William Mougayar

On Tech, Business, Society.

Terrible Tuesday, Whimper Wednesday, Terrific Thursday: A Week to Remember in Crypto Regulation

This was a week to remember for crypto industry regulation.

Terrible Tuesday

On Tuesday April 18, 2023, the US House Financial Services Committee conducted a Hearing Entitled: Oversight of the Securities and Exchange Commission with SEC Chair Gary Gensler in the hot seat. During this hearing, it became abundantly clear that the SEC was purposely not doing anything new to update their rules pertaining to crypto regulation, while they were rushing with 48-52 ruling updates, as I already pointed out in a previous post,US Policy on Cryptocurrency Is Lopsided: It is Solely Focused on Mitigating Risks while Suffocating Innovation, Leadership and Growth. The SEC continue to firmly believe that the industry must fit its square pegs into its round holes. 

As expected, the Democrats praised Gary Gensler and threw him soft ball questions.

Unsurprisingly, the notable Congressmen that skewered Chairman Gensler the most were Reps. Patrick McHenry, Tom Emmer, and Warren Davidson. To add to this wonderful trio, a newcomer, Rep. Byron Donalds delivered a final coup de grâce that summed it up.

The other takeaway is that the SEC didn’t seem to care if they were pushing the crypto industry outside of the US. Sure enough, two days later, Coinbase and Gemini announced they were setting-up offshore operations

It was a terrible day, if you were in Gary Gensler’s shoes, despite his cavalier attitude during that marathon hearing.

Whimper Wednesday

On Wednesday April 19, 2023, the US House Subcommittee on Digital Assets, Financial Technology, and Inclusion conducted another Hearing Entitled: Understanding Stablecoins’ Role in Payments and the Need for Legislation.

Contrasted with the fireworks-heavy preceding day, that hearing was a bit of a whimper. Democrats were wishy-washy on supporting stablecoins. Rep. Maxine Waters had the audacity to declare that we “are starting from scratch”, a very sad statement that typified how politics can quickly lead to a stalemate when each side digs deeper into its own positions. Sadly, that Hearing was short, and ended in a status quo situation despite the fact that many in the crypto industry had high hopes for seeing stablecoin-related legislation be the first to get passed, given the many months of preparations.

Terrific Thursday

Thankfully, the European Union saved the week, with something tangible. Almost three years in the making, the Markets in Crypto-Assets Regulation (MiCA) was passed by the European Parliament. Although not perfect, it did usher clarity and an willingness to fold crypto into the traditional financial system. Clearly, the EU doesn’t want crypto to be an outlier. This was a good step in the right direction, especially when contrasted with the US policy of trying to keep crypto outside of the financial system while tightening the noose on it.

Former SEC Chair Jay Clayton said it well this morning on CNBC. 

But why wasn’t he so hawkish and effective as the SEC Chair for four years? 

What’s next? 

Next week, another new Hearing was just announced by Rep. Patrick McHenry, entitled: “The Future of Digital Assets: Identifying the Regulatory Gaps in Digital Asset Market Structure”.  

Indeed, the gaps are getting wider, with each passing day that the SEC continues on its current path of crypto exclusion. Rumors has it that Senator Elizabeth Warren also has something planned. 

Republicans appear to have the upper hand in terms of increasing the heat on the SEC. 

Two questions remain:
Can the US Congress move fast and pass at least one piece of legislation to put the breaks on the SEC’s damaging path?

Can the US House of Representatives oust Gary Gensler as Rep. Davidson seems to be determined to do when he introduces his awaited legislation hopefully next month?

This movie will surely have multiple future seasons and episodes, but the US spectators are getting tired of being taken around in circles.

Why Eighty-One Cryptocurrency Bills? US Congress Just Needs One 

The US Congress needs to take a strategic approach to Crypto by grabbing the bull by the horns.

The US Congress should stop proposing crypto-related Bills like throwing mud at a wall to see what sticks.

