The rules are in flux as a new U.S. administration takes over.
The DealBook newsletter delves into a single topic or theme every weekend, and today it takes you on a quick tour of the regulatory scene for cryptocurrency, a fast-changing field that may represent the future of the financial industry. (If you don’t already receive the daily newsletter, sign up here.)
Stock market mania has made the headlines in recent days, but recall that a run-up in crypto prices to new highs a few weeks ago raised all of the questions about investor protections and regulations now vexing policymakers coming to grips with GameStop.
In fact, crypto prices are starting to go haywire again. Yesterday, Robinhood imposed restrictions on crypto trading, as it did for the stocks at the center of the market mayhem.
The crypto world has been ahead of the curve when it comes to platform outages, outsize volatility and trading based on memes. Tension between the establishment and the masses is at the core of cryptocurrency, which was born from a desire for decentralization.
The latest resurgence comes with regulations in flux as a new U.S. administration takes over.
Rules for renegades
There is a lot going on in crypto right now. Some say too much, too fast. Others complain that the United States is too slow, falling behind because its rules are outdated and unfit to address the inventions that blockchain technology has created.
But markets and regulators have been here before. “The basic, overarching issue is that digital asset innovation has outpaced our regulatory framework,” said Timothy Massad of Harvard, who is formerly the chairman of the Commodity Futures Trading Commission and has written extensively about crypto asset oversight. “That’s not unusual. There’s always a tension between innovation and regulation.”
It is not problematic, he said, unless regulators wait for a crisis and then respond in a rush, which they often do. “Regulation won’t stop innovation,” Mr. Massad said, “unless it’s done badly.”
But there is reason to believe the Biden administration’s financial regulators will be crypto savvy, based largely on the fact that Gary Gensler, the nominee for chairman of the Securities and Exchange Commission, has taught courses on blockchain and digital currencies at M.I.T. Let’s drop in on a class to get a sense of him as a regulator …
What Gary Gensler thinks
Excerpts from an opening class in 2018 of the “Blockchain and Money” course taught by Mr. Gensler at the M.I.T. Sloan School of Management:
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Are cryptocurrencies commodities or securities? “It’s a moving target,” he said of one the biggest debates among crypto regulators (more on that below). In a “broad sense of what the S.E.C. is trying to accomplish,” he said, consider this: “Whenever you’re thinking about public policy, folks like myself who once was a regulator, we think in the ‘duck test.’ And then we secondarily think about the actual words in the congressional act. Where is the common sense? And if it quacks and walks like a duck, it’s probably a security.”
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Regulators deal with start-ups and incumbents in different ways. In the fintech world, new challengers “take risks and beg for forgiveness, whereas incumbents tend to have to ask for permission,” Mr. Gensler said. This creates an “unlevel field,” but “I’m not crying for JPMorgan,” he added. “The big incumbents, they have their advantages.”
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Robinhood is a “wonderful” app. When he asked the class if they had ever used the fee-free trading app, half of the students raised their hands. “If anybody is interested, show up and I’ll do office hours on how Robinhood commercializes your order flow,” he said. “But it’s a sort of wonderful app. Millennials love it.”
The S.E.C.: Ripple of uncertainty
Many of the things that Mr. Gensler lectured about will soon be applied in real-life regulatory scenarios, perhaps most immediately what to do about brokers straining to handle the trading volumes in heavily shorted stocks. For crypto, specifically, a priority will most likely be a case the S.E.C. filed late last month against Ripple Labs and two of its executives.
The agency accuses the execs and the company of having raised more than $1.3 billion since 2013 in unregistered securities offerings by selling the cryptocurrency XRP to investors. By not registering as a security, Ripple created an “information vacuum” for investors about how XRP was used to fund Ripple’s operations, the S.E.C. said.
The Ripple case is a moment of reckoning for many cryptocurrencies issued and distributed by companies or people, unlike Bitcoin, which is released via a decentralized network of computers and considered by most to be a commodity, which has fewer rules for buying and selling. To judge whether XRP is a security, the agency will apply the “Howey Test,” which refers to a Supreme Court case in 1946 involving a citrus farm in Florida.
The “complaint is historic, and not in a good way,” said Ripple’s defense counsel, Joseph Grundfest, a professor at Stanford Law and a former S.E.C. commissioner. The agency has “no coherent crypto strategy” and is imposing 20th-century precedent on 21st-century technology, he said. He declined to predict what Mr. Gensler’s crypto credentials might mean for the matter: “I’m not in the speculation business.”
In 2018, Mr. Gensler said there was “a strong case” that XRP was a security.
Two other issues to watch at the S.E.C.:
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Will it ever approve a Bitcoin exchange traded fund? Many have tried, and it would be a major move toward mainstreaming crypto investment.
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New rules for brokers holding digital assets. Last month, the agency requested input for custody regulations for cryptocurrencies that would address their “unique attributes.” The Blockchain Association, a trade group, was working on its submissions, but its executive director, Kristin Smith, said the crypto community was more worked up about rules proposed by the Treasury Department.
