America’s financial markets are remarkably successful. The US has less than 5% of the world’s population, yet over half of global investment capital is generated in American markets. The US dollar has long been the reserve currency. With all this, one would think that regulating crypto wouldn’t be difficult.
Yet almost no one is satisfied with the current state of regulation. Efforts by regulators, legislators and market participants have met resistance from one another. Consensus remains elusive—and will remain so until the reasons for the regulatory challenge are understood.
Regulators, entrepreneurs and investors alike need to consider five points:
• Regulation of America’s public markets is broad and rigorous, while private-market access is highly restricted. The public capital markets are so extensively regulated that companies with less than $1bn in value find the costs of being publicly traded prohibitive. Deep pools of private capital have emerged to fund innovation and growth in small and medium-size companies, though regulations mostly limit these pools to institutional and high-net-worth investors.
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Crypto ventures, with their global, retail funding models, have exposed the burden the US places on retail investing. Regulators have made the policy choice that growth companies will have to look to private markets, and small investors will have limited means to invest in growth companies. Many of the calls for clarity in the regulation of crypto are actually complaints about this longstanding policy. The law is clear. The question is whether the policy should change.
• The Uber strategy worked for taxis, but it won’t work for crypto. Many in the entrepreneurial community view regulation not as an obligation but as a burden to be overcome with innovation. They have been emboldened by the success of Uber and similar companies whose early products skirted regulation. The savings and enhancements offered to consumers were so compelling, and the existing rules so arcane, that enforcement was limited, and regulations eventually bent to innovation and consumer choice.
But as recent market events have shown, the fundamentals of regulation — transparency, limited leverage, liquidity and accountability — remain necessary. This is where the Uber analogy fails. Automobile safety and driver accountability, the core of taxi regulation, weren’t compromised. Where crypto can achieve regulatory objectives with greater operational efficiency, it should be embraced.
• The word “crypto” refers to a spectrum of products under multiple regulatory bodies. Crypto financial products range from stocks and mutual funds to margin loans and bank deposits. Other crypto products, including NFTs (non-fungible tokens), are akin to art and other collectibles. Some crypto combines characteristics of securities and banking products. That leaves crypto regulated by multiple agencies with overlapping authority. A fund that invests in bitcoin is subject to regulation by the Securities and Exchange Commission, the Commodity Futures Trading Commission and state regulators. If the fund is offered by a large bank, the Federal Reserve and the Federal Deposit Insurance Corp. may have a say. Proactive cooperation among regulators, an often cumbersome endeavour, is essential.
• Crypto emerged globally and at the retail level, which is a challenge for US regulators. Financial regulation is largely domestic and institution-focused. Retail-investor protection is largely accomplished through oversight of the institutions that serve retail customers.
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Many cryptoassets, including bitcoin, followed an unprecedented developmental path. They emerged globally, not domestically, and largely at the retail, not the institutional, level. The decentralised nature of crypto has meant there is often no easily identifiable sponsoring institution, and even when known, the relevant issuer or platform may be overseas and beyond the reach of US regulators. The familiar tools of American regulators, including licensing, mandatory disclosures and market-wide secondary-trading rules, aren’t readily available.
• Opposing views are entrenched. Many market participants believe crypto is synonymous with fraud. There is evidence supporting this, including the initial-coin-offering craze and the recent $15bn collapse of the Terra stablecoin. Some experienced investors believe regulators should have shut down many crypto products years ago.
Meanwhile, crypto bulls see massive investment opportunities, operational efficiencies and regulatory enhancements. They cite frictions in the global financial system, the rise of bitcoin as an alternative asset, the operational capabilities of stablecoins, and the large amount of talent and hundreds of billions in investment capital in crypto innovation and Web3 products as signs of a transformation of global financial infrastructure. They believe regulators should embrace the benefits of crypto by relaxing and augmenting existing regulations.
Each group fears that yielding to the other would cost billions in either losses to innocent victims or missed opportunities for investors. In this environment, consensus is elusive. As a result, even well-measured government action is met with criticism, creating a bias against action—which is precisely the opposite of what each camp demands.
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To move forward, the US needs, first, to embrace the efficiencies provided by tokenising such well-understood services as payments and custody of assets in digital form. The presidential working group, led by the Treasury, should move forward on stablecoin rules, identifying the characteristics that make stablecoins a means of payment (akin to money transfer) and not a security or commodity. The SEC should issue requirements for the custody of tokenised assets.
America must also go after those who are flouting its laws, as the SEC did with initial coin offerings. Starting there, we will soon know more. The opposing camps will have little to challenge, and the next step will be easier.
What the US should not do is fail to act. Other nations, including China, have entered the race to modernise the global financial infrastructure. Winning that race is essential to the dollar’s reserve status and the continuing global influence of America’s capital-markets policy.
This article was first published by The Wall Street Journal.
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