Innovative and disruptive technologies are often confusing by their very nature. Without some prior frame of reference, understanding whether and how to regulate these technologies can be even more challenging. Nowhere is this phenomenon more clear than with cryptocurrency and other digitally native financial assets.
A new high level policy proposal from one of the biggest names in the crypto industry seeks to address this confusion head on.
The Status Quo of Crypto Regulation
Since its introduction in 2009, crypto has blossomed into a $2.7 trillion industry with over 330 million users worldwide, leaving financial regulators flummoxed. The lack of regulatory clarity has made investors, and the financial industry at-large, skittish. For example, while the Office of the Comptroller of the Currency (OCC) began allowing banks to provide crypto custody services in 2020, traditional banks have been slow to adopt crypto holdings due in no small part to a lack of clarity from the Securities and Exchange Commission (SEC) and other financial regulators about the nature of crypto assets.
For their part, the Biden administration has been all talk with little action when it comes to crypto regulations. SEC Chairman Gary Gensler has been the most boisterous administration proponent of tougher restrictions on crypto. Believing the crypto industry to be the “Wild West” where “people get hurt” without oversight, Gensler is a strong proponent of disclosure rules for crypto transactions. The only major policy to come out of the SEC on crypto so far has been the incredibly recent move to declare stablecoins -- a relatively small subsection of the total crypto landscape -- under SEC jurisdiction as securities.
President Biden is reportedly considering issuing an Executive Order (EO) on crypto. However, the directive in question is unlikely to have any teeth. Though the White House has declined to comment on the proposal, the EO “would charge federal agencies to study and offer recommendations on relevant areas of crypto -- touching on financial regulation, economic innovation and national security,” according to Bloomberg. It is safe to assume that, should an EO of this sort be signed, it would likely be the first in a series of more concrete directives informed by the reports produced.
Where regulators have been vague and flighty at both the federal and state level, the crypto industry is attempting to provide solutions.
Coinbase’s Regulatory Framework
Earlier this month, Coinbase -- one of the largest cryptocurrency exchanges in the world -- released a proposal for a new regulatory framework surrounding crypto. Taking its name from the shorthand for “decentralized application,” the Digital Asset Policy Proposal (dApp) was released in the hopes that it would “animate an open and constructive discussion regarding the role of digital assets in our shared economic future.” In short, the framework urges financial regulators to adapt to the “decentralized evolution of the internet” and the emergence of digitally native assets. As Coinbase’s chief policy officer, Faryar Shirzad, told CNBC, absent a unified regulatory regime, America is “at risk of becoming a ‘taker’ of regulation as opposed to the primary ‘shaper’ of modern financial services.”
While there is a lot to unpack in the 28-page report, Coinbase’s main argument is simple and accurate; established decades before the birth of digital assets, or even the internet for that matter, the current financial regulatory framework is not conducive to regulating crypto. Addressing the regulatory issues surrounding crypto is far more complicated than simply plugging digitally native assets into a regime built around securities and commodities. Few would disagree with this argument.
To remedy the confusion around crypto regulation, Coinbase proposes a four pronged approach:
- Pillar One: Regulate Digital Assets Under a Separate Framework
- Pillar Two: Designate One Regulator for Digital Asset Markets
- Pillar Three: Protect and Empower Holders of Digital Assets
- Pillar Four: Promote Interoperability and Fair Competition
The first two of these pillars are relatively straightforward. In essence, they assert that crypto should be regulated independently from existing financial instruments and put under the sole jurisdiction of a new, purpose built agency. This new framework would be finely tailored to the intricacies of digitally native assets. The other pillars are less self-explanatory.
Pillar Three aims to achieve three related goals. First, it seeks to provide enhanced transparency around crypto transactions by developing a “robust disclosure regime tailored to the specific characteristics, risks, and benefits of different digital assets.” This includes establishing different disclosure requirements for different types of assets as necessary. Second, it attempts to protect investors by leveraging the new disclosure requirements into consumer protection regulations. Finally, it proposes laying out baseline requirements for marketplaces for digital assets (MDAs) around “cyber and operational integrity and resiliency.”
The fourth pillar is the least enumerated. In short, it recommends establishing a framework that “affirmatively promotes interoperability across the crypto ecosystem.” This would entail supporting continued development of “communication, competition and cross-pollination among protocols,” as well as totally open protocols.
In general, these are all thought provoking policy options, but some are more pressing than others. Since broad sweeping federal reforms are rare and often take years to come to fruition, policymakers should walk before they run.
How The dApp Fits In
When it comes to providing regulatory certainty to an uncertain market, regulators and legislators should prioritize the lowest hanging fruit that can bring immediate clarity. This entails laying out explicit legal definitions and clearly delineating regulatory jurisdiction. In this sense, pillars one and two of the dApp are a priori to pillars three and four.
The most pressing issue facing the crypto community is the discordance of current regulations. Currently, the Internal Revenue Service (IRS) classifies cryptocurrencies as property, the Commodity and Futures Trading Commission (CFTC) classifies them as commodities, while the SEC has continually flip-flopped on whether or not they are securities. Clarifying this confusion should be the top priority.
Towards this end, the dApp provides one of the most comprehensive solutions to date. Creating a separate regulatory framework tailored specifically to digitally native assets would simultaneously provide much needed clarity and allow space for future innovation. Similarly, unifying regulatory jurisdiction to a single agency would practically eliminate the issue of contradictory definitions and regulations. While Coinbase’s proposal for a self-regulating organization might not be preferable to a traditional executive agency, there is clearly an immediate need for a regulatory organization with expertise in handling digitally native assets. The current piecemeal approach has demonstrated its incapability of properly handling crypto.
While enhancing transparency, protecting against fraud, and promoting interoperability are all laudable goals in due course, they are prescriptions for much less fundamental challenges. Once regulatory clarity is achieved, policymakers can then turn their attention to filling in the remaining gaps.
What the dApp lacks in specificity it makes up for in agreement. After consulting with stakeholders, thought leaders, and policymakers from across the country, Coinbase’s framework appears to be as close to a consensus opinion as we have seen. They’ve even open-sourced the framework on GitHub.
The Path Forward
Much remains in flux surrounding the future of crypto regulation. Should the White House decide to move forward with their plan to have federal agencies “study and offer recommendations” on pathways forward, they would presumably engage the industry in dialogue. At this stage, the dApp could serve as a roadmap for regulators. Coinbase -- along with other industry groups like the Blockchain Association -- have already done much of the legwork and consensus building necessary to properly inform future regulatory action.
As the strength of crypto firms and investors continues to grow in Washington, it is unlikely that the Biden Administration will haphazardly issue directives without serious consultation with the industry. Crypto investors in particular played a significant role in forming the bipartisan amendment to the infrastructure package that would have laid out new disclosure requirements on crypto brokers. While this amendment was ultimately doomed by Sen. Richard Shelby’s (R-Ala.) objection, the fact that Sens. Wyden (D-Ore.), Toomey (R-Pa.), and Lummis (R-Wyo.) heeded crypto investors calls to more narrowly define “brokers” is very telling.
Whether it be legislative or executive, any major change to crypto regulations will be closely monitored by the crypto industry and its investors that have proven to be remarkably politically active. With this newfound political clout, it would be remarkably difficult for the Biden administration to promulgate new rules without the industry’s backing. This gives Coinbase and other crypto players significant leverage to shape the new regulations in ways that are productive rather than destructive. Hopefully, the dApp will play an important role in future dialogue surrounding crypto regulation and will produce hard policy results with regulatory clarity in the near future.
