recent testimony by the chairmen of the Commodity Futures Trading Commission (CFTC) and Securities Exchange Commission (SEC) before the Senate Banking Committee provided a welcome breath of fresh air to the cryptocurrency community. Rather than rushing to regulate, these policymakers urged restraint and humility towards financial innovation.Libertarians generally don't expect much of government regulators. Hearings on the hill about how to approach some new, unregulated activity often boil down to little more than nebulous demands to "do something" and boss people like us around. This is especially pronounced with a revolutionary new technology like bitcoin. For these reasons, a
Last week, the cryptocurrency community breathed a collective sigh of relief as two of the most relevant financial regulatory bodies in the United States signaled an unusual understanding of blockchain technologies and explicitly committed to a "do no harm" approach towards cryptocurrencies. In his remarks before the committee, CFTC Chairman J. Christopher Giancarlo told the body that "we owe it to this generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one." SEC Chairman Jay Clayton, while more skeptical about certain cryptocurrency applications and fundraising vehicles, nonetheless praised the technology's promise to "facilitate capital formation [and provide] promising investment opportunities." Both men outlined a regulatory path forward that, while still imperfect (as most things are), would be much preferable to many alternatives.
Contrary to some people's preconceived notions, bitcoin and cryptocurrencies are hardly "unregulated." By virtue of the flexible nature of these technologies—vicariously or simultaneously serving as alternative currencies, payment systems, registries, or even next-generation legal devices—cryptocurrencies touch upon the domain of several regulatory bodies. Thus, a panoply of separate policy guidance documents have emanated from bodies as diverse as the Department of Treasury, Internal Revenue Service, Federal Election Commission, and each of the separate states.
This isn't necessarily a bad thing. If properly constrained, the limited regulatory functions of these dispersed offices could be vastly preferable to the more expansive authorities granted to a hypothetical "Department of Cryptocurrency." The challenge, then, is to ensure that our policies indeed remain properly constrained. The according downside, of course, is that entrepreneurs and cryptocurrency users face regulatory uncertainty as they wait to see how different policymaking bodies will respond.
There have been two large sources of regulatory uncertainty in terms of U.S. financial regulations. One of them concerned how the SEC would approach the burgeoning world of "initial coin offerings" (ICOs). An ICO is a kind of cryptocurrency crowdfunding mechanism. In theory, ICOs would provide promising technology projects with seed funding and reward backers with the project's returns—a kind of democratic, distributed venture capital fund. In practice, ICOs have unfortunately boiled down to little more than a wild west of unaccountable projects and outright scams that seemed to flagrantly skirt established SEC securities regulations.
Even diehard cypherpunks have recognized the problems that fly-by-night ICO scams generate for novice investors and the community as a whole. Yet many have feared that such shady schemes could generate the pretext for onerous regulations that impose innovation-stifling costs on legitimate cryptocurrency projects as well. No one wants to see fraudulent scams proliferate. But we must ensure that the policies put in place to mitigate those problems don't also ensnare beneficial, value-producing developments.
Additionally, many have wondered how the CFTC might approach potential cryptocurrency market price manipulation. While the CFTC does not have jurisdiction over "spot" transaction markets that merely facilitate direct exchanges, it does have the authority to investigate fraud and price manipulation occurring on such markets. The recent pivot of two CFTC-regulated institutional exchanges—CBOE and CME Group–to include cryptocurrency futures trading further embroiled the U.S. futures regulator in virtual currency matters. Then, in late January, it was reported that the CFTC had been investigating the popular bitcoin exchange Bitfinex for its involvement with a controversial dollar-backed crypto-token called "Tether" that critics suspect of being little more than a tool to artificially prop up the price of bitcoin. Some have attributed the recent price slide in bitcoin to this news, but it's always hard to tell. Regardless, the extent to which a regulator like the CFTC would involve itself in cryptocurrency price fluctuations could have a dramatic impact on these markets' futures and potential.
The SEC and CFTC have undertaken pronouncements and actions on cryptocurrency in the past. In 2014, the CFTC first turned its eye to these new technological developments. In 2015, the body formally established that virtual currencies would be considered a commodity and therefore fell under the purview of the Commodity Exchange Act. In 2016, the CFTC began undertaking specific actions against actors suspected of violating those rules. The SEC, meanwhile, has published numerous investor bulletins, alerts, and statements on virtual currencies and ICOs. In December, the SEC's newly-formed "Cyber Unit" dedicated to cryptocurrency activities launched its first suit against an alleged ICO scam.
