Up-to-the-minute regulatory prognostications attracted strong attendance to a Permissionless 2022 panel discussion in Palm Beach, Florida last Wednesday.
Coming only a week after the TerraUSD and LUNA stablecoin debacle, everyone agreed that decentralized finance (DeFi) is receiving a brighter spotlight than ever. And in the wide-ranging discussion titled, “Regulatory Clouds on the Horizon,” industry advocates addressed the clouds which could rain potential regulation as well as who or what should ultimately be in charge of jurisdiction for the wider crypto ecosystem: the SEC, CFTC or a self-regulatory body.
Quotes are lightly edited for clarity.
Moderator Jordan Nof of Tusk Venture Partners immediately began with the Terra elephant-in-the-room as Chamber of Digital Commerce’s Perianne Boring revealed that her association’s members are wondering how Terra will affect regulatory momentum, but noted the unique properties of Terra’s product saying:
“What’s interesting about Terra in particular is that it’s an algorithmic stablecoin. For those who have been following stablecoin policy closely, the President’s Working Group (PWG) on financial markets put out a set of recommendations for stablecoins last November – and that [group] included the chair of the SEC, the chair of the CFTC, the Fed, and Treasury. Treasury Secretary Yellen led this effort. The group had a number of recommendations for new regulations for stablecoins -essentially, Congress is going to need to implement these recommendations. The scope of that report and the recommendations was limited to stablecoins that are backed one-to-one to the dollar reserves in a bank account. Algorithmic stablecoins were outside of that scope. So when Secretary Yellen pointed to Terra recently and said, ‘Look, this is why we need to push stablecoin recommendations forward.’ -to me, I didn’t think that was productive because the recommendations didn’t include algorithmic stablecoins. And I think it gives a lot of fuel to the SEC.
For those who remember SEC Chairman Gensler’s remarks, he started using a different vernacular. He started calling them ‘stable value funds’ (instead of stablecoins), essentially trying to put forward the argument that these are securities and they should be under the SEC’s jurisdiction. So, I think that the SEC could pretty easily say, ‘Look, this is why it should be within our jurisdiction.’
We should not regulate out of fear because of one tragic example when we put forward new public policy. We need to go through the formal public policy process, bringing in the stakeholders, having engagement with the private sector and doing this in a thoughtful way because if we are regulating too quickly, and we hammer the nail in the wrong way, we can do a lot of damage to the future growth of this industry in the US. To put it in the words of President Biden, we want the US to be the global leader in developing blockchains and this certainly could be a risk to that.”
Former CFTC Brian Quintenz was more sanguine on imminent, regressive U.S. regulation as a result of Terra:
“Ultimately, I don’t think [Terra] is a big deal for creating something immediate and permanent in regards to stablecoin regulation – [it won’t come sooner] than would otherwise take place. A number of those reasons were what Perianne said -that the PWG report did not focus on algorithmic stable coins at all. Beyond that, I think there’s a valid question to ask: what regulation would have actually solved in the case of Luna and Terra? I don’t know the answer to that question. And if someone has a suggestion, I’d be happy to hear it. But if you can’t answer that question, then why are you putting forward regulations in the first place? Not to mention that one of the things policymakers in DC hate and fear the most is being embarrassed. And if they’re going to testify in front of Congress and mention Terra or Luna, they better be prepared to explain exactly what happened in very technical detail and answer questions about how they would have fixed that problem. I don’t think anyone wants to do that.”
“So, if you take that reputational publicity downside risk, and then you combine it with an Executive Order that was issued that has a number of reports that need to be produced in response to the Executive Order in the September/October time frame…. and first of all, they’d be jumping the gun if the administration put out any kind of legislation before those reports came online. But even if they started to try to bring legislation out quickly, then you’re right at the November elections where there may be a power shift in Washington, where you get more checks and balances and any legislation that’s being proposed by the administration takes on a whole different view.”
Blockchain Association’s Ron Hammond offered that in advance of this year’s election he anticipates DC rhetoric will swing toward hot button issues such as inflation, the economy, gun rights and the like, rather than blockchain industry regulation. He added, “Crypto doesn’t really resonate as much with the voter base as much as those other issues. Very soon, Congress is going to get to the point where the work grinds to a halt and a lot of regulators are going to be able to move in because they know Congress isn’t going to take action – that’s what my concern is… there will be more enforcement actions, more grandstanding from a lot of regulators. The hope is that at least Congress can say it has some checks on them. You will see a lot of bills introduced on stablecoins, but I’d say there’s a 10-20% chance there is any movement (on the bills) since at a bare minimum legislation must pass Congress – both in the House and the Senate – and there’s a huge educational gap (currently).”
