When Regulators Hurt the People They Are Trying to Help
Regulations, we are often reminded by regulators, exist to protect people. This is especially true in financial services, where trust in institutions is paramount. The digital asset industry is no exception, as demonstrated by high-profile failures like the collapse of FTX.
But instead of calling for sensible new rules that accommodate this emerging ecosystem, America’s federal regulators insist on falling back on archaic rules that do more harm than good. Foreigners and our geopolitical rivals are laughing all the way to the bank.
Leading the charge on this backwards approach is the chairman of the SEC. Gary Gensler talks a good game about protecting Americans, but his insistence that laws passed during the Great Depression are sufficient for an asset class born almost a century later is bonkers. So is his application of the so-called Howie Test to determine which digital assets are securities. Howie was a Supreme Court decision handed down in 1946. The transistor, the tiny semiconductor that made digital computing possible, wasn’t invented until 1947.
This ornery approach has mostly harmed ordinary Americans. Crypto projects that used to raise money from their users now restrict investment opportunities to millionaires and VCs (such restrictions limit the jurisdiction of the SEC). Students of mine who hope to enter the industry are regularly told they may have to relocate outside the US. According to venture firm Electric Capital, the US has lost 14 pts in developer share over the past 5 years. Leading American crypto firms such as Coinbase are trying to diversify internationally.
Crypto projects often give away some of their tokens to early adopters to bootstrap adoption and distribute ownership. These risk-free “airdrops” can be a windfall for enterprising youngsters, but most projects now block Americans from participating. Thus, the popular (and mocking) refrain on social media: “The SEC just protected me from getting free money.”
Other “protections” offered by the SEC are an arbitrary accounting rule that prevents the biggest banks on Wall Street from offering digital asset custody by making it cost prohibitive, leading to dangerous concentration. Eight of ten of the newly launched Bitcoin ETFs use Coinbase — a small FinTech by Wall Street standards — as their custodian. Issuers and investors would prefer at least some of these products hold their coins with the likes of BNY and State Street, but the SEC won’t sanction it. The agency claims crypto assets pose additional risks to custodians, which they do. But its solution only makes sense if the risk is 100%.
This ruling is so egregious that Congress voted to overturn it in bipartisan fashion, only to be vetoed by President Biden. His reasoning? “My Administration will not support measures that jeopardize the well-being of consumers and investors”
Things get even more quixotic when it comes to stablecoins, tokenized dollars that have gained significant traction. Stablecoins offer more efficient payments and a new way for people to access the dollar abroad. They are also a potential solution to America’s spiraling national debt, because they are backed by Treasuries. Stablecoin issuers already own more than $100 billion in Treasuries, a figure widely expected to grow. But they need to be regulated.
A sensible federal regulator would throw its support behind the pending bipartisan legislation that has been floated in the House and Senate — crypto assets need to be regulated. But the leadership of the SEC, FDIC and Federal Reserve have only thrown sand in the gears of progress.
They’ve argued these novel payment instruments should be regulated as securities or only issued by chartered banks. This is a bit like arguing self-driving cars could be regulated with traffic rules created long ago for horse-drawn carriages. One solution would require Americans to file a 1099 for every $5 transfer, the other would make the too-big-to-fail banks even bigger.
The lack of regulatory clarity has hurt domestic issuers and given the upper hand to offshore players like Tether. Stablecoin issuers now collect billions of dollars in interest income from the U.S Treasury. Newer players pass most of that income unto their users, unless those users are American — passing interest income to Americans may invite the wrath of the SEC. What to make of an American government that protects Americans by only paying interest to foreigners?
Ronald Reagan once quipped that the nine most terrifying words in the English language are “I’m from the Government, and I’m here to help,” At least in this context, he was right.
