It
is easy to think of the most prominent blockchain advocates as a united
front, whose ranks are tightly closed in the face of the common enemy —
a horde of fierce crypto critics, unwieldy regulators, anti-money
laundering zealots, “bitcoin is a scam”-ers, and the stakeholders of the
old, centralized financial system. On this battlefield, the crypto
camp’s fundamental positions are aligned, and its strategic goals are
clear. However, in the times of armistice, blockchain champions get
together by the campfire to ponder the important details of their common
cause, and — astonishingly — at times, they disagree.
This time around, the metaphorical campfire was lit at the MIT Technology Review's Business of Blockchain 2019 conference, which took place on May 2 on the premises of the Massachusetts Institute of Technology’s Media Lab. One of the panels saw Caitlin Long — the woman who is spearheading Wyoming’s transformation
into what she herself called the “Delaware of crypto law” — have a
deferential yet rather intense exchange with Coin Center’s director of
research, Peter Van Valkenburgh, one of the industry’s most eloquent speakers who is known for many notable deeds — for example, standing up for crypto to a bully last October.
The panel, which also featured MIT professor and former Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler,
was on crypto regulation, and the main point of contention was whether
it is better done on the federal or state level. While they were
ultimately concerned about the same thing — i.e., the backwardness of
the United States’ regulatory environment that can chase promising
startups away to more friendly jurisdictions — Long and Van Valkenburgh
offered two drastically different visions of the best way to go about
the issue.
Hurdles on all levels
The tension over the
boundaries of federal vs. state authority has informed American politics
since the foundation of the republic. In the realms of commerce and
finance, a relative balance was achieved when the states assumed
jurisdiction over the “consumer-facing” commercial law while the
agencies of federal government came to oversee operations with more
specialized, “institutional” financial instruments — such as securities
(Securities and Exchange Commission, SEC),
futures and options (Commodity Futures Trading Commission, CFTC), and
broad financial crimes (Financial Crimes Enforcement Network, FinCEN).
It
has become a truism that, for crypto enterprises in the U.S.,
navigating the regulatory landscape is about as easy as making it
blindfolded through a minefield. All the agencies mentioned above are
interested in some subset of digital assets: The CFTC is eyeing smart
contract-powered futures options; the SEC is struggling to decide
whether all initial token offerings are under its purview, or just some
of them; and FinCEN, facing the need to investigate money laundering
schemes and shady transactions, understands crypto assets as something
it is used to dealing with (i.e., money). In addition, the Internal
Revenue Service (IRS) is treating crypto as property for the taxing purposes, which means that capital gains and losses come into play.
To top it all off, individual states have begun to institute guidelines and regulations of their own, with Wyoming blazing the trail
by establishing its own classification of tokens. This is not a small
deal, either, since companies operating online automatically fall under
jurisdiction of every state whose residents they serve — meaning that
now they have to comply with state regulations, too.
This chaos is
due to the fact that there is no universally agreed-upon, federally
enforced definition of a digital asset. While it would come in handy if
one existed — for the purposes of delineating the boundaries of
different national regulatory bodies’ jurisdiction over different types
of tokens — it is also an arduous task to formulate such a definition,
let alone to steamroll such a bill through Congress. The last few months
saw continuous attempts on behalf of a group of blockchain-conscious members of Congress to introduce more clarity with a bill known as the Token Taxonomy Act.
The
crypto community, though, seems to be divided over not just the bill
itself but the very idea of a Congress-enacted, binding definition of a
digital token with a claim of federal preemption. Some critics point out
that, absent a clear understanding of terms and a sufficient corpus of
case law on the matter, it is nearly impossible for a bill to define
central concepts around crypto assets in a way that would eliminate
dreadful ambiguity when enforced. Others, including
Caitlin Long, argue that it is not the federal government’s business
altogether, and an attempt by Congress to introduce such a taxonomy
would amount to an infringement on states’ rights. Long’s talk at the
MIT Technology Review event, her polemic with Van Valkenburgh at the
panel, and a subsequent interview to Cointelegraph provide a closer look
at the “states’ rights” argument that she stands by.
Financializing crypto assets
Put
very simply, there are two major elements in regulations that bind
financial firms: those related to consumer protection and prudential
regulations, which are rules that dictate the need for such firms to be
able to handle risks and hold sufficient assets. One of the central
theses that Long advanced throughout the conference is that the
inadequacy of current U.S. crypto regulation stems from overemphasizing
the consumer protection side while ignoring the solvency issues.