A search on the federal GovTrack website with the keyword “cryptocurrency” reveals eighty-one (81) cryptocurrency-related Bills have been introduced by Congress since 2014. They are spread across various topics: taxation, CBDCs, stablecoins, token classification, commodities aspects, consumer protection, ransomware, mining, foreign issues, and code of conduct for ownership by US officials. 

These are good topics because they are part of the nitty gritty aspects of blockchain, but that’s not the right approach. Tackling these matters one by one requires some good knowledge of crypto because they are nuanced topics where details matter. Except for a minority, most Congress Members do not have sufficient knowledge about blockchain and cryptocurrency to go granular on it. Therefore these are not the right starting points hoping that one of them will pass or make a significant impact on the currently stagnating regulatory environment for crypto.

Instead of getting lost in the weeds, Congress needs to be more strategic about it. They should just focus on passing a single Bill as a manifesto declaring crypto as essential to US security, its economy, prosperity, and ongoing technological leadership. 

Let’s call it “The US Cryptocurrency Leadership Act”. This Act would direct all government agencies to facilitate and prioritize innovation around blockchain-enabled technologies, cryptocurrency, and their adoption across society, government, and business.

Japan’s Liberal Democratic Party has this text in their recently published Japan’s NFT Strategy for the Web 3.0 Era: “The arrival of the Web 3.0 era is a great opportunity for Japan. But if we continue as we are now, we will surely miss the boat. We should design our national strategy to develop our digital economy in the Web 3.0 era, utilizing NFT and crypto assets, and position it as a pillar of growth for new capitalism.”

This was an excellent example of how to state the intent of a country’s leadership. 
As for the US, here’s what the text of this hypothetical Cryptocurrency Leadership Act would look like. The first paragraph is taken verbatim from the White House Framework for Responsible Development of Digital Assets which started off well but went downhill right after.

US Cryptocurrency Leadership Act

The digital assets market has grown significantly in recent years. Millions of people globally, including 16% of adult Americans, have purchased digital assets—which reached a market capitalization of $3 trillion globally last November [2021]. Digital assets present potential opportunities to reinforce U.S. leadership in the global financial system and remain at the technological frontier.

While US government agencies and regulators are already aware of the potential risks pertaining to their oversights, the US needs to prioritize the innovative and entrepreneurial aspects of this emerging market to allow it to achieve its full economic growth potential. 

Blockchain technology and cryptocurrency are essential innovations that the US must lead in. Just as the US achieved leadership with e-commerce and web-enabled businesses during the early days of the Internet, we need to seize the opportunity of this next technology phase representing the Internet of money. 

Today, the US has some catching up to do. The lack of regulatory clarity has already hindered the full entrepreneurial potential of this sector. 

More than one million tech jobs in the US are at risk of fleeing. Thousands of companies are already involved and affected. Billions of dollars in venture capital have been poured into startups and potentially promising projects. 

The US leadership will have implications for our economic security, trade, and the strength of the US dollar. Therefore, the US must develop a sound strategy focused on blockchain-based technologies and cryptocurrencies, and let innovation play the role it should.

The risks within cryptocurrency are manageable, but they should not become impediments to making progress toward the propagation of this technology. 

With that in mind, we are ordering the SEC to reverse its current course and provide additional clarity and openness toward cryptocurrency. Instead of focusing on enforcement actions that are costly and damaging, they should rather dig into their panoply of existing capabilities, and redirect their resources to start updating rules and regulations pertaining to cryptocurrency and blockchain-enabled technologies.

Within 90 days, being the lead agencies, the SEC and CFTC must come back and present together updated regulatory actions that are coordinated and aligned within their current scope and mandates in order to make crypto more friendly in the United States.

Coordination is important and should be accomplished vertically within each topic instead of horizontally by governmental agencies. Today, various departments have published what they see from their vantage point, but this siloed approach has resulted in overlapping and sometimes conflicting conclusions (e.g. the SEC disagreeing with the CFTC on the status of Ethereum). Instead, we need to tackle these various topics, one by one across agencies, which would result in a cohesive view that is coordinated and harmonized. For example, there should be a single token classifications report that transcends any particular agency treatment. This approach would yield more clarity because the market is organized that way.

