a computer hack remain. In our experience, immediate action is best pursued incrementally, taking complementary steps that are free from challenge, both in authority and in principle.

We have three recommendations for US regulators:

Require all crypto intermediaries to implement basic client protections. Despite all the novelty and promise of blockchain technology, most crypto transactions are not recorded on-chain, but rather on traditional ledgers maintained by centralized intermediaries. But these entities say the products they trade do not require them to register with the Securities and Exchange Commission or the Commodity Futures Trading Commission, which means investor protection relies on state laws written for l telegraph era that are woefully inadequate, especially when trading and leverage. are here. Although we believe most of the tokens they trade are securities, we need a path to compliance that does not depend on contentious classification issues.

We believe the SEC and CFTC should issue a basic set of standards, including (1) segregation of client assets, (2) limits on lending, (3) restrictions on operating business adversarial such as trading, (4) prohibitions against fraud and manipulation, including sham trading (when someone trades with themselves or an affiliate to inflate the market price or volume of a security ) and (5) governance requirements.

These standards could easily be drawn from existing requirements for our securities and derivatives exchanges. The two agencies would then tell trading platforms: Adopt these basic standards for everything you trade if you are not already registered with the SEC as a securities intermediary or with the CFTC as as an intermediary in derivative products. The agencies would not give up their ability to argue that registration is required, but they would establish a provisional period during which an intermediary would not be closed for failure to register as long as it meets the basic standards. This would assure platforms and their customers that operations would continue on a much more responsible basis while classification and other issues are resolved.

While we believe agencies can implement this plan using their existing authority, that would not prevent Congress from codifying this approach or pursuing other initiatives to strengthen regulation. This would significantly improve investor protection while the legislative process (which we welcome) unfolds.

Provide rules for the use of stablecoins. The use of stablecoins has exploded. Global daily transactions using stablecoins, which are digital assets that claim to peg their value to national currencies like the US dollar, are estimated to regularly exceed $50 billion, with most facilitating crypto transactions. Stablecoins may have the potential to improve payments in use cases beyond crypto. But the fact is that they lack stability, which poses risks of bank runs. The fact that exchanges such as FTX offered a return on stablecoin deposits illustrates the risks presented by the interdependencies between stablecoin issuers, crypto exchanges, and investors.

Banking regulators should take the lead in creating a regulatory framework, a topic all of us have written about recently, but the SEC and CFTC can help by requiring intermediaries to use only compliant stablecoins, providing a basis additional stability to commercial markets. At a minimum, they must be issued by a regulated entity that holds cash reserves and high-quality liquid assets.

Continue rigorous enforcement of the law. Crypto proponents complain about regulation by enforcement, “but enforcement is needed when many industry players will use a colorable claim to avoid or delay compliance. Offers have flouted public offering rules. , often failing to provide even basic financial information or disclosing risk.The two agencies have also filed various lawsuits against unregistered or illegal products, Ponzi schemes and other scams, and they should continue to do so. But these targeted efforts by their nature should be complemented by broader approaches of the kind we suggest.

DeFi Platforms

Our proposed initiatives, which focus on intermediaries, should not be interpreted as suggesting that we give a free pass to DeFi” (decentralized finance) platforms, which seek to eliminate intermediaries by offering software protocols, such as programs trade matching or asset lending, on public blockchains. On the contrary. While their structure may look different, many of the same risks are still presentcams, hacks, lack of operational resilience and potential for protocol manipulation. And many DeFi platforms, contrary to their claims, have identifiable controllers and beneficiaries It may take some creativity to implement basic regulatory requirements for DeFi platforms, but we expect regulators are up to the task. They will no doubt be helped by centralized intermediaries in this t effort, as they will have new incentives to ensure that their DeFi competitors offer equivalent protections.

For many years, we have shared the same views on crypto regulation. Whatever the promise of this new technology, crypto should be subject to a strong regulatory framework. Fears that the United States will act unilaterally or more rigorously should not hold us back either. We have each taken initiatives, the SEC to crack down on ICOs and the CFTC to regulate exchanges where industry critics have claimed the United States will be out of sync and innovation will move overseas. It didn’t happen; instead, other countries followed our lead or wished they had. Those who invest and risk their hard-earned money in our financial markets must know that the rules of the game are fair and stable and that bad actors will be weeded out. We hope that the Congress and our successors will be guided by this common perspective and offer these initiatives in the spirit of moving forward.

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