New York legislators appear to value protecting consumers from harm far more than the affections of digital asset exchange operators.
Thursday brought a joint hearing of the New York State Assembly’s Standing Committee on Consumer Affairs and Protection and the Standing Committee on Banks. The hearing examined the “transparency and security of the cryptocurrency industry and potential improvements as they relate to investor and consumer protection.”
The state Senate’s banking committee held a similarly digital currency-focused hearing last month that saw numerous critics take shots at blockchain-based entities for overpromising, underdelivering, and straying far outside their regulatory boundaries.
But there were also defenders like BSV Blockchain Association Global Public Policy Director Bryan Daugherty, who pushed back against the mantra that all blockchain consensus mechanisms are ecological nightmares. Daugherty sought to distinguish the environmental cost of a limited bandwidth blockchain like BTC versus the data-rich individual blocks on the BSV blockchain.
Daugherty was back offering testimony at Thursday’s hearing and reiterated his views that the digital asset sector has failed to live up to its potential due to “ineffective infrastructures, speculative trading practices, and unproductive ecosystems.”
The BTC blockchain’s inefficiency and high transaction costs helped fuel a shift away from peer-to-peer transactions and contributed to “the proliferation of centralized exchanges and the reliance on off-chain transactions.” Daugherty likened exchanges to “unsupervised playgrounds” whose narrow focus on token speculation had “hindered advancements in blockchain technology and the realization of a scalable, universally credible ledger.”
Unlike crypto speculators, Daugherty believes “advocates of blockchain technology are more invested in the innovative potential of this technology beyond mere value exchange … They see its numerous applications, including data integrity assurance, auditing data custody, enabling microtransactions, offering DDoS protection, and facilitating identity verification, among others.”
Daugherty said regulation acted as “guardrails on the highway of the digital economy.” As such, he offered his strong support for the CRPTO Act recently drafted by New York Attorney General Letitia James, which proposes reducing “fraud and dysfunction” in the blockchain/digital asset sector by imposing some of the toughest rules in the nation.
The NYAG’s office has been among the most vigorous in pursuing crypto crooks, bringing cases against Celsius, Tether, and countless others, while the New York Department of Financial Services (NYDFS) has imposed hefty fines on exchanges such as Coinbase (NASDAQ: COIN).
Self-wheeling and dealing
Following Daugherty’s testimony, he was asked by Consumer Affairs committee chair Nily Rozic what aspect of the CRPTO Act might prove the most beneficial. Daugherty pointed to the Act’s plan to force exchanges to forego their ability to trade against their own customers by simultaneously acting as market-maker/broker-dealer in addition to facilitating token trades between customers.
Daugherty said wearing all these different hats gave exchanges “the ability to fleece people out of their pockets.” This view was echoed by Shamiso Maswoswe, the NYAG office’s investor protection chief, who said such systems were “rife for self-dealing.” Maswoswe said the NYAG wants to impose “structural separation,” forcing exchanges to decide what primary role they wanted to play and leaving other tasks to other companies.
Christopher D’Angelo, the NYAG’s chief deputy for economic justice, noted that this separation “may not be good for some vertically integrated incumbents.” But it would be good for consumers, who would benefit from price competition via truly independent broker-dealers conducting arms-length transactions.
To whom much is given, much will be required
New York led the way in reining in the digital asset sector’s worst impulses with the introduction of BitLicense in 2015. NYDFS superintendent Adrienne Harris said Thursday that the NYDFS had licensed 33 digital asset firms, nine of which held Limited Purpose Trust (LPT) licenses, allowing them certain additional benefits under state banking laws.
Harris said “many, many multiples” of BitLicense applicants had failed to pass NYDFS scrutiny. Most of these failures were due to “insufficient” anti-money laundering (AML) and know-your-customer (KYC) requirements, while in other cases, “character fitness” was a dealbreaker.
With over 60 NYDFS individuals devoted to digital assets, Harris said the NYDFS continues to probe operators who either refuse to apply for a BitLicense or were rejected. These probes include ‘mystery shopping,’ aka attempting to sign up with a company not authorized to operate in New York. Harris said the NYDFS is potentially looking at geofencing to limit New Yorkers’ access to unauthorized sites.
While some panelists and Assembly members expressed concern that the state’s rigorous digital assets regime could deter new entrants, Harris said the exact opposite was true. Far from creating disincentives, New York’s approach was drawing “responsible companies.” D’Angelo added that similar threats were voiced before Bitlicenses were announced.
In terms of NYDFS’s ability to enforce its regulatory guardrails, Harris cited what she called the “first orderly wind-down of a virtual currency” following this spring’s order to Paxos Trust to halt minting new BUSD stablecoins. That said, Harris said she’d welcome “additional authority to pursue unlicensed entities” following “substantive events” impacting New York residents.
Winklevii’s ‘it wasn’t me’ routine falls flat
This led to a discussion of New York-licensed Gemini, which left 340,000 users—a significant number of New Yorkers among them—of its Gemini Earn product out some $900 million when the company to which Gemini lent those funds—Digital Currency Group’s Genesis Global Capital—went bankrupt earlier this year.
Genesis didn’t hold a BitLicense, and yet Gemini was able to transfer New Yorkers’ assets to the company, a delegation of responsibility of which most Gemini customers were completely unaware. D’Angelo described this as a “loophole” in the current regulations that would be closed by the CRPTO Act, allowing NYAG to “see across all business lines and partners” of Bitlicensees.