Here are the parts that should be addressed by this strategic report, along with our expectations on the direction that should be taken.

  1. Exchanges: create a new license class for digital assets exchanges crypto including details on risk, KYC/AML, and reporting standards, along with specific requirements for all allowed services: listings, custody, brokerage, audits, fees, marketing, ancillary services, etc.
  2. Tokens: we should allow token-based innovative business models to be tested, iterated upon, and perfected in order to maximize their chances for widespread adoption at scale. 
  3. ICOs and token generation events: we need to allow tokens to be created, and a path for them to become tradable at a given time in their maturity cycle. 
  4. Licenses: we need a single place where all required crypto-related licenses are clearly visible in order to make navigation of the regulatory maze more approachable.
  5. Exchange Traded Funds (EFTs): EFTs proposals should be considered without prior bias or prejudice against them for being in the crypto space. 
  6. Consumers: US consumers should be allowed to trade cryptocurrency or participate in emerging token projects at some maturity levels, and based on risk factors related to their income and net worth brackets.
  7. Disclosures: disclosure standards for token-based projects should be published and followed by tokens that are listed on US exchanges.
  8. AML/KYC/CFT: existing processes around these practices should be rolled in
  9. Taxes: clarity around tax treatment for crypto assets, including staking, and other DeFi-related income.
  10. NFTs: we need confirmation that NFTs are not securities, rather they are collectibles. They are potentially the future of loyalty programs, community rewards, and membership perks, therefore the NFT market shouldn’t be burdened by regulatory uncertainty. 
  11. DeFi: DeFi is not perfect, but it’s innovative. It should be allowed to continue growing with the right guardrails, not roadblocks.
  12. DAOs: DAOs should be allowed to register as corporations.  
  13. Banks: banks should be allowed to offer on/off ramps to crypto, hold a % of their assets in cryptocurrency, become certified custodians, and own or back USD-based stablecoins. 
  14. Mining: Responsible cryptocurrency mining practices should be allowed according to published energy consumption standards. No state should ban mining.

In the meantime, the SEC and the CFTC should place a moratorium on all crypto-related lawsuits, except for clear fraud cases.

With this Act, it is useful to compare the advent of blockchain technologies and cryptocurrency to the arrival of the automobile at a time when the transportation infrastructure consisted of dirt roads. Gradually, the shift was made to paving roads and later creating highways, along with updating the rules of conduct. These updates allowed cars to reach their full potential as they became faster and safer. 

Today, if we don’t allow for the paving of new infrastructure rails and if we don’t modernize parts of our regulations, we will see a disastrous mismatch similar to what might have happened if fast/modern cars would have continued to drive only on dirt roads: chaos, traffic jams, and dust in the air would have been part of that outcome. 

This Cryptocurrency Leadership Act also calls for the creation of a joint government-private sector salvation committee consisting of a bipartisan group of 10 government members and 10 private sector leaders working hand in hand to oversee the direction and implementation of this new chapter in US cryptocurrency policy.

Let’s take the high road on crypto. Let’s be strategic about it. 

Let’s hope the US Congress can start thinking about passing this one Act to unlock this industry’s potential, unchoke the choking, and pave the way for US leadership.

Cryptocurrency Is Not Napster 

Napster was killed to save copyrights. What does killing crypto save? Nothing.

There are interesting analogies between Napster’s rise and fall during the 1999-2001 period and today’s situation with the cryptocurrency sector in the US.

Napster was a popular peer-to-peer file-sharing network written and launched in 1999 by then-18-year-old Shawn Fanning. It was originally conceived as a workaround to his increased frustration with dead MP3 dead links emanating from central music websites he was visiting. Napster proposed to solve this vexing situation by bypassing these websites and stringing together users’ personal computers where MP3 files were stored. (MP3 is a compression standard that preserves CD-quality sound files)

Suddenly, Napster became famous for sharing digital music between users. At its height, it boasted 80 million users after passing 25 million in its first year. Its popularity rivaled top applications, email, and instant messaging. 

Sadly, Napster’s success could not last because it couldn’t control copyrights over its network. So, in essence, it became illegal.

