The writer is professor at the American University Washington College of Law
The regulatory pressure is mounting on the crypto world in the biggest and most important market, the US.
The Securities and Exchange Commission this week commenced an enforcement action against crypto exchange Coinbase for failing to comply with securities registration requirements. This followed hot on the heels of Monday’s action against the Binance exchange.
The Binance complaint is filled with damning allegations on its business model, including the now famous quote attributed to a senior compliance officer: “We are operating as a fking unlicensed securities exchange in the USA bro.”
After the failures of crypto operations Terra/Luna, Celsius and FTX, most consumers have now wised up to the perils of crypto investment. According to one recent survey, 75 per cent of Americans who have heard of cryptocurrencies are not confident in their safety and reliability. The crypto industry’s parade of fraud and failure may also even be starting to wear down its previously stalwart venture capital supporters: there are some indications that some crypto venture capital investors are shifting their focus to artificial intelligence.
In this context, it’s particularly jarring to see Republican members of Congress propose a mammoth piece of draft legislation that is a prettily wrapped gift for the crypto industry. These members of Congress seem determined to legislate a market for crypto that the industry is struggling to sustain on its own. To paraphrase the character Regina George in the film Mean Girls, lawmakers should stop trying to make crypto happen.
This latest proposal repeats many of the problems from earlier proposals for crypto legislation. It takes jurisdiction over many crypto assets away from the Securities and Exchange Commission and gives it to the Commodity Futures Trading Commission (which is much smaller and has limited experience regulating retail-dominated markets). Like earlier proposals, this could also create opportunities for traditional financial assets to sidestep existing financial regulation simply by recording ownership on a public blockchain.
What is particularly notable about this proposed legislation, though, is its staggering complexity. The proposal is 162-pages long, and peppered with extremely dense and complicated definitions. This kind of legislation would soon become outdated, because it is so closely tied to how the crypto industry and its underlying technology operate at this particular moment in time. Its complexity would also undoubtedly create many loopholes for the crypto industry to exploit.
As economists Andy Haldane and Vasileios Madouros wisely counselled, “as you do not fight fire with fire, you do not fight complexity with complexity”. Blunter, simpler rules are a more effective way of protecting the public from harm — but the crypto industry is intent on convincing lawmakers that blockchain technology needs its own bespoke, highly exploitable rule book.
This proposal is also notable for being particularly hostile to the SEC. It creates legal presumptions that favour the industry that are hard for the regulator to rebut. And it requires the SEC to implement bespoke exemptions that will expose retail investors to the crypto industry’s harms. Perhaps most egregiously, Section 504 of the proposal provides a new weapon for industry — not just the crypto industry, but any firm under the SEC’s jurisdiction — to challenge its rulemakings.
The SEC was created to protect investors from harm, but this legislation would require it to also consider whether its rulemakings “promote innovation”. This superficially neutral requirement could be weaponised like requirements to provide cost-benefit analysis on rule changes before it. Litigants would petition courts to strike down SEC rules for perceived impediments to innovation.
In reality, a lot of financial innovation is designed to serve the innovator, not the public. If SEC rulemakings accommodate private sector innovation in the way this draft legislation intends, that will fundamentally undermine the investor protection mission of the regulator.
FTX’s Sam Bankman-Fried supported previous US legislative proposals; Binance’s Changpeng Zhao backed the EU’s Markets in Crypto Assets regulation, due to come into force in 2024. Proposal after proposal seems designed to legitimise crypto as an investment option. If this current proposal were to become law, traditional finance would inevitably become intertwined with the FTXs and Binances of the world, with all the instability that would entail.
And for what? Blockchain technology has extremely limited utility. And the crypto industry built upon that technology can never deliver on its promises. The rest of the world is increasingly waking up to these limitations — Congress needs to wake up too, and stop trying to make crypto happen.
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