By: Mark Lurie CEO & Founder of Shipyard Software
What’s the likely timeframe for, and shape of, any new US regulation? What are its prospects for passing Congress/Senate?
The timeframe is difficult to say. As we all know, legislation can take years to progress through Congress. When it happens faster than normal, it’s usually because of sustained public outcry and/or security incidents.
Public Outcry: Cryptocurrency has lots of compliant actors acting in good faith and lots of non-compliant actors acting in bad faith. Currently, Gary Gensler calls the crypto market a “wild west” where buyers must recognize “caveat emptor”. This may be true, but most people trading crypto know it. I don’t think there will be a general public outcry until money is lost by people who don’t realize it’s a wild west. When normal people have expectations of stability and lose a lot of money, more regulation will come quickly.
Security Incidents: Laws change as quickly as security risks, often haphazardly with unexpected consequences. Consider the Patriot Act, which became law not two months after 9/11 and added AML/CFT protocols to the Bank Secrecy Act. When national security is at stake, governments pass legislation and regulations quickly. Crypto has already had a critical moment of national security when the Colonial Pipeline was shut down in a ransomware attack, and a more serious incident would certainly hasten regulation.
Here’s the thing – there doesn’t necessarily need to be new legislation. Existing legislation and regulations cover almost all of the problematic behavior in crypto! Tokens that are securities are already regulated as securities. Same with Lending, same with derivatives, same with exchanges. Regulation exists for all of these things. However, because the technology is new, enforcement actions are just beginning, many people in crypto don’t follow them or don’t even realize what they are. Meanwhile, since court cases haven’t set precedents yet, lawyers have huge leeway in making interpretations. This isn’t really a crypto problem, it’s just a new market problem. And the SEC is wise to avoid stifling a new, innovative industry with premature over-enforcement. As enforcement increases and regulators specify how existing legislation and rules should be interpreted and applied, the existing legislation will mostly work in crypto just like it has in other markets. The SEC and other regulators have started to do this, but it’s difficult to move fast; they only have the resources they have. When they do enforce, they only go after the worst of the worst, both because that’s their job and because they don’t want to risk losing cases. What crypto needs isn’t new legislation. It needs regulators that are willing to specify how and when they see existing rules apply.
The only exception to this is decentralized finance – like decentralized exchanges. Here, traditional regulations are impossible. No one runs blockchain code; it runs itself on thousands of different computers at the same time. Meanwhile, online wallets are anonymous, so KYC is impossible? Legislation does need to adapt to be practical for decentralized finance. That way, good actors can comply, and bad actors can be deterred. But there are common-sense ways to do this by adapting existing legislation to prioritize AML (the actual problematic behavior) over KYC (a means to prevent money laundering). The technology exists, legislation and regulators just need to apply pressure wisely.
Regulators have in recent weeks put pressure on global crypto platforms such as Binance. What impact would US regulation on crypto have on the business model of such platforms?
Enforcement of US Regulation has serious impacts on the business model of centralized exchanges. Binance and other companies lose lots of revenue and customers when they can’t serve customers in the US. The pressure is especially effective when regulators from multiple countries coordinate their actions, as happened with Binance recently. And it’s not just that they lose customers, it’s also that partners are less willing to work with them. If Binance is under pressure from regulators, OTC desks and Market Makers don’t want to work with them. I’ve seen it happen over the last several weeks. Custodians vet transfers more thoroughly. Enforcement of regulation has a serious effect.
Regulation of decentralized exchanges probably wouldn’t have a huge effect; it would just be tilting at windmills, like the music industry and filesharing. Who will regulators go after? You can’t sue bits and bytes. Trying to do so will only show the government’s bark has no bite. Instead, the government needs to support regulation that empowers the good actors within the decentralized finance community. In other words, the only way to marginalize the bad actors is by privileging the good actors and letting natural selection do its work.
What sway do US regulators have over such platforms at the moment, especially when the location of the entities behind websites and platforms is not clear?
A lot! For centralized exchanges like Binance, regulators can make it very hard and costly to access to the US market, they can make it harder to engage with US partners or with anyone who themselves serve the US market. While Binance has been quite slippery with its noncommittal domicile, international coordination of regulators is working and Binance is taking regulation much more seriously. Since the US largely drives FATF, they can exert a lot of pressure on international regulators to coordinate action.
For Decentralized Finance, they have relatively little sway. They would have more sway if they brought the informal economy into the light by creating new legal recognition of the unique structure of decentralized organizations.
What legislative tools would national financial regulators need to increase their ability to compel platforms/exchanges based overseas but serving customers online to boost transparency/compliance with rules?
There are plenty of legislative tools already. Regulators just need to better enforce the rules on the books so deterrence can do its work. That’s why they have decided to go after Binance, and it’s working. Other exchanges immediately increased their compliance efforts to prevent US customers from using services. There are plenty of tools to do so; exchanges just need to give a genuine effort.