America may be under attack by Chinese balloons, but perhaps send some F-35s to Washington to investigate the windbags blowing all that hot air around ‘cryptocurrency’ regulation.
Tuesday saw Bloomberg report on the latest move by the U.S. Securities and Exchange Commission (SEC) to cut ‘crypto’ off at the ankles. The SEC is reportedly eager to impose new limits on virtual currency firms acting as “qualified custodians” of digital assets for their clients. Bloomberg’s sources say the SEC has scheduled a Wednesday (15) vote on the proposal, which could limit digital asset involvement by hedge funds, pension funds, and private equity firms.
Tuesday also saw the U.S. Senate Committee on Banking, Housing and Urban Affairs hold a hearing titled ‘Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets.’ The hearing is a response to the collapse of so many former blockchain stars, including Sam Bankman-Fried, whose FTX exchange and other related entities are currently mired in a Delaware bankruptcy court.
Committee chair Sen. Sherrod Brown (D-OH) got things underway with a verbal highlight reel of the 2022 “crypto nightmare” but found a silver lining in the traditional finance sector being largely insulated from the contagion. Brown, a noted ‘crypto’ skeptic, observed that “as it turns out, fortune doesn’t favor the brave, it favors wealthy insiders.” The onus on Congress now was to decide “for whom we want our financial system to serve.”
Sen. Tim Scott (R-SC), the committee’s ranking Republican, prefaced his opening statement by addressing “the elephant in the room.” Or not in the room. Scott was referring to the SEC’s enforcement actions against digital assets and the absence of SEC chairman Gary Gensler from Wednesday’s proceedings.
Scott noted that Gensler appeared to have “lots of time to go on the morning talk shows,” so if Gensler intends to continue cutting a swathe through the virtual currency ranks, Congress needs to hear from him “sooner rather than later.”
Addressing FTX’s downfall, Scott singled out the SEC for saying crypto firms had the responsibility to comply with existing regulations while ignoring that “it is also the responsibility for regulators to enforce existing regulations and to conduct appropriate, effective supervision.”
Scott wondered, if regulators “already had the authority” to tackle digital asset excesses, why hadn’t they used that authority to prevent catastrophe? If regulators “have the tools they need, were they just asleep at the wheel? If they don’t, why aren’t they here to tell us what they need?”
Scott mused how, if the SEC had “provided the slightest bit of guidance” or hadn’t “failed to take any meaningful pre-emptive action,” Americans might have been protected from the collapses of LUNA, Celsius, Voyager, and BlockFi.
“Americans deserve to know why no action was taken prior to FTX’s collapse and how millions of dollars of Americans’ hard-earned money just vanished.”
Scott also went down a bit of a rabbit hole by wondering why regulators were focusing on “progressive social issues” rather than improving financial literacy among those most likely to be victimized by digital asset collapses. No one mentioned drag queens reading storybooks to children, so Gensler appears unlikely to be labeled a ‘groomer,’ at least until he shows up in person.
The entire barrel is rotten
The committee heard testimony from three witnesses. Two of them—Georgetown University Professor Linda Jeng and Vanderbilt University Professor Yesha Yadav—were decidedly pro-crypto, while the third—Duke University Policy Director Lee Reiners—appeared for the ‘thumbscrews are too good for crypto bros’ faction.
Reiners spoke first, noting that the current state of digital currency “scarcely resembles the purely peer-to-peer version of electronic cash” described by Satoshi Nakamoto in his 2008 Bitcoin white paper. “Most people invested in crypto simply because they thought they could sell it to someone else at a higher price in the future. Sadly, these people were wrong.” (Read Reiners’ full written testimony here.)
Reiners cited numerous ways that crypto is undermining America’s security, including as fuel for ransomware attacks, a means of evading economic sanctions, and financing terrorism. And in the wake of FTX and other collapses, “the crypto industry is spinning new narratives to deflect and obfuscate the damage they have wrought.” Don’t swallow the ‘one bad apple’ line, says Reiners. “How many more must fail before we conclude that the entire barrel is rotten?”
Reiners says most Americans don’t care whether digital assets are regulated by the SEC or the Commodity Futures Trading Commission (CFTC). While he agrees with Gensler that most tokens are securities, Reiners believes others—like BTC—are commodities. But while the CFTC regulates commodity derivatives, it doesn’t regulate commodity spot markets. As a result, U.S. crypto exchanges “are presently not regulated at the federal level.”
Reiners suggests Congress “carve out cryptocurrency from the definition of ‘commodity’ in the Commodity Exchange Act and recognize cryptocurrencies as securities under a special definition to the securities laws.” This would bring all digital asset regulation under the SEC, which “simply has more expertise, more resources and more appetite for enforcement” than the CFTC. And “unlike the CFTC, the SEC has a statutory mandate to protect investors.”
America: f—k, nah!
Professor Jeng struck a very different tone, befitting her role as chief global regulatory officer at the Crypto Council for Innovation, whose members include Coinbase (NASDAQ: COIN), Gemini, Block (NASDAQ: SQ), and digital asset-focused hedge funds Andreessen Horowitz and Paradigm. (Read Jeng’s written testimony here.)
Jeng said the past year saw “legitimate projects fail and outright fraud committed against customers transacting in digital assets. Both have caused significant harm,” which appears to be Jeng’s way of saying digital currency doesn’t bankrupt people, people bankrupt people. Regardless, the losses caused by these failures/frauds call for an “urgent need to establish formal federal oversight and demonstrate the inadequacy of regulating solely by enforcement.”