During its short life, Napster sparked the peer-to-peer technologies movement and captured the imagination of its application outside of music. Fawning’s invention was “file sharing via a peer-to-peer method.” Soon after, more than 200 startups with various file-sharing solutions entered the P2P file-sharing market. P2P became the essential tech of the day, just as AI is today.

Proponents of Napster opined that users were just sampling the music and that it was contributing to more CD sales. Others argued it was a wake-up call against distribution companies’ excessive monopolies and their being adverse to accepting new technologies.

During its ups and down, Napster was described as revolutionary and world-changing. It even placed temporary doubts in the music industry’s business model, forcing it to defend its intellectual property. Napster was unstoppable, except by court order. 

Soon enough, the Recording Industry Association of America (RIAA) filed a lawsuit against it. The National Association of Recording Merchandisers joined them with a panoply of artists such as rock band Metallica and rapper Dr. Dre. Ultimately, these groups won, forcing Napster’s shutdown in 2001. 

Technically, none of the information resided in a central server in Napster’s possession. Everything was spread across millions of user computers, but Napster was guilty of “tributary” copyright infringement. In essence, Napster facilitated other people’s infringement, not violating copyright itself.

There are uncanny parallels between crypto and the blockchain today about how a new revolutionary technology becomes so popular that it generates enough fear to warrant an assault against it. 

The difference this time is that crypto is not an illegal technology. Furthermore, it’s not the private sector that wants to shut it down. Instead, it’s the US Government, its agencies, and regulators.

They are doing so by dramatizing crypto’s pitfalls while ignoring its virtues. Sadly, every tool at their disposal is being deployed to erect barriers, manufacture choke points, instill fear, launch lawsuits, impose arbitrary fines, and do almost anything short of declaring crypto illegal. 

The most recent Economic Report of the President featured 30 pages bashing the technology behind crypto in a very biased way. Operation Choke Point 2.0 has been well documented as an overt series of actions the Biden Administration took to discredit the crypto industry. And the cherry on the cake became the SEC’s increased pace of litigations against several crypto actors.

But crypto is not Napster. So yes, they do share a native element: peer-to-peer technology. But the analogy stops there. 

Sending money at the speed of the Internet isn’t breaking any laws. It only challenges existing financial rails and infrastructure. It’s a competitive factor anyone can adopt.

Napster was killed to save copyrights. So, what does killing crypto save? Nothing, except that it might kill about 1 million crypto-related jobs that are at risk of leaving the US to more welcoming parts of the world such as the European Union, UK, Switzerland, UAE, Hong Kong, Singapore, Australia, and Japan, who are going out of their way to welcome crypto businesses.

While US regulators and government agencies have been attacking the crypto industry, the USD as a reserve currency for global commerce is being challenged by the Chinese Yuan. Countries like Brazil, France, Russia, Iran, and Saudi Arabia are gradually replacing the USD in favor of the Yuan for their trade, including with Latin America, Asia, and Africa.

If not for the assault on crypto, the US would already be in a leading position with a crypto-enabled digital dollar that could quickly be adopted worldwide as a de facto standard. In another world, the same agencies currently attacking crypto would focus their efforts on backing it. Even US banks would immediately throw their weight behind cryptocurrency more decisively if it weren’t for the government pouring hot water on it so frequently.

There is also a political dimension. The crypto agenda is so polarized today, as some believe it might be a crucial swing voter issue during the next US elections. 

Crypto is not Napster. Don’t kill it. The collateral and consequential damage will be irreversible and too grave to ignore.

How the SEC Could Easily Regulate Crypto

There is no need to change the Securities Act of 1933

Almost every other Western regulator has updated their rulings for crypto, and although none is perfect, at least they have made changes and given cryptocurrency businesses and users some clarity and a chance to comply. 

The leadership of Hong Kong, Switzerland, Singapore, the UAE, and Japan has been well documented. Recently, Japan’s ruling party has published a commendable white paper, Japan’s NFT Strategy for the Web 3.0 Era, as a calling for Japan’s leadership in Web3 and NFTs as the next frontier. 

