America is Losing on Crypto

I spent the weekend at the ETH Denver crypto developer conference and left feeling rejuvenated. Thousands of energetic young people, fueled by the desire to build something new and better, converging in one place to learn, code, debate and innovate. Attendance was twice last year’s event, and there was little talk of FTX, coin prices or regulatory challenges. As one friend put it, it was like all the negativity of last year never happened.

Then I returned to an American regulatory crackdown best described as shambolic. Regulation of the crypto industry was always inevitable and in many ways desirable. Blockchain technology is uniquely capable of building trust in a digital setting, but the industry built on top of it has a lot of growing up to do. Sensible regulations can pave the way for growth and mass adoption.

But that’s not what we are getting in the U.S. Here we have a hodgepodge of uncoordinated actions best described as a Pincer movement, forcing responsible companies into dangerous corners they can’t get out of. The goal, to the extent there is one, seems to be to either prevent the industry from growing or to drive it offshore. Here are a few examples:

Banking

For years, federal bank regulators have told the biggest American banks to keep away from crypto. This has forced the industry to rely on smaller state and regional banks for basic services. But concentration of any sector in a handful of small banks is always dangerous and risks runs, like the one that happened at Silvergate. Now those same regulators are telling small banks they need to limit their exposure to crypto as well.

The result? Companies like exchanges and stablecoin issuers have no choice but to look offshore.

Custody

Most institutional investors are not allowed to custody their own assets and have been relying on fully-regulated state chartered institutions to store their coins. Now the SEC is saying those custodians may not be good enough, with the implication that registered investment advisors should look to bigger, federally regulated custodians.

But those companies don’t want to offer crypto custody because another SEC guidance forces them to fully reserve against client assets, an unprecedented decision that makes crypto custody cost-prohibitive.

The result? Institutions may need to go offshore for compliant custody.

Stablecoins

Stablecoins are arguably the killer app of crypto, offering a win-win where foreigners get access to digital dollars and the federal government gets a new source of demand for its debt. Oddly, American regulators keep trying to kill them.

New York-based Paxos has been a pioneer in issuing fully regulated and generally trustworthy stablecoins. It is the only issuer that has a Trust charter and the first to publish transparent reserve reports down to the CUSIP. But now it is being investigated by both the New York Department of Financial Services and the SEC, forcing it to abandon BUSD, the 3rd largest dollar coin.

Its loss has been Tether’s gain, and the unregulated offshore issuer is laughing all the way to the bank (it will make billions in profits this year but pay little American taxes). Meanwhile established payment providers like PayPal are being ordered to stay away from stablecoins.

The result? American companies who want to offer innovative payment products can’t.

Securities

Governments in Europe, the Mid East and Asia have created classifications for different kinds of digital assets so they can regulate each smartly, taking into account unique features and risks. America keeps going in the opposite direction, applying a broad analogue brush to anything that lives on a blockchain. Here, we have no choice but to treat tokens needed to pay for cloud storage, U.S. dollars meant for payments and digital basketball cards the same as Apple stock. It’s absurd.

The result? American projects have a harder time raising money, American developers have a harder time finding work, and American users are blocked from new products.

ETFs

Most developed countries have spot Bitcoin ETFs that give people direct exposure to the cryptocurrency via existing market infrastructure. America does not, despite repeated attempts by both crypto natives and veteran Wall Street firms to create one. What we do have are far more complex, inefficient ETFs tied to Bitcoin futures.

The result? American ETF issuers lose out to foreign counterparts and American investors get inferior products.

…

The list goes on, but I’ll stop here. We can speculate on the motivations of the US regulatory apparatus, but that won’t change the outcome. Unless something changes, an ecosystem that began as an American phenomenon will succeed elsewhere, taking all of its jobs, tax revenues and influence with it.

The U.S. has always been the envy of the world for both tech and finance. We seem content to lose the lead on both, unless Congress and the courts intervene.