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The digital asset industry is at a major crossroads. Regulators around the globe are moving to enact rules for the 15-year-old industry. The EU Parliament in April approved a slate of regulations called Markets in Crypto Assets (MiCA), the most comprehensive multi-jurisdictional framework for digital assets ever. Hong Kong (with the tacit approval of China) plans to deliver a licensing regime this spring, putting it in a two horse race with Singapore to join Japan as a digital asset hub in the Asia-Pacific (APAC) region. The G-20 group of nations is pushing for global regulation, with the support of the International Monetary Fund (IMF).
Meanwhile, in the U.S. we have fragmentation, frustration and fighting. This is a global economy now. Blocking digital assets in the U.S. doesn’t stop the industry from moving forward. It simply puts American businesses at a competitive disadvantage.
The digital asset industry is at a major crossroads. Regulators around the globe are moving to enact rules for the 15-year-old industry. The EU Parliament in April approved a slate of regulations called Markets in Crypto Assets (MiCA), the most comprehensive multi-jurisdictional framework for digital assets ever. Hong Kong (with the tacit approval of China) plans to deliver a licensing regime this spring, putting it in a two horse race with Singapore to join Japan as a digital asset hub in the Asia-Pacific (APAC) region. The G-20 group of nations is pushing for global regulation, with the support of the International Monetary Fund (IMF).
Meanwhile, in the U.S. we have fragmentation, frustration and fighting. This is a global economy now. Blocking digital assets in the U.S. doesn’t stop the industry from moving forward. It simply puts American businesses at a competitive disadvantage.
U.S. capital markets are the strongest and most liquid in the world largely because of our regulatory regime. But when it comes to digital assets, we’re on a path to becoming one of the worst regulatory jurisdictions in the world. If we want a piece of this growing global industry, legislators and regulators need to get their act together – and fast.
What we have right now is a situation where we’re making rules piecemeal. We have per-state handling of digital assets such as New York’s BitLicense, and inconsistent money-transmission rules from state to state. States are granting charters for crypto banks while the Federal Reserve is blocking access to its systems.
The Office of the Comptroller of the Currency (OCC) is denying all charters. The Securities and Exchange Commission (SEC) is implementing accounting rules which effectively block traditional financial institutions from participating in digital assets, while again stalling on defining digital assets. Instead, it is leaning heavily into enforcement, which isn’t a problem in and of itself. It’s that the SEC isn't making it clear what firms are doing wrong. Groundbreaking firms, with few avenues of recourse available, are suing regulators just to get their questions answered.
At the legislative level, the bills in play have become bogged down in partisan politics and it’s looking less and less likely that any federal legislation will pass this year.
Overall, U.S. regulators and legislators starting to participate is more positive than not. They are critical players in the financial ecosystem. Industry can’t safely build businesses without them, but regulators must act quickly. If they don’t, bad actors will continue to flourish, and firms that want to play by the rules will move to jurisdictions where growth and innovation are possible.
The best approach right now would be to extend the basic investor protections of our traditional financial markets to include digital assets, while thoughtfully crafting new rules that fit the technology and exempting firms from other rules that do not.
The SEC has made some moves in the right direction. The agency's February 2023 draft amendment to bring digital assets under the "custody rule" is a great example of applying a rule that already works. In traditional financial markets, trading and custody are separate functions. Crypto has no such market structure, and the lack of regulation requiring it left the door open for fraudsters to make off with billions.
That could have been avoided if it had acted faster. When BitGo decided to pursue a trust company charter back in 2017, we approached the OCC for federal oversight. At the time, the banking regulator would not charter us, so we instead became a state-chartered trust company. But we didn’t know whether we would be considered a “qualified custodian” per the SEC.
We proactively and voluntarily approached the SEC with that question in 2018, submitting a formal no-action letter. It declined to opine on that letter for over four years. If it takes that long to address such a basic question, how can we avoid falling behind competing markets?
The SEC in April put out a statement considering a proposal to update the definition of exchanges to include decentralized exchanges (DEXs). Here is a case where some of the rules apply, but others not so much. DEXs should be regulated and investors protected. But decentralized finance (DeFi) actually has the potential to do some of regulators’ work for them by enshrining their written rules in automated, auditable code.
DeFi’s real-time auditability and immutable public ledger is proving to be very useful for helping investigators recover funds. Spreading the same rules over DEXs like a schemer of peanut butter would be unnecessarily cumbersome and could potentially inhibit the usefulness of the technology.
[The SEC] declined to opine on that letter for over four years. If it takes that long to address such a basic question, how can we avoid falling behind competing markets?
The SEC has also taken a number of actions against staking programs offered by exchanges. This is a case where new rules are needed. Staking is a brand new way of validating transactions, and there are many variations on staking that don’t fall neatly into the existing rules.
What if instead of just shutting programs down and levying fines, the SEC said, "OK, we get it, this is new and in a gray area. Stop doing these three things. Do these other three things, and you have six months to get this done and keep going. No need for a fine – we just want to see you move forward and build safe products."
That’s the kind of collaborative attitude we need to move forward – not more actions against token issuers for selling unregistered securities, and against exchanges for facilitating the trading of them. SEC Chair Gary Gensler has repeatedly said that all that issuers and exchanges need to do is register and make the same disclosures about digital assets as companies are required to do when they offer securities.
Yes, disclosures are in order. However, there are some disclosures that don’t apply, as well as things you might want to know about a digital asset that wouldn’t be included in current disclosure requirements. For example, MiCA requires that projects disclose the type of blockchain consensus mechanism they use, and its environmental impacts. But for now, they can do that in a public white paper, rather than a prospectus. Providing new definitions and rules like these seems like a better course than regulation by enforcement.
The digital asset sector is a trillion dollar industry, requiring proportional banking support. By refusing to provide clear guidance for traditional banks to participate (and nearly every bank in America has wanted to participate in digital assets for at least four years), regulators inadvertently created significant concentration risk in a handful of relatively small banks, including Silvergate Bank, which grew its business by offering innovative products to the digital asset industry.
If instead of having one small bank shouldering 85% of the banking needs of the industry, we had had hundreds of banks each holding 1% of the industry on their shoulders, it would have been better for both industries. Regulators could have helped that happen.
The underlying cause of all the digital asset and bank implosions and consequent loss of investor funds is not due to the inclusion of digital assets in our markets; the problems are caused by excluding them. Legislative and regulatory failures to keep pace with innovation and create paths to invest in digital assets under the safety of capital markets supervision is directly responsible for harming the very investors these rules are supposed to protect.
There is no doubt that our established, regulated trading markets mitigate risk better than crypto markets. The best thing we could do to mitigate risk in crypto markets would be to help the established trading markets, banks, and custodians – our stewards of risk mitigation – participate. It's not a two-month effort. It's a multi-year ever-evolving effort, because the difficulty of keeping up with innovation is constant.
Once software enters an industry, it propels change, and the financial services industry is one that is particularly slow to change. The digital asset firms that are building for the long term are not seeking to avoid regulatory oversight or to build speculative assets and markets. We’re in it to build better financial markets and we want to work with regulators to get clear guidance on how to take digital asset products and services to market.
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