Cryptocurrencies

Regulators Threaten Coinbase and Cryptocurrency Innovation

Innovation should be more important than regulation.

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The cryptocurrency market continues to grow across the world as new products make it easier for people to invest, sell, and trade with cryptocurrency. But without changes to the mindset of regulators, many of these products will fail to make it to consumers.

Look no further than Coinbase, which last week stopped plans to offer its new lending product due to threats of legal action by the Securities and Exchange Commission (SEC). The "Lend" program would have allowed users to earn interest on their holdings if they held specific types of cryptocurrency. The SEC rationale for the lawsuit is that the Lend program violated longstanding security regulations, even though it's more akin to a traditional savings account.

This is unfortunate. Not only does it stall financial technology innovation, but it also denies consumers the ability to earn high interest rates at a time of rising inflation. There's a better way to deal with innovative financial products than through threatening lawsuits. They're called regulatory sandboxes, and the SEC should take after forward-thinking states and adopt one.

A sandbox is an alternative regulatory structure to deal with products that come with regulatory uncertainty. Companies that have such products can apply to test their products for a set period of time as long as they still comply with consumer protection standards. If they are accepted into the sandbox, they can offer it to consumers. When the testing period ends, they either comply with existing regulatory standards or they work with regulators to change those standards based on their experience in the sandbox.

The first regulatory sandbox was deployed in the United Kingdom in 2014. It's had 700 participants since 2015 with approximately 80 percent of those companies still in existence, a much higher rate than non-sandboxed firms. Companies in sandboxes were also more likely to raise money, raised more venture capital funding, and made it to market faster.

There are now 70 different sandbox programs in 57 jurisdictions and countries. Arizona was the first state to adopt a sandbox in 2018, and the Consumer Financial Protection Bureau (CFPB) has recently updated its sandbox program at the federal level. The most common type of sandboxes across the world are within financial technology. There are 27 companies in financial technology sandboxes across Arizona, Hawaii, and West Virginia, with the CFPB sandbox granting regulatory relief across 10 different financial products.

One of the most interesting companies to be granted participation in a sandbox is BlockFi. Like the product Coinbase proposed, BlockFi offers interest-bearing cryptocurrency accounts in the Hawaiian sandbox. But BlockFi has also run into trouble with attorneys general in other states for the same product. New Jersey, Vermont, Alabama, Texas, and Kentucky have ordered cease-and-desist or show-cause orders to the company over its interest-bearing product.

It's likely that these attorneys general and financial regulators didn't have a regulatory structure to deal with this new kind of financial product. Rather than allowing permissionless innovation, they opted to shut down the products entirely because of some nonzero risk of consumer harm. As the SEC attempts to grapple with the cryptocurrency industry, it almost certainly made the same calculation.

But this need not be the case. The CFPB and states have shown that sandboxes can deal with new financial products by having regulators and companies work together to spur innovation, all while protecting consumers. The revamped CFPB sandbox has issued eight no-action letters in 2020, giving companies certainty that they can provide their new products. Some products include small-dollar loans that provide cheaper rates than payday lending, allowing earned wages to be made available before they are paid, and autosave programs for employees. These programs all have pro-consumer benefits; they just needed regulatory certainty to get off the ground.

The cryptocurrency industry quickly evolved from a little-known technology 10 years ago to a market worth an estimated $2 trillion, with hundreds of companies across the world providing services to consumers. An estimated 46 million Americans own bitcoin (to say nothing of alternative cryptocurrencies). El Salvador's recent recognition of bitcoin as legal tender and other reforms were controversial, but they show a growing acceptance of cryptocurrency. Whether the SEC wants to admit it or not, changes to our financial system are already here.

What is happening now with Coinbase will certainly happen to more financial technology companies down the road. Threatening to sue every company with a new cryptocurrency product is not only a poor use of taxpayer resources, but it also causes the United States to fall behind on blockchain and cryptocurrency technology.

The SEC should follow the lead of the states and CFPB and adopt a regulatory sandbox for cryptocurrency. In the meantime, states should continue to lead the way and bring some much-needed regulatory federalism to financial technology and other industries.

NEXT: Progressive Democrats Propose Eviction Moratorium Far More Sweeping Than the One the Supreme Court Struck Down

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  2. I started typing a comment three times, deleted it, and now I’m trying again.

    Cryptocurrency was initially sold to the world in a framework that was a bit like Marxian Communism. Marxism would defeat capitalism because capitalism would eventually collapse under the weight of its own contradictions.

