Setting aside differences: a common-sense approach for crypto regulators

Coinbase CEO Brian Armstrong has pushed the big red button on crypto regulation, suggesting a framework of do’s and don’ts for the sector. 

In a blog post, Brian pushed for comprehensive regulations on centralised actors, while also saying that decentralised protocols should be allowed to flourish given that open-source code and smart contracts are “the ultimate form of disclosure.

Restoring trust

He shared his views on regulation in a blog on Dec. 20. where he suggested ways in which regulators can help “restore trust” and move the industry in the right direction as the market attempts to recover from the immense damage caused by FTX and its spectacular collapse.

Decentralised protocols do not fall into the same equation, the CEO emphasised.

“Decentralised arrangements do not involve intermediaries [and] open-source code and smart contracts are “the ultimate form of disclosure,” Armstrong said, adding that on-chain, “transparency is built in by default” in a “cryptographically provable way” and as such should be left alone, for the most part.

Brian explained in a tweet that regulators need to “preserve the innovation potential of this technology,” and “thus focus on intermediaries, where additional transparency and disclosure is needed.”

Stablecoin focus

Since fallible humans are involved, Armstrong says regulation is important for centralised actors, with the CEO hoping that FTX’s implosion “will be the catalyst we need to finally get new legislation passed.”

According to him, custodians and stablecoin issuers are “where we’ve seen the most risk of consumer harm, and pretty much everyone can agree [that regulation] should be done.” This is true with respect to the complete and total collapse of the Terra-Luna UST stablecoin and ecosystem earlier in May. 

The argument does not hold up when it comes to Tether, which has never refused a USDT redemption.

Armstrong advised that the United States should begin with stablecoin regulation, in line with standard financial services laws. He suggested that regulators should implement a state trust charter or an OCC national trust charter.

Presently, US Senator Bill Hagerty has introduced the Stablecoin Transparency Act, which is expected to pass into the Senate in the months ahead after the Christmas season.

Armstrong went on to note that stablecoin issuers shouldn’t have to be banks unless they want the ability to have fractional reserves or to invest in riskier assets. Still, issuers should satisfy “basic cybersecurity standards,” establishing a blacklisting procedure in order to comply with sanction requirements.

Setting a somewhat unnerving precedent, Armstrong suggested that regulators may use stablecoin regulation in order to target crypto exchanges and custodians.

The CEO suggested that a federal licensing and registration regime would enable exchanges or custodians to legally serve people within that market, strengthening consumer protection rules and mitigating manipulative market practices.

Legacy headwinds

Notably, there are those in both the US and EU who do not want to ‘legitimise’ the industry as they see it as a threat to the system. The ECB recently lashed out against the sector, noting that banks should be wary of promoting and investing in something that “should not be legitimised” to mitigate what it called ‘reputational risk’. 

In the US, senator Jon Tester, who serves on the Senate Banking, Housing, and Urban Affairs Committee recently told NBC: “I see no reason why this stuff should exist. I really don’t.” Suffice it to say the doubters are out in force.

Exchanges turn the page?

On the other side of the isle, Bitfinex – the world’s oldest crypto exchange – released an open letter delineating major events that brought the crypto market to its knees. In the open letter, Bitfinex echoed similar sentiment, yet with a greater tone of scepticism and emphasis on core values.

“Many are now calling for more appropriate regulation. Bitfinex is committed to working to further the development of the digital asset industry in a responsible way and we welcome regulation that supports a flexible, risk-based approach to consumer protection.” 

“Crucially however, regulation should not stifle innovation and ingenuity. It is important that all parties take a measured and balanced approach to avoid excessive regulatory generalisation, and recognise that the isolated activities of bad actors should not overshadow all the good work that is being done by groups like Bitfinex.”

The open letter ended on a positive note about innovation as ‘the hallmark of the industry’. 

Done right, regulation could indeed protect customer interest while allowing the industry to thrive. This approach involves a light-touch take on innovation, all the while empowering demonstrably good actors who have withstood the test of time through thick and thin. 

Given the timing of these press releases, the two exchange behemoths behind USDT and USDC (indirectly) may be setting aside their differences in the wake of the utter devastation wrought by bad players, against whom regulators are still well behind the curve.

Could regulators take a similar approach?

For years, the US Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) have not served the market due to infighting about oversight. Armstrong put it diplomatically, suggesting that regulators should now implement a federal licensing and registration regime to enable the exchanges or custodians to legally serve people within that market.

In other words, Armstrong argues for further legitimacy via collaboration in the crypto world.

Armstrong acknowledged that while the courts are still figuring things out, the US Congress should oblige the two regulators to categorise each of the top 100 cryptocurrencies by market cap as either securities or commodities.

“If asset issuers disagree with the analysis, the courts can settle the edge cases, but this would serve as an important labelled data set for the rest of the industry to follow, as, ultimately, millions of crypto assets will be created,” he said. 

A way forward?

Given the international reach of crypto businesses, Armstrong also urged regulators from countries to look beyond what’s happening in the domestic market, and consider the implications that foreign business might have on their citizens.

He said: “If you are a country who is going to publish laws that all cryptocurrency companies need to follow, then you need to enforce them not just domestically but also with companies abroad who are serving your citizens.”

“Don’t take that company’s word for it. Actually go check if they are targeting your citizens while claiming not to.”

The CEO went on to say that if regulators do not take this approach, they will “unintentionally be incentivizing companies to serve your country from offshore jurisdictions”. In other words, by turning a blind eye to the sector, regulators actively create the conditions that maximise financial harm to citizens. This has resulted in “billions of dollars of lost wealth.”

As such, Armstrong argues that a collaborative effort from companies, policymakers, regulators, and customers will be required from financial markets all around the world — particularly those from G20 countries.

While the CEO remains optimistic that progress can be made in 2023, it remains to be seen whether regulators will finally choose to embrace the crypto ecosystem without choking out progress or innovation, as is their propensity. 

As things stand, the bodies have floated to the surface. Companies that are still around, servicing clients such as Bitfinex, Coinbase and Kraken (among others) have come out spotless while regulators’ abrasive and often outright aggressive attitude towards the digital economy has largely come full-circle, back into their loving embrace.

Will regulators start acting in the best interest of users at long last, or would it be healthier if regulators remained on the side-lines? Only time will tell.