Three Arrows Capital, Celsius Network, FTX, BlockFi and Genesis: just a smattering of significant cryptocurrency companies declaring bankruptcy since mid-2022, collectively loosing tens of billions of dollars, including a lot of investors’ funds. Does this mark the end of crypto in the non-regulated shadows, with its techno token Ponzi-schemers and dodgy decentralized finance (DeFi) products?
Well, no, because nothing stimulates legislation more than a crisis, and capital market professionals should take note. Clarified rules will mean more institutional and retail adoption as crypto moves up the ‘mainstream finance’ maturity curve and knocks on the IRO’s door.
The spotlight now shines brightly on regulation and the legal constructs needed to underpin crypto in the US – one of the slower-to-adopt countries – which will shape the use of virtual assets globally. It is on the agenda at the 118th session of Congress and lawmakers are more educated and motivated than they once were. FTX changed the game, in part for the sheer size of its $8 bn dollar loss. But also, embarrassingly, founder Sam Bankman-Fried was well known on Capitol Hill for his policy and regulatory contributions, and his companies donated to at least one in three lawmakers’ campaigns, according to CoinDesk research.
Upcoming ‘Crypto Congress’
Sheila Warren, CEO of the Crypto Council for Innovation (CCI), which represents an alliance of crypto’s most influential companies, refers to this as a ‘Crypto Congress’, reflecting the need for oversight hitting a ‘trifecta of interest, understanding and urgency’ with lawmakers, as she told CoinDesk. It is a topic for immediate priority by the House Financial Services Committee and the Senate Banking Committee, starting with the FTX hearings. FINRA, one of seven national regulatory organizations with crypto in their purview, is also studying crypto marketing practices that could lead to new policies.
The first bill expecting legislation before the end of 2023 is for stablecoins – at the core of crypto trading and decentralized contracts, with trading volume in the tens of billions of dollars every day. Stablecoins peg their market value to an external reference like the US dollar in the case of Tether’s USDT or Circle’s USDC. Stablecoins need trusted reserves and disclosure to avoid a threat to the wider financial system. The Federal Reserve could potentially license them, enabling issuers to borrow from the central bank and interface with the Federal Deposit Insurance Corporation for insurance coverage.
Both the Senate and House agricultural committees have been actively working on bills proposing new powers for the Commodity Futures Trading Commission (CFTC), including spot market regulation for commodities like Bitcoin. One bill is the Digital Commodities Consumer Protection Act, proposing strict rules for customer assets impacting investment advisers, custodians and exchanges, with provisions for international harmonization.
A key underlying issue to be ironed out is basic definitions, like what level of decentralization is needed for a crypto asset to be a currency, such as Bitcoin or Ethereum, versus what constitutes a security or investment contract, and subject to SEC registration using the Howey Test, a Florida fruit merchant’s precedent of 1946. Crypto assets do not fall neatly into these existing structures created long before digitization and the internet. Crypto pundits have also expressed concern when these are applied to DeFi instruments that have unique composability and permissionless features.
SEC or CFTC taking the lead?
An often-debated topic is which regulatory body should take the lead: the SEC or CFTC? Caroline Pham, CFTC commissioner, is happy for this to fall onto her agency.
‘Policy first from Congress then rules from regulators come next,’ she said at the Messari Mainnet Conference last fall. But she stressed it is not a ‘zero sum game’ – securities fall under the SEC, payment falls under banking regulations and then there is everything else. SEC commissioner Hester Peirce, known as ‘Crypto Mom’ for her long-standing support of digital assets, told Bloomberg that collaboration between the two regulators may be the answer.
Linda Jeng, regulatory head of the CCI, told Bloomberg that lagging US regulatory clarity is forcing innovative companies to go to offshore jurisdictions to base their businesses. She points to Europe’s Markets in Crypto-Assets Regulation bill, hailed for its comprehensive and wide-ranging regulation covering money laundering, the environment, corporate reporting and consumer protection, being applied to crypto exchanges and stablecoins as well.
Litigation and legislation phase
We’ve moved from a period of ‘guidance and enforcement action’ to a ‘litigation and legislation phase,’ says Kristin Smith, CEO of the Blockchain Association, representing more than 100 companies and pro-innovation national policies, while speaking at Mainnet.
She summed up the last 10 years as US state and federal regulators trying to fit crypto assets within existing laws, with various agencies like the SEC and the IRS using the only two tools they have: industry guidance on crypto’s fit with existing laws and enforcement action, which has been escalating. The CFTC and SEC have brought more than 100 actions against crypto-asset companies to date.
Smith says litigation is not the best policy tool – crypto companies like Ripple, Greyscale and Coinbase have all pushed back on regulators’ actions against them. ‘Reasonable legislation leads to workable regulation,’ she says. ‘The game is in the courts and in Congress now.’
‘Thoughtful and smart policy’ might best sum up what the crypto industry and companies want, purpose-built for decentralized networks, to protect investors and the integrity of financial markets. Crypto just had its Enron moment.
Linda Montgomery is a Toronto-based fintech and digital assets marketing executive and an IR professional