The Treasury: Riled up about reporting
This week, the Treasury Department’s Financial Crimes Enforcement Network, known as FinCEN, extended by 60 days the comment period for proposed reporting rules on digital wallet transactions that it says would prevent money laundering. First announced on Dec. 23, with a 15-day comment period, the move incited outrage in the crypto community. The regulator has twice relented, noting the “robust” engagement that came after what opponents called “midnight rulemaking” by Steven Mnuchin, the secretary of the Treasury at the time.
It showed the crypto industry could force a pivot by a powerful agency. They argue that the proposed disclosure and record-keeping requirements are “arbitrary and unjustified,” as Jack Dorsey of Twitter and Square wrote in a comment letter:
The incongruity between the treatment of cash and cryptocurrency under FinCEN’s proposal will inhibit adoption of cryptocurrency and invade the privacy of individuals. Yet, the rule fails to explain the difference in risk.
The procedural win doesn’t guarantee that the new secretary of the Treasury, Janet Yellen, will shift gears on the matter. At her confirmation hearing, she suggested that many cryptocurrency transactions were associated with illicit activity, which Ms. Smith of the Blockchain Association called “a very disappointing reaction.” In written testimony released later, Ms. Yellen offered a more nuanced take, saying regulators should “look closely at how to encourage their use for legitimate activities while curtailing their use for malign and illegal activities.”
The C.F.T.C.: Act fast
Chris Brummer, a professor at Georgetown Law and a “fintech guru,” is in the running to become the next commissioner of the C.F.T.C. Picked for the same gig in 2016, his nomination was withdrawn by the Trump administration. Since then, Mr. Brummer has testified before Congress on blockchain policy, edited an online journal and book on crypto assets, and written a textbook, “Fintech Law in a Nutshell.” He’s an expert, in other words.
Whoever takes over, “knowledge can’t fill the major regulatory gaps,” Mr. Massad, of Harvard, said. In his view, however crypto savvy the next financial regulators are, they can’t solve the problems that are raised by new technologies without a comprehensive law designed for digital assets. Otherwise, too much crypto activity will be left unregulated for too long.
A case in point, perhaps, is the civil enforcement action filed in the fall by the C.F.T.C., accusing BitMEX, a cryptocurrency exchange, of operating an unregistered trading platform selling crypto derivatives. It is accused of facilitating transactions that earned more than $1 billion in fees since 2014 without “the most basic compliance procedures.” BitMEX owes a reply next month. In a companion criminal case, the Department of Justice contends that BitMEX execs deliberately flouted anti-money laundering rules.
The O.C.C.: Crypto comptrollers
The Office of the Comptroller of the Currency briefly had a crypto insider at its helm: Brian Brooks left his job as chief legal counsel at Coinbase to become O.C.C.’s acting chief for eight months. Among the achievements that he cited when stepping down earlier this month was helping to clarify “certain activities related to crypto assets” for federal bank regulations.
The President’s Working Group on Financial Markets, which features the heads of the Treasury, Fed, S.E.C. and C.F.T.C., sought his views on stablecoins — cryptocurrencies with steady values designed to be used as means of exchange — and the group’s statement seemed to bear his mark. It’s positive about the potential for digital tokens to “improve efficiencies, increase competition, lower costs and foster broader financial inclusion.”
Michael Barr, the dean of public policy at the University of Michigan who served as an assistant Treasury secretary under the Obama administration, is a leading candidate for the top O.C.C. job. He was once a member of Ripple’s board (he left before it was sued by the S.E.C.) and had advised a fintech trade group. The O.C.C. decides whether to grant banking charters to new firms, like fintech and crypto companies, and his ties to these firms have led some progressives to lobby against his appointment.
This week, Representatives Jamaal Bowman of New York and Ayanna Pressley of Massachusetts urged President Biden to nominate Mehrsa Baradaran, a banking law scholar at U.C. Irvine, to lead the agency and prioritize racial and economic equity. In Senate testimony in 2019, Ms. Baradaran said, “I do not believe cryptocurrency is the best solution to the problems of financial inclusion and equity in banking.”
Looking ahead
What three crypto market watchers predict for rules and regulators in 2021:
▶︎ Petal Walker, special counsel at Wilmer Hale, formerly a chief counsel at the C.F.T.C.
Wants: A robust regulator to simplify the process for entrepreneurs.
Dreads: Fear-driven regulation that’s not data-driven and stifles innovation.
Person to watch: Mr. Gensler. On the Hill, the S.E.C. is seen as the top cop on the beat.
▶︎ Nikhilesh De, regulatory reporter at CoinDesk
Expects: Scrutiny on decentralized finance, or DeFi, after its banner year in 2020.
Suspects: Approving the FinCEN wallet rules will deter U.S. crypto businesses.
Person to watch: Mr. Gensler. The industry claims to seek clarity. He may provide it.
▶︎ Timothy Massad, senior fellow at Harvard’s Kennedy School, formerly the chairman of the C.F.T.C.
Wishes: Nonbank payment systems reliant on digital assets get more scrutiny.
Rejects: A piecemeal approach to crypto oversight.
Person to watch: Overall strategy, not specific individuals.
What do you think? What will be the important issue in crypto regulation this year? Who is the most important person to watch? Let us know: dealbook@nytimes.com
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