    Cryptocurrency was supposed to act… outside the traditional system of fiat currency (the latter we were told would also eventually fail under the weight of its own contradictions (a concept I partially agree with)) and would therefore be immune to the regulatory machinations of the traditional financial system.

    This whole article seems to be making the case that Cryptocurrency will die in the crib without the life-giving support of regulatory subsystems… or be strangled in the crib with the wrong ones…

    Am I off base here?

    1. Bingo. The whole point of crypto was to provide an anonymous payment system outside the purview of government.

      Instead. It’s not anonymous. And the “banks” aren’t secure. If I store it on my laptop or USB it is at risk of loss. If I store it in a third party marketplace, it can be easily stolen.

      I think the gamification of the stock market has made people think bitcoin is just as real as Tesla stock. Ok. Bad example.

      1. And Coinbase is eager to report everything the government asks for, so they can make bank making like a crypto-bank.

      2. There’s another part that bugs me. All of this seems to be a tacit admission that cryptocurrency(ies) can’t be transacted with without complex abstraction layers. So the regulators don’t have to go after the cryptocurrency, they just go after the people providing the abstraction layers.

        1. You can buy Bitcoin today, using Bisq, using an escrowed transaction and Zelle or travelers checques, completely anonymously. It is relatively heavy on the friction and not easy to scale.

          You can also do what I have done: go on craigslist, meet up with someone and hand them a stack of cash for bitcoin, relatively anonymously.

          You can also convert cash to crypto by buying and running, or renting mining gear. Depending on the crypto and your power-rates this can be a good exchange rate- because competition pushes mining rewards to just about the exchange rate.

          All of the above allow you to acquire crypto directly without revealing your identity, if that is important to you. Alternatively you can buy it through an exchange and tell the government who you are, shift it out of the exchange and anonymize it with mixed success (depending on how much you are moving around.)

          Or if you don’t care whether the government knows you have the money, just buy on an exchange and shift it into your private wallet. No Fuss. No Muss.

          The article above is not about acquiring Crypto, it is about these value-add abstraction layers. Those are increasingly under scrutiny.

          1. You can also do what I have done: go on craigslist, meet up with someone and hand them a stack of cash for bitcoin, relatively anonymously.

            This is kind of what I’m talking about. The average joe isn’t going to want to transact in bitcoin by meeting someone behind the AM/PM out of the back of a white panel van. Crypto (bitcoin) was initially sold as something that you could fill your tank with at that same AM/PM, completely anonymously and the government couldn’t track or know who the gas was sold to etc.

            And again, the acquisition of bitcoin doesn’t seem relatively easy (anonymity being the big issue due to the ledger problem of course)… it’s the spending that seems to be where thing break down.

            1. This is just demonstrably un true.

              There are videos all over twitter of people in El Salvador walking into a McDonalds or Starbucks and buying food with Bitcoin. They are not doing it anonymously but they ARE doing it without an actual bank. Today, an El Salvadoran in Los Angeles can go to an ATM and use his cell phone to deposit cash in his pocket, verify his identity and send the money to his family for McDonalds tonight.

              Trying to be anonymous adds steps, but for the vast number of people, they just need quick transfer in a currency that cannot be debased by their government, and Bitcoin is solving this in countries all over. That it is difficult in the US is largely because we haven’t needed it due to a very robust payment infrastructure in our Fiat economy.

      3. “Instead. It’s not anonymous. And the “banks” aren’t secure. If I store it on my laptop or USB it is at risk of loss. If I store it in a third party marketplace, it can be easily stolen.”

        Add to that it was supposed to be separate and decentralized from the stock market and dollar, but truly whenever the stock market is threatened crypto just goes down (S&P dump x 5). Fed makes an announcement that sounds bad for traditional finance? Crypto dumps also (and way harder). Traditional markets and banks show a hint of struggle? Dow drops 2% crypto drops 20%.

        Its an awesome casino, and I think the tech is worth looking into. And I have made a boatload off the crypto market. But all of the promises for now havent come to fruition. Ill continue to hold a bunch (because at this point its house money honestly) in case it does take off, but it looks like it is about to get even more intertwined with traditional markets, even moreso than it already is

        1. I’m not sure how to think of Crypto in relation to the US dollar. if the economy gets shaky, the market crashes, will the value of crypto go up? It seems to generally go up no matter what. But then again, so does gold. But then again (and forgive me, because I’m thinking this through as I type it), is it like a Hotel California investment, whereas because crypto is nigh impossible to transact with (YOU CAN’T TRANSACT IN GOLD, EITHER!! — I know, just bear with me)… and by ‘transact’ I mean “sell it”, then it has become a kind of one way investment vehicle. You can buy into it, but then you’re kind of stuck with it.