In a previous article, The SEC is Not Being Straight with the Industry, I exposed the many tools the SEC already has at its disposal, only if it wanted to enact updates.

The cryptocurrency industry isn’t asking the SEC to amend the Securities Act of 1933. That’s a tall order. 

But the SEC could make some simple amendments to become more friendly to crypto and that could go a long way as a helpful move for an industry that is begging for it.

In line with the many tools already at their disposal, here’s what the SEC could do. The following is a 7-part regulatory update the SEC could easily implement if they had the will to.

First, publish a pre-approved list of tokens that would be allowed to trade in the US without being named securities. These could be curated from the top 100 tokens currently on CoinMarketCap representing the most credible projects with visible traction. The SEC could evaluate them based on their decentralization maturity aspects. Approximately fifty to one hundred such tokens would be expected to emerge from this list. 

Second, grant a special license to at least five US Exchanges, and allow them to list the above-published set of approved tokens without naming them as securities. In one scoop, this would simultaneously neutralize those nebulous lawsuits against tokens or exchanges that were allegedly accusing them to violate Securities laws just because the SEC chose to conflate tokens with securities loosely. This license would also allow these exchanges to offer ancillary services such as loans, derivatives, staking, NFT listings, and other popular DeFi services. Along with this new license, the SEC could tuck in rules about broker-dealer status, custody requirements, KYC/AML reporting, and overall allowable risk-related aspects.

Third, label other tokens (up to the top five hundred potentially) as “small cap tokens”, and allow them to trade in a subcategory of services, similar to the Nasdaq’s small cap. Allow the above five exchanges to provide such services, and grant five additional crypto exchanges special licenses where these “crypto small cap” projects could trade within strict rules. All other lesser-known tokens would be relegated to overseas or offshore exchanges, therefore de-risking that segment for US consumers.

Fourth, require all token projects allowed to trade in the US to publish regular disclosures and adopt reporting practices comparable to those in place today for public companies, except for a handful of extremely decentralized tokens where a central team no longer influences, controls or manages the evolution of that project. Obviously, notable exemptions would be Bitcoin and Ethereum. Concurrently, work with the industry to develop such transparency standards and reporting requirements that would mix traditional data with the novelty of blockchain/crypto-related data (e.g. gas revenues, number of wallets, number of holders, on-chain transactions, etc.). This would squarely align with the SEC’s mandate of mitigating information dissymmetry by “enforcing practices that prohibit deceit, misrepresentations, and other fraud in the sale of securities”, except that the word “securities” is replaced by “digital assets.”

Fifth, allow Initial Coin Offerings (ICOs) but with restrictions for consumers. For example, the SEC could play it safe and only allow ICOs that have been first backed by VCs (VCs have higher selection thresholds than consumers). US citizens could be allowed to participate via capped amounts, based on their income levels, at the same terms as VCs. Tokens could be locked for a minimum of one year, and up to three years. All new token projects will have three years to qualify for listing in the small-cap or standard crypto Exchanges, depending on their maturity evolution. Otherwise, they would be relegated to offshore trading. 

Sixth, allow banks to provide on-ramps and off-ramps to crypto exchanges in the US easily and openly. Start to unchoke the choking trend that is underway. By the same stroke, allow banks to hold up to 5% of their assets in cryptocurrency, as well as become certified custodians, and own or back USD-based stablecoins.

Seventh, continue to promote the use of KYC, AML, CFT (counter-terrorism financing) methods, and tax reporting obligations by all participants in the crypto ecosystems. Specifically, allow DeFi to prosper without impractical restrictions on self-custody wallets. Allow DAOs and not-for-profit crypto foundations to incorporate and provide clarity on their legal status. Declare NFTs as non-securities, because they are more like collectibles, and allow the mining industry to continue unharmed.

Of course, these seven actions are wishful thinking. The SEC and other US government agencies are already knee-deep in a search-and-destroy expedition. It is unlikely they will unwind their actions unless a strong US Congress edict comes their way. 

What Congress can do will be the subject of the third and final installment in this series.