Earlier in January, CFTC Chairman Giancarlo and SEC Chairman Clayton co-authored a piece in the Wall Street Journal that signaled their new emphasis on "distributed ledger technologies," or DLT. While the op-ed extolled these developments as "productivity-driving innovations" that their "regulatory efforts should embrace," it came with the somewhat ominous title of "Regulators are Looking at Cryptocurrency."
The joint testimony put a little more meat on the bones of just what "looking at cryptocurrency" means.
First, SEC Chairman Clayton did not mince words regarding his office's stance on ICOS: Projects that are security offerings should be regulated like securities offerings, "end of story." Furthermore, in his estimation, every ICO that he's seen so far has indeed met the definition of a regulate-able security in the eyes of the SEC. This could dampen some of the often eyebrow-raising shenanigans in the ICO space, wherein sneaky "crypto-sovereign citizens" attempt to skirt U.S. securities law by incanting the right combination of magic legalese. Exactly what kind of project could constitute a hypothetical non-security ICO is still unclear, although the chairman did intimate that such an arrangement would be possible. And he likewise confirmed that "pure cryptocurrency" projects would not be subject to SEC securities regulations, but again, the definitions here are still a bit murky.
The CFTC, meanwhile, has become somewhat of a cryptocurrency research center over the previous months. Chairman Giancarlo's remarks belied a deep appreciation for the benefits that virtual currencies can bring, along with the according regulatory humility of a responsible policymaker. He first emphasized the need for the regulators to become students of these new technologies, and "learn everything [they] can" before promulgating policies. (Apparently, the chairman has a willing teacher within his own family: During one amusing part of the hearing, Giancarlo revealed that his own niece was an early bitcoin adopter and diehard "hodler," thereby earning the praise and memes of many in the community.) Once regulators have boned up, then they can turn to educate consumers. In a world where so many regulators wish to regulate first and ask questions later, Chairman Giancarlo's explicit embrace of permissioness innovation for cryptocurrencies is a refreshing change of pace.
Perhaps the most interesting path forward proposed by the chairmen had nothing to do with the SEC or the CFTC at all. Rather, both policymakers recognized the problems created by our current patchwork of state money transmission regulations. Libertarians generally support state's rights and decentralization of authority as a guiding principle—and for good reason. But there are some situations where federalism can counterintuitively produce more bad regulations than if the federal government had set a basic threshold of economic freedom at the outset, as even the intellectual champion of modern federalism, Richard Epstein, recognizes. The problems with state-based regulation of virtual currency transmitters were laid out clearly in a recent Coin Center report from Peter Van Valkenburgh. (As a disclosure, I helped Peter with some of the background research and reviewed the report.)
Currently, cryptocurrency exchanges that wish to operate in the United States must become certified in each of the 50 states plus three territories where their customers reside. As a network business, which becomes more valuable as more customers sign up, it is imperative that virtual currency providers cast as wide an operational net as possible. Yet when each separate jurisdiction requires a hefty registration fee and various regulatory hoops that businesses must jump through before getting the green light, achieving the kind of compliance that is necessary can be costly, indeed. Furthermore, a handful of interventionist-minded states can effectively dictate how virtual currency businesses must operate across the entire country by virtue of their onerous regulations in a kind of regulatory race to the bottom.
CFTC Chairman Giancarlo's written testimony explicitly discusses these "shortcomings of the state-by-state money transmission licensure," while SEC Chairman Clayton agreed on the need to bring "clarity and fairness to this space" through possible federal intervention. Clearing up some of the regulatory costs wrought by irrational state-based licensing rules would go a long way to improving competition and innovation in the virtual currency transmission industry.
Overall, the recent bitcoin hearing in the Senate was welcome news for the virtual currency industry. At least in terms of financial regulation, the leading policymakers seem to really grok the technology and appreciate the immense power—for good or for bad—that their rules could wield on this developing community. If only more regulators would follow their steps and develop a healthy sense of humility as well!
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