          And what I mean bu this is I have done some research on crypto exchanges and in the forums I keep hearing the same thing: If bought Crypto ten years ago, it’s worth $3,000,000 US now, how do I sell it?

          The answer is always the same, “Weeellll, if you just want to sell a few thousand worth, some exchanges can handle that, but no exchange can handle a transaction that large”.

          I don’t know if this is really true, still true etc. But every crypto forum I went to seem to get very quiet or vague if you wanted to move large amounts of real money.

          1. “The answer is always the same, “Weeellll, if you just want to sell a few thousand worth, some exchanges can handle that, but no exchange can handle a transaction that large”.”

            This is flat out wrong. I don’t know where you are reading this. Well, let me modify that. If you are talking about Bitcoin, or Ether or one of the other very large cryptos, it is flat out wrong.

            There are only ever going to be 21 Million BTC. And yet countries and companies the world over are increasingly using it as a reserve currency in place of treasuries. Fucking Tesla liquidated like 100 Million in Crypto back in Q2. They had no problem doing it. I can guarantee you that if you are sitting on $3 MM in Bitcoin, you can call Coinbase and they will fall all over themselves to take that crypto off of your hands.

            The only thing I can think is that these messages you are reading are from people invested in some obscure altcoin. Yeah, if you have a stake representing 10% of an alt coin’s market cap- an alt coin with little liquidity- you are going to find it difficult to find buyers.

      4. “The whole point of crypto was to provide an anonymous payment system outside the purview of government.”

        No it wasn’t. It was designed to offer a currency that couldn’t be debased by government. And it works that way.

        “And the “banks” aren’t secure.”

        You don’t need banks to store it.

        ” If I store it on my laptop or USB it is at risk of loss.”

        This statement is so spectacularly wrong that I am convinced that all you know about Crypto you read on Bloomberg. Google “Seed Phrase”.

        1. “The whole point of crypto was to provide an anonymous payment system outside the purview of government.”

          No it wasn’t. It was designed to offer a currency that couldn’t be debased by government. And it works that way.

          I believe that both things are true. Yes, it was designed to work a currency that can’t be debased by government. But the keyword is ‘currency’. If we define currency as a medium of exchange (that is presumably reasonably easy to move about the economy) then Bubba’s statement is also true.

          ” If I store it on my laptop or USB it is at risk of loss.”

          This statement is so spectacularly wrong that I am convinced that all you know about Crypto you read on Bloomberg. Google “Seed Phrase”.

          I am not an expert in bitcoin, but bitcoin are lost and stolen all the time. With one notable case being the user literally forgot the password to his encrypted bitcoin wallet leaving him without access to his thousands (hundreds of thousands) worth of bitcoin.

          I don’t think that this is a major problem of bitcoin, because regular dollars in their physical form can also be destroyed or lost with no method of recovery.

          1. “If we define currency as a medium of exchange (that is presumably reasonably easy to move about the economy) then Bubba’s statement is also true.”

            No. If you look at every definition of currency, you will find that none of them mention one thing about anonymity from government. They talk about scarcity, divisibility, acceptability, etc. Privacy has never been in the mix.

            Bitcoin (and other coins, like Litecoin) is easy to move about the country. All you need is a cell phone. Or a computer. Or one of hundreds (and growing) ATMs all over the country. I think that a lot of peoples’ perspectives are heavily skewed because they live in a country (like the US) where electronic banking is taken for granted. I cannot stress enough how important it is to look at the revolution BTC is starting in the developing world countries like El Salvador.

            “I am not an expert in bitcoin, but bitcoin are lost and stolen all the time. With one notable case being the user literally forgot the password to his encrypted bitcoin wallet leaving him without access to his thousands (hundreds of thousands) worth of bitcoin.”

            The ways that bitcoin is lost or stolen are the same ways that dollars are lost or stolen- through people being fished, opening a trojan, or otherwise scammed. But the note about “forgetting my password” is a sensational article based on decades old practices and technology. Today your wallet is a Hierarchical Deterministic Wallet, that allows you to rebuild the private keys from scratch as long as you have a 12 – 24 word seed phrase memorized or copied and kept in a safe location

            As you note, every currency has risk of theft or destruction, and the most can be said about Bitcoin (and other crypto) is that the risks may have slight differences. The beauty of Blockchains is that your money is actually distributed all around the world. The vulnerable component is the private key allowing you to access that currency. You can lose that key, just as you might lose your private swiss bank account number, or the stack of bearer bonds in your safe. But that is fundamentally different from what bubba said about losing it just because I stored it on a USB.