This failure to establish a new digital asset-specific regulatory arena “risks offshoring innovation and putting American businesses, consumers, and the economy at a competitive disadvantage to our foreign peers. It could also jeopardize an important national security lever of the U.S. government: the pre-eminence of our financial system.”
Who watches the watchmen? Who cares?
Professor Yadav’s solution to the regulatory dilemma would be to give digital asset exchanges the authority to act as ‘self-regulatory organizations’ (SRO), building on a model that has long been applied to traditional stock exchanges. Exchanges would be responsible for “oversight of the market as a whole,” including “writing rules, monitoring the market, and exercising discipline.” (Read Yadav’s written testimony here.)
Yadav says this SRO model isn’t a substitute for government regulation but would “complement” those efforts. It’s also a solution that can be imposed relatively quickly, particularly since it doesn’t seem to require exchanges to actually do anything but pinky swear that everyone they’re dealing with is doing just swell.
As for the potential ramifications of letting more bad apples inflict more damage on the American consumer, Yadav says the exchanges wouldn’t dare let standards slip; otherwise, they would suffer the “loss of reputational damages.” We think Yadav kept talking after this point but we were laughing so hard we couldn’t hear her.
Questions & Answers (Speeches & Sermons)
Sen. Scott announced that the reason the U.S. financial system is the global boss is because “the sun never sets on American innovation.” But when it comes to digital assets, regulators have “muddied the waters,” and “had the SEC provided anything besides hostility to the crypto industry,” investors could have been spared billions in losses.
Reiners wasn’t directly responding to Scott, but he took issue with the mantra of ‘regulation by enforcement,’ calling it “a catchphrase the industry uses to deflect from the fact that they’ve willingly chosen to operate outside the regulatory perimeter … The SEC has been quite clear … most cryptocurrencies are securities that need to be registered… The only people who seem to be confused about this is the crypto industry.”
Sen. Robert Menendez (D-NJ) got Yadav to admit that multiple government agencies could be granted oversight of her SRO exchanges to ensure their regulation of digital assets is actually regulated.
Jeng told Menendez that it would be very, very, very bad for fiat-backed stablecoins to be classified as securities and brought under the SEC’s purview because stablecoins “act as digital money” and “I cannot pay you with a security.”
(In Reiners’ written testimony, he noted that stablecoins are not “a widely used payment mechanism … and I doubt they ever will be.” Reiners also noted Gensler’s analogy of stablecoins being only good as “poker chips at the casino – if you want to speculate in the crypto economy, you need stablecoins.”)
When Menendez asked whether other nations were bitch-slapping ‘Murica in terms of digital asset innovation, both Yadav and Jeng were quick to agree, with Yadav calling the U.S. “extremely behind the curve.”
Reiners dissented, saying it was far more important to get regulation right than to be first. “The Bahamas rolled out the red carpet for Sam Bankman-Fried. Obviously, it didn’t turn out so well.” Reiners added that U.S. dollar clearing in New York is “an instrument of foreign policy, and crypto undermines all of that. We should not be embracing something that is undermining our sovereignty.”
Sen. Katie Britt (R-AL) expressed unease with possible overregulation leading to “offshoring jobs and innovation to places like China, to our adversaries.” Jeng said the market would either go to jurisdictions where there’s greater regulatory clarity, or they’ll go into shadow banking. Either way, the result would be a “bifurcated U.S. financial system” that would “drive innovation to other countries” that are “actually quite jealous” of U.S. pre-eminence.
Sen. Bill Hagerty (R-TN) threw a bone at digital asset conspiracy theorists, citing the “coordinated chorus of regulators” working to cut ‘crypto’ off from traditional banking. Hagerty namechecked Operation Choke Point and suggested—as some crypto bros have recently opined—that a virtual currency-focused Choke Point II is underway.
Britt asked about “common sense guardrails” for lawmakers to keep in mind when crafting regulations, prompting Jeng to say consumers need “clear legal rights in the property that they purchase.” Noting the multiple digital asset bankruptcy proceedings currently in play, Jeng said these courts “had really nothing to work with” in terms of customers’ legal rights to their digital assets.
Sen. Thom Tillis (R-NC) focused on requiring ‘proof of reserves’ (PoR) from crypto firms, saying he was working on legislation that would address the commingling of customer funds. Reiners retorted that PoRs “aren’t worth the paper they’re written on,” citing the recent Binance/Mazurs debacle. Reiners said there’s no good reason crypto intermediaries can’t submit to an actual audit.
Jeng said PoR could be defined in different ways, while Yadav said companies needed to also reveal their liabilities. The fluid nature of digital assets meant such ‘proofs’ basically needed to be done daily as a “proof of solvency.” Yadav also warned about illiquid exchange-issued tokens such as Binance’s BNB or FTX’s FTT, saying customers needed assurance that they could actually cash out these poker chips.
Sen. Elizabeth Warren (D-MA) said she’d be reintroducing the Digital Asset Anti-Money Laundering Act she authored with Sen. Roger Marshall (R-KS) last year and wondered why digital asset firms couldn’t comply with the same AML rules as other financial operators. Warren recalled how Congress passed the Bank Secrecy Act in 1970 over the objections of banks who said it would be “a tremendous expense and a pain in the neck.” Banks ultimately had to make it work and crypto firms will have to do the same. And that’s about as close to a Valentine as crypto bros could expect on Tuesday.
Watch: Law & Order: Regulatory Compliance for Blockchain & Digital Assets
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