The U.S. government’s approach to regulating crypto-currencies will determine whether the industry evolves to thrive or wades into obscurity
The regulatory landscape for crypto-currencies in the U.S.
Crypto-currency regulation is coming to the U.S. – and it’s likely to have a major impact on the industry’s future.
The first key distinction to consider when analyzing the current state of the crypto regulatory landscape in the United States is the difference between the government’s legislative and enforcement approaches. This comes down to comparing what the government says to what it does in practice, which is important because the difference between the two approaches provides valuable insight into the government’s true intentions for the industry and the asset class.
On the legislative front, crypto-currency-related bills have proliferated over the past year, including Senators Cynthia Lummis and Kirsten Gillibrand’s proposed Crypto-Currency. Responsible Financial Innovation Act, Representative Josh Gottheimer’s bill Stablecoin Innovation and Protection Act of 2022, Senator Pat Toomey’s bill TRUST Act of 2022 on Stablecoin, and Senators Debbie Stabenow and John Boozman’s bill on electronic commerce. If these bills pass as proposed, the regulatory and industry landscape for crypto-currencies will see significant changes, most of which are viewed positively by industry stakeholders.
Perhaps most notable is that the Commodity Futures Trading Commission would overtake the Securities and Exchange Commission to become the primary regulator of the asset class by gaining authority over the crypto-currency cash and derivatives markets. Until recently, this move was seen as very welcome by industry players, who were fed up with the SEC’s aggressive approach based on the “regulation by enforcement“.
Another major change that would follow if these bills were passed would be the introduction of much stricter rules for the issuance and management of stable currencies. This could lead to an implicit ban on unbacked, algorithmic, or “endogenously guaranteed” and 100% reserve requirements for stablecoin issuers. Stablecoin issuers would likely be required to have bank charters, which are very difficult to acquire, or to register directly with the Federal Reserve. This would greatly reduce the risks of deregulation in the crypto-currency market. However, it could also centralize the on-chain economy if the space becomes too dependent on regulated stablecoin providers.
Perhaps the most important development on the legislative front, however, is the White House’s recent comprehensive framework for regulation of the digital asset space. This framework was released on September 16 after President Biden signed an executive order on the “Ensuring responsible development of digital assets.” in March. It includes the views and recommendations of the SEC, the Treasury Department and multiple other government agencies on how to regulate crypto-assets.
The framework site provides the clearest overview to date of how the Biden administration plans to handle crypto-currency, including plans to step up enforcement against illegal practices, pushing users away from crypto-currency and toward government-issued and controlled centralized payment solutions, such as FedNow and CBDCs, amending the bank secrecy law to explicitly apply to digital assets, and leveraging the country’s position in international organizations to promote greater cross-border cooperation on crypto-currency regulation and enforcement.
If the administration begins to implement its plans, the U.S. crypto industry will increasingly resemble a fintech rather than the grassroots movement that seeks to create an alternative financial system. By applying excessively stringent regulatory requirements to the industry, its stakeholders could begin to leave the United States for more crypto-friendly jurisdictions, leading to an exodus of web3 talent and ultimately the enslavement of America on the global crypto scene.
Regulation through law enforcement
On the enforcement front, there are several critical cases pending that, depending on their outcome, could reshape the crypto-currency landscape in the country. The most well-documented of these cases is SEC v. Ripple in which the securities agency is suing the blockchain company for allegedly conducting an illegal securities offering by publicly selling XRP tokens. Judging by the latest developments in the case, it will likely be settled out of court, which would be a major victory for both Ripple and the U.S. crypto industry. For the securities agency, losing the case or settling out of court would make it much more difficult for other crypto companies to be sued for the same charges, giving crypto issuers and exchanges a much-needed break.
The second critical case is SEC v. Wahi, where the securities agency is suing a former Coinbase employee and two co-conspirators for insider trading. In a blatant example of “regulation by enforcement,” the SEC argues that “at least” nine of the crypto-currencies listed on the exchange were securities. If accepted by the court, this claim could have broad implications for the industry by making it easier for the agency to prosecute crypto-currency exchanges for unlawfully offering unregistered securities.
In another ongoing case highlighting the SEC’s approach of “regulate through enforcement“, the agency is attempting to establish its hold on the industry by making broad claims that could have serious implications for the asset class. Indeed, in SEC v. Ian Balina the agency argued that Ethereum transactions should be considered “taking place“in the United States because more Ethereum nodes are located in the United States than in any other country. Therefore, according to the SEC, Ethereum should fall within its jurisdiction. If the court accepts this argument, the SEC could then attempt to establish jurisdiction over all Ethereum transactions involving tokens that it considers securities, regardless of the location of the transaction’s counterparties.
In another disappointing development for the crypto community, the CFTC – following in the footsteps of the SEC – decided not to rule on the issue of Ethereum.suing a decentralized autonomous organization and its token holders, accused of operating an illegal derivatives trading platform. The CFTC’s victory in this landmark case would set a terrible precedent for DeFi protocols and token holders by ensuring that they can be held accountable for various crimes as “unincorporated associations“. This would effectively devastate DeFi, making it impossible for protocols and DAOs to operate without risking lawsuits.
Finally, the Treasury’s decision to sanction the Tornado Cash decentralized privacy protocol is one of the major enforcement actions that has already had a significant effect on the industry. This is the first time a government agency has sanctioned a smart contract – immutable code living on the blockchain – and several key blockchain infrastructure providers, such as Alchemy and Infura, have already complied with the sanctions.
Many crypto-currency legal experts, including U.S. crypto-currency advocacy organization Coin Center, consider the measure unconstitutional and a blatant overreach of jurisdiction, and will likely challenge it in court. However, if the Treasury wins a contested lawsuit, the entire cryptoeconomy could suffer, casting doubt on its ability to maintain its core principles such as decentralization, credible neutrality and resistance to censorship.
Depending on whether or not the recently proposed crypto-currency regulations take effect, and on the outcome of enforcement proceedings, the U.S. crypto landscape could look completely different within a few years. The optimistic view is that the SEC and CFTC lose any lawsuits that could set the industry back, while lawmakers pass the more favorable proposed legislation that offers regulatory clarity. If that happens – and the odds are pretty good – the U.S. could become the leading crypto-currency-friendly jurisdiction in the world, supporting the entire global industry.
On the other hand, the worst case scenario is that lawmakers take far too long to pass favorable crypto regulations, while the SEC and CFTC slowly regulate the space through enforcement. This would severely hamper the remarkable growth of the U.S. crypto industry and any technological innovation that comes with it. Given the considerable international political and economic influence of the United States, such a scenario would also bode ill for the global crypto industry. One potential outcome of a difficult regulatory environment is the fragmentation of DeFi into “RegFi,” composed exclusively of regulatory-compliant protocols, and DarkFi, composed of truly decentralized, non-compliant, censorship-resistant protocols.