The SEC is Not Being Straight with the Crypto Industry

They could make changes if they wanted to.

The SEC is right and wrong at the same time in their crypto-regulation approach. It’s quite simple. By continuing to apply current procedures as is, they are right, and almost every token would undoubtedly be labeled as a security. However, with an open mind, they could easily make some regulatory updates, and demonstrate how easy it could be to find a place for cryptocurrency in the spectrum of regulations under their control.

Sadly, the missing (but necessary) conditions were to have the conviction that the blockchain, cryptocurrency, and token business models are novel enough to warrant such changes.

Instead, the SEC has been hiding behind the pretext there is nothing to change in the current rules while taking cover in Congress’ inability to direct them otherwise.

This is a very disingenuous positional play by the SEC, as it points to a clear discriminatory bias against crypto. Here’s the proof.

A review of SEC’s news announcements over the past year reveals they have proposed numerous changes across the board. This includes introducing new registration forms, updating rules (e.g. best execution rules), opening comment periods on issues, publishing enhancements to their frameworks, modernizing reporting requirements, updating electronic filing requirements, and specifically proposing amendments as they see fit, just to name a few of these actions. 

To be precise, here is a chronological sample of such headlines pulled from their website: 

  • SEC Proposes to Modernize the Submission of Certain Forms, Filings, and Materials Under the Securities Exchange Act of 1934 (March 2023)
  • SEC Office of Municipal Advisors Frequently Asked Questions (March 2023)
  • SEC Proposes Changes to Reg S-P to Enhance Protection of Customer Information (March 2023)
    SEC Proposes to Expand and Update Regulation Systems Compliance and Integrity (SCI), the set of rules adopted in 2014 (March 2023)
  • SEC Finalizes Rules to Reduce Risks in Clearance and Settlement (February 2023)
  • SEC Proposes Rule to Prohibit Conflicts of Interest in Certain Securitizations (January 2023)
  • SEC Proposes Regulation Best Execution, first established in 1968 (December 2022)
  • SEC Proposes Enhancements to Open-End Fund Liquidity Framework (November 2022)
  • SEC Adopts Amendments to Modernize Fund Shareholder Reports and Promote Transparent Fee- and Expense-Related Information in Fund Advertisements (October 2022)
  • SEC Adopts Rule Amendments to Modernize How Broker-Dealers Preserve Electronic Records and Enhance the Electronic Recordkeeping Requirements for Security-Based Swap Entities (October 2022)
  • SEC Proposes Rule Amendments to Modernize Beneficial Ownership Reporting (February 2022)
  • SEC Proposes Cybersecurity Risk Management Rules and Amendments for Registered Investment Advisers and Funds (February 2022)

The evidence points to the fact that they “can” implement change…only if they wanted to. All of the above initiatives are a display of the tools and span of changes already at their disposal.

Conspicuously absent from these seemingly progressive updates are specifically positive ones relating to the crypto industry. Instead, all news updates about crypto relate to negative actions such as SEC charges against firms or people, lawsuits, or Wells Notices.

This approach contradicts one of Chairman Gensler’s three goals in the SEC’s FY 2022-2026 Strategic Plan, “…keep pace with evolving markets, business models, and technologies.” 

“Keeping pace with evolving markets, business models, and technologies” in the blockchain market has been the last thing on the SEC’s mind, which is why crypto is absent from regulatory innovation. Their modus operandi has been: “Nothing new here.” So, if you’re in crypto, “keep trying to fit your square pegs into our round holes.” The SEC has continued to use the only hammer they wanted to use: enforcement actions. 

Token models are very interesting and innovative. They deserve a chance to be accepted. 

The industry is not asking the SEC to amend the Securities Act of 1933. It is only asking for some change. 

Chairman Gensler, tear down your artificial crypto regulatory wall! Stop hiding behind the mask of rigidity, and adopt the mindset of innovation and flexibility. 

In Part II, I’ll discuss how the SEC could take an easy road to regulating crypto without making it too complicated.

Page 2 of 66

Powered by WordPress & Theme by Anders Norén