Later the panel swung to the debate around what agency should have the authority to regulate the emerging crypto space. With the blockchain industry’s aversion to cryptocurrency’s identification as a security and resulting SEC oversight, panelists rallied around the idea of a single authority – or unified approach – identifying the CFTC for its “flexible approach” which tilts toward self-regulation and allows the markets to decide.
Former CFTC commissioner Quintenz argued a pragmatic approach:
“The idea of a regulator might sound good in theory, but it’s always awful in practice. If you look at a diagram of companies in the financial services space and what they do, and the regulatory agencies that touch those activities, it looks like a Jackson Pollock painting. The jurisdiction has no clarity. So when you add something new [such as crypto], you don’t get clarity, you just add on top of the existing regulatory system. This is why I think the best thing to do is pick an existing regulator and create the bulk of the responsibility within that regulator so that you try to provide that regulatory clarity maybe with new authorities. And we were talking before about about Congress overreacting to a crisis. Maybe the crisis is the lack of clarity and the aggressiveness of the SEC, and trying to apply a rule set in a way that destroys the functionality of blockchain based tokens? Maybe that’s the catalyst to try to rethink, before we get Congress involved in picking something else, and giving new authorities to a different agency – possibly with the CFTC recognizing its principles based history – and also its experience looking at exchanges that are trading and offering margine, leveraged Bitcoin […] contracts and the examinations of the spot market that it has to do to try to ensure that those markets are operating with integrity. So there are a lot of positives to that. One of the aspects of trying to carve out that jurisdiction is to define what a digital asset is. If you can define digital asset as something that is not a very narrow definition under security, then all of a sudden you have a lot of clarity.”
“So is that is that one of the core tenets anything for the SEC? To take this wrong? Lack of variance it just crystal clear black and white? What other frameworks are out there, potentially raising even on an option.”
“For the longest time, we thought the no action letters, were going to be something that seems to be playing out a lot more. So, no action letters means that the SEC gives its blessing that they are not going to have an enforcement action against you. ‘We’re not going to see you as violating securities law. In our mind, this is our way of saying this is not a security or it’s not in our jurisdiction. We’re we’re gonna let this proceed’ in simplistic terms…”
“We never really saw anything over the past two or three years on the the token side for them to say this is a security or not on an individual token basis. And so that’s been a little concerning, but also not really shocking, in my opinion. There’s also two other approaches. An approach that I took on my legislation was even more of a brightline test: you meet these certain criteria – which is still a part of how you define decentralization – if you are fully decentralized, then among other factors, you are not a security and more under the CFTC’s jurisdiction. However, there’s also other approaches such as a safe harbor proposal from the SEC’s Hester Peirce: you can have a couple of years where you’re able to experiment and build your token and then you have a review period where the “Is it a security or not” question is answered.”
“So there’s never a right answer, at least I’d say at the current moment, and each person has their own his or her own views, but I will say it’s better than anything else that we’ve seen so far. And lack of regulatory clarity has been killer. And that’s why a lot of the companies – especially in the DeFi space – have been relocating…”
Digital Chamber of Commerce’s Boring said that she’s been seeing and hearing the same thing with her industry contacts and posed to former CFTC commissioner Quintenz if a self-regulatory body was possible for the digital assets industry. He thought so but with a caveat and pointed to industry group The National Futures Association, which has been around almost as long as the CFTC and is a self-regulatory body.
“They have delegated powers from the CFTC,” said Quintenz. “They have membership from the industry and are an adjudicatory group. (…) In absence of a federal oversight regime, for crypto trading – for spot crypto transactions – the industry and centralized exchanges have tried to get together and form some alliances around self-regulatory principles. We’ve seen a number of efforts that have been a little fragmented and not everyone has participated. I once thought that [self-regulation] could help push out the time where there might be a crisis that Congress overreacts to – either luckily, or through wonderful management – maybe both. We haven’t seen a crisis even in the absence of a full and wide membership, self-regulatory group. And I think now we’re at the point in time where crypto is of the size and scale and the centralized groups that are managing trades and custody, are at the size and scale where they can’t really avoid being in the legislative conversation for an oversight regime. I think the time has passed for that self-regulatory model on its own. But I do think that if Congress does pass a regulatory framework, self-regulation should be a part of that and is a part of that in some legislative bills that I’ve seen.”