            1. No. If you look at every definition of currency, you will find that none of them mention one thing about anonymity from government. They talk about scarcity, divisibility, acceptability, etc. Privacy has never been in the mix.

              This thread is undoubtedly stale, but no one made that claim. I never said that, and bubba never asserted that.

              Bubba and I are asserting that the CRYPTO enthusiasts claimed that Bitcoin was a currency that would remain anonymous. That’s what was sold by the bitcoin evangelists, and it turned out to not be true.

              I never asserted that the definition of currency was ‘anonymity’. I never asserted that, don’t believe it.

    2. “Am I off base here?”

      Sort of. Here is the problem:

      Once you have crypto currency, you are in a pretty good place. So for example, in El Salvador where the country is clearing hurdles to let citizens get currency and if necessary transfer it to fiat, the system is working quite well.

      However in the United States, the country has put increasingly more difficult mechanisms in place preventing you from easily converting Crypto to cash. You have to go to an exchange where they use KYC (Know Your Customer) identity verification, and other friction. That exchange then, as we see above, is a choke point where the government can infringe your ability to move the money around.

      All that said, it is relatively easy to move your crypto out of the exchanges into cold storage. In that position, it is less a currency and more a store of value. In El Salvador, however, they are actually using it as a store of value.

      1. “In El Salvador, however, they are actually using it as a store of value.”

        Er as a currency.

        TL;DR The government can strangle crypto for US users, but the cat is out of the bag on the rest of the world. People use crypto today as a currency that is global, with few fees and no bank required- as long as there is someone else willing to accept it.

      2. Question: Why do I want to convert my crypto to cash? I admit this is… kind of a trick question.

        1. Here, instead of being cryptic, let me be clear…

          When crypto first hit the scene, the crypto evangelists kept shouting that crypto was an alternate currency.

          But when it became abundantly clear that transacting (daily transacting, not just purchasing crypto, but buying things with it like candy-bars and houses) ranged from difficult to impossible, they moved the goalposts and said “crypto is a store of value”. Now, as stores of value go, I’m not fundamentally against that, but a store of value is a very different thing than a currency.

          As much of a “goldbug” as I am, Crypto looks remarkably like gold. It’s a store of value, but the AM/PM isn’t taking my nuggets at the pump. There has to be an ongoing abstraction layer and exchange mechanism to convert bitcoin to cash and vice versa.

          1. I totally agree that this is the “chicken and the egg problem”. If people won’t accept my Bitcoin, then I can’t spend it. And if no one is spending it, no one wants to accept it.

            Again, let me just say that this is a perspective we in the US have because we already have the privilege of a robust electronic money system. But in countries like El Salvador, where most of the people have 2 cell phones but 10% have bank accounts, the calculation is different. Bitcoin is an easy way to get money remitted from your family in the US, and then make payments for services.

            “There has to be an ongoing abstraction layer and exchange mechanism to convert bitcoin to cash and vice versa.”

            To put it simply, this is a (potentially) temporary problem. In Africa, the lack of a stable currency in certain countries led people to use cell phone minutes as a currency. It was simple- send a text to your cell company, with a phone number of the person you are paying, and then the number of minutes to transfer. It was so easy, and so ubiquitous that people stopped CARING about converting the minutes to hard currency. Everyone needed cell phone minutes, but more importantly, everyone was willing to accept minutes as an exchange of value because they knew they could trade it with someone else for some other good or service.

            The same is slowly happening with Bitcoin. I agree, I can’t find a lot of people in LA who will take my bitcoin (though there are more people than you would suspect). But I know for a fact that McDonalds is already accepting Bitcoin in El Salvador. It is trivial for them to deploy the same infrastructure here. And worst case, I could bail on the US and take my BTC to El Salvador to live.

            The decision to accept a token as currency fundamentally comes down to the faith you have in someone else taking it off you. In the US we haven’t really reached that point[1] and so we still have to think about the intermediate step of converting bitcoin to dollars, which adds friction and decreases utility. But that is changing and changing fast.

            [1] I will note that the biggest problem with the US is that they do not treat BTC as a currency, and so every transaction is tracked for capital gains/loss. The real question is whether they will ever change that legality.

            1. Just to add to Overt’s message we have bitcoin accepting businesses and BitCoin atm’s in semi rural MT.

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  6. “Rather than allowing permissionless innovation, they opted to shut down the products entirely because of some nonzero risk of consumer harm.”

    Considering there would be massive outcry when a shit ton of people lose their money on this, I’m not sure why anyone is surprised.

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