Five challenges of crypto regulation


America’s financial markets are remarkably successful. The United States has less than 5% of the world’s population, but more than half of the world’s investment capital is generated in US markets. The US dollar has long been the reserve currency. With all this, one would think that regulating cryptocurrencies would not be difficult.

However, hardly anyone is satisfied with the current state of regulation. The efforts of regulators, legislators and market participants have met with resistance among themselves. Consensus remains elusive, and will remain so until the reasons for the regulatory challenge are understood.

Regulators, entrepreneurs, and investors alike should keep five points in mind:

The regulation of public markets in the United States is extensive and rigorous, while access to the private market is highly restricted. Public capital markets are so extensively regulated that companies worth less than $1 billion find the costs of going public prohibitively high. Deep private equity funds have emerged to finance innovation and growth in small and medium-sized companies, although regulations primarily limit these funds to high net worth and institutional investors.

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Crypto companies, with their global retail funding models, have exposed the burden that the US places on retail investment. Regulators have made the political decision that growth companies will have to look to private markets, and small investors will have limited means to invest in growth companies. Many of the calls for clarity in cryptocurrency regulation are actually complaints about this long-standing policy. The law is clear. The question is whether the policy should change.

Uber’s strategy worked for taxis, but it won’t work for cryptocurrencies. Many in the business community see regulation not as an obligation but as a burden to be overcome with innovation. They have been encouraged by the success of Uber and similar companies whose early products dodged regulation. The savings and improvements being offered to consumers were so compelling, and the existing rules so mysterious, that enforcement was limited, and regulations eventually leaned toward innovation and consumer choice.

But as recent market events have shown, the fundamentals of regulation – transparency, limited leverage, liquidity and accountability – remain necessary. This is where the Uber analogy fails. Car safety and driver responsibility, the core of taxi regulation, were not compromised. When crypto can achieve regulatory goals with increased operational efficiency, it should be adopted.

The word “crypto” refers to a spectrum of products under multiple regulatory bodies. Crypto financial products range from stocks and mutual funds to margin loans and bank deposits. Other crypto products, including NFTs (non-fungible tokens), are similar to art and other collectibles. Some cryptocurrencies combine features of securities and banking products. That leaves cryptocurrencies regulated by multiple agencies with overlapping authority. A fund that invests in bitcoin is subject to regulation by the Securities and Exchange Commission, the Commodity Futures Trading Commission, and state regulators. If the fund is offered by a large bank, the Federal Reserve and the Federal Deposit Insurance Corporation may have a say. Proactive cooperation among regulators, an often cumbersome endeavor, is essential.

Crypto emerged globally and at a retail level, which is a challenge for US regulators. Financial regulation is largely national and institution-focused. The protection of retail investors is largely achieved through the supervision of institutions that serve retail clients.

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Many crypto assets, including bitcoin, followed an unprecedented development path. They emerged globally, not nationally, and largely at the retail, not institutional, level. The decentralized nature of cryptocurrencies means that there is often no easily identifiable sponsoring institution, and even when known, the relevant issuer or platform may be offshore and out of reach of US regulators. from US regulators, including licenses, mandatory disclosures, and market-wide secondary trading rules, are not readily available.

Opposing views are entrenched. Many market participants believe that cryptocurrencies are synonymous with fraud. There is evidence to support this, including the initial coin offering craze and the recent $15 billion collapse of the Terra stablecoin. Some seasoned investors believe that regulators should have shut down many crypto products years ago.

Meanwhile, crypto bulls see massive investment opportunities, operational efficiencies, and regulatory improvements. They cite frictions in the global financial system, the rise of bitcoin as an alternative asset, the operational capabilities of stablecoins, and the vast amount of talent and hundreds of billions in investment capital in crypto innovation and Web3 products as signs of a transformation. of global. financial infrastructure. They believe that regulators should take advantage of the benefits of cryptocurrencies by relaxing and increasing existing regulations.

Each group fears that caving in to the other would cost billions in losses for innocent victims or lost opportunities for investors. In this environment, consensus is difficult to achieve. As a result, even well-measured government action is met with criticism, creating a bias against action that is precisely the opposite of what each field demands.

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To move forward, the US needs to first embrace the efficiencies provided by tokenizing well-understood services like payments and digital asset custody. The presidential task force, led by the Treasury, must advance stablecoin rules, identifying the characteristics that make stablecoins a means of payment (similar to money transfer) and not a security or commodity. The SEC should issue requirements for custody of tokenized assets.

The United States should also go after those who flout its laws, as the SEC did with initial coin offerings. From there, we will know more soon. The opposing camps will have little to challenge and the next step will be easier.

What the United States must not do is stop acting. Other nations, including China, have entered the race to modernize the global financial infrastructure. Winning that race is essential to the dollar’s reserve status and the continued global influence of US capital markets policy.

This article was first published by The Wall Street Journal.