There’s no turf war, except that turf war
Much of the hearing was devoted to concerns that CRPTO might create a turf war between NYDFS and NYAG, as well as potentially leading to duplication of responsibilities. D’Angelo minimized these concerns, saying “multiple regulators for different activities” is common enough, adding that the U.S. Securities and Exchange Commission (SEC) had advised companies not to rely solely on their Bitlicense to ensure compliance with federal securities regulation.
However, Harris suggested that CRPTO could provoke “complicated questions” and “create confusion” in the marketplace. Harris believes too much tinkering with New York’s‘ gold standard’ regulation could prompt federal legislators to impose a top-down solution, something no one in New York wants to see.
Crime and punishment
John Melican, chief legal officer at analytics firm Elliptic, reminded the Assembly that the authorities’ initial reaction to the internet was to view it as “a potential vector for criminality.” For many, this view masked the internet’s true potential, and while Melican acknowledged that criminals “were great beta testers and exploit vulnerabilities” in new technology, he urged the Assembly not to throw out the baby with the bathwater.
Melican also gave the Assembly insights into blockchain’s ability to track illicit activity, citing a new Elliptic report on Chinese chemical companies selling fentanyl precursors to Mexican cartels, who paid for these products in BTC or USDT (Tether). Melican said BitLicensees already possess tools similar to those Elliptic used to identify and track these transactions.
Committee chair Rozic raised some eyebrows when she noted that “a significant portion” of transactions occur off-chain—i.e., on centralized exchanges—and wondered if regulations should be crafted that would make these transactions public and thus enhance the detection of criminality.
Before anyone could answer, Rozic moved on, asking why digital asset companies aren’t required to issue a prospectus before issuing a token. (Do ICO white papers count?) The Global Blockchain Business Council’s Andrea Tinianow got off the funniest line of the day when she responded that certain tokens didn’t have central issuers and then cited ETH as an example (the Ethereum Foundation’s significant pre-mine of ETH apparently doesn’t count).
There was much discussion of digital asset companies targeting “marginalized communities,” including people of color and those whose socio-economic status limits their ability to access traditional financial services/products.
Despite the crypto world’s mantra of financial inclusion, D’Angelo called this targeting of certain communities “predatory inclusion,” citing data that indicated marginalized communities suffered disproportionately high losses from crashes and rug-pulls.
Assemblyman Chris Burdick asked panelists whether New York regulators should be given the authority to hinder “predatory marketing” of digital assets, including by social media influencers who don’t always disclose their ties to crypto firms.
Tinianow suggested such a move could infringe on First Amendment rights, while the Crypto Council for Innovation’s Ji Hun Kim suggested that such a rule “makes asset buyers look naïve.”
Daugherty was one of the few panelists to agree with the idea of empowering NYAG to rein in marketing excesses. However, Daugherty wasn’t as enthusiastic about Burdick’s suggestion to limit digital asset investments to “sophisticated investors.” Daugherty said educating consumers about potential hazards might be a better way forward.
Assemblyman Alex Bores asked Daugherty what he meant in his testimony about a “scalable, universally credible ledger.” Daugherty said the largest token by market cap (BTC) represented “a gross misunderstanding of what Bitcoin was meant to be,” adding that the BTC chain’s scaling limitations leave it incapable of improving infrastructure problems in the legacy environment.
Daugherty contrasted this with the BSV token, having shunned the ‘digital gold’ mantra, instead serving primarily as a means of accessing the underlying BSV blockchain technology. Daugherty said tokens should be judged on the utility they provide, and BSV’s combination of scalability and transaction fees that can dip as low as 1/5000th of a cent could result in the “one universal source of truth” that Bitcoin’s original vision promised.
Daniel Alter, a partner at Abrams Fensterman LLP and a former NYDFS staffer who helped develop the Bitlicense program, agreed that underlying blockchain technology has “remarkable” potential. But while Alter also agreed that the argument for additional regulation was “valid,” the question was “by whom and to what extent.”
Alter said CRPTO “tries to bite off too much” and would “create a mini-SEC in New York.” He urged New York to “keep a leash on the market but don’t stifle it.”
Not quite Sophie’s choice
Overall, the committee members didn’t appear all that concerned with calming digital asset operators’ fears that more regulations may be on the way. They also didn’t appear to buy the veiled threats of a mass exodus of digital asset firms from the state.
They did appear intent on ensuring that New York continues to set the regulatory pace, nodding appreciatively when Harris claimed other jurisdictions were effectively “copying and pasting” the NYDFS rulebook when creating their own digital asset oversight regimes.
They also appeared intent on ensuring the greatest protections for state residents. Harris noted that last year’s collapse of FTX—which wasn’t licensed to operate in New York—led to customer losses in California that were “1000x” the losses experienced by New Yorkers who chose to sign up with FTX despite its lack of local approval.
It’s hard to imagine BitLicensees such as Coinbase taking solace from Thursday’s hearing, given management’s visceral response to any individual or entity telling it what it can or cannot do. Coinbase recently issued rash threats to shift its operations overseas, where it could engage in questionable activities that have made rival Binance such an international pariah.
This is the choice facing New York legislators. Give the exchanges and token hustlers enough rope, and they’ll eventually hang not only themselves but their customers as well. Rein in the sector’s excesses, and you risk losing these operations to more laissez-faire jurisdictions. For the time being, New York legislators appear to believe that the latter option is preferable.
As Daugherty observed, the crypto exchanges have only themselves to blame for this scenario. They could have chosen to build revolutionary products for governments, businesses and the public. Instead, they chose to open casinos. Now that the dramatic popping of the token bubble has scared off their customers, they’re panicking because there are no more sheep to fleece.
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