In
her talk, entitled “The Financialization of Cryptoassets,” Long
explained that many digital assets do not qualify as securities, hence
they should be treated as property. Commercial law related to property
was mainly formulated in the age when all possessions were tangible,
which warrants the need for updating this legal area so as to define
digital assets — or to “financialize” them.
The key difference
between the traditional financial system and blockchain-based systems is
the way custody and settlement work. Normally, people do not own the
shares in their brokerage accounts. Instead, they own IOUs (“I owe you”)
from their brokers, who own IOUs from custodians, etc. With this murky
chain of ownership, it is not uncommon that several entities have claims
on one asset; it is often impossible to tell where exactly the asset is
at the moment; and finally, settlement can take days.
None of
these are an issue with digital assets: You can own them directly, they
are easily traceable and settlement takes minutes. All that this novel
type of property needs is to be treated as such, and to have sound
regulation of custody. In Long’s opinion, not only are states in a
better position than the federal government to ensure both, but they
have the priority to do so.
The panel: state vs. federal
The
regulatory panel ensued, now featuring Peter Van Valkenburgh and Gary
Gensler alongside Caitlin Long. The Wyoming native kicked off the
discussion with the same sentiment that permeated her talk:
“States control commercial law.”
Coin
Center’s Van Valkenburgh responded that his uneasiness with state-level
crypto regulation comes from the fact that, in many cases, it boils
down to states applying archaic money transmitter laws and licensing
requirements to crypto businesses. As a result, instead of having just
one federal authority to deal with, successful fintech companies that
maintain presence in all of the United States have to “have 54 awkward
conversations” with regulators instead of just one. And because money
transmitter laws are outdated, they also do not do much to protect the
customers.
When MIT’s Gensler attempted to dwell on the consumer
protection side for a little longer, Van Valkenburgh retorted that
state-level regulation is not the sharpest tool to combat things like
money laundering, either: When it comes to financial crimes, states
cooperate with the federal regulator, FinCEN, who applies federal
legislation — i.e., the Bank Secrecy Act. Coin Center’s Van Valkenburgh
also argued that managing custodial risks on the state level is not a
great idea, since such processes are better handled by specialized
federal authorities, such as the SEC or CFTC. In sum, Van Valkenburgh
contended that it is better to have a clear-cut, uniform federal
regulation than a host of disparate, state-specific regulatory regimes.
Caitlin
Long came back, criticizing some hard-regulating jurisdictions like New
York that spend extensive resources on consumer protection and
anti-fraud regulation of crypto while caring much less about solvency
and allowing
established financial institutions like Merrill Lynch to get away with
trading assets that they do not hold. She described the forthcoming
Wyoming crypto custody rules, which she sees as a way to maintain direct
ownership of digital assets and preserve the powerful advantage of
blockchain-powered systems over traditional finance.
Grounded in
the common law notion of bailment, this type of custody will entail
handing the keeper possession of the asset, but not the title. Long
likened this type of arrangement to valet parking, where the only thing
the custodian can do is to take the vehicle to a safe storage space.
Both
Van Valkenburgh and Gensler didn’t sound convinced that solving the
custody part of the puzzle would automatically resolve all the consumer
protection issues. However, Van Valkenburgh begrudgingly conceded that
state-level regulation could make sense, but only if every state adopted
a “rational approach.” In turn, Long suggested that, “if we do it on
federal level through Congress, we will get the worst-case scenario,” to
which Van Valkenburgh responded that there seem to be enough reasonable
policymakers on the Hill, and that the situation might not be all that
grim.
In an interview with Cointelegraph after the panel, Long
doubled down on how the egregious Merrill Lynch situation demonstrated
New York authorities’ application of double standards: The firm was able
to walk away from doing essentially the same that Bitfinex has been
recently accused
of doing, but with a much harsher potential fallout. The fact that
regulators are going much harder on Bitfinex suggests that they might be
picking on crypto enterprises. She also drew a line within the crypto
industry itself, distinguishing between highly leveraged exchanges,
which would be unable to comply with the new Wyoming statutes, and those
that are “truly solvent,” and which will likely end up in the state.
Finally, Long commented on Van Valkenburgh’s pro-federal regulation approach, suggesting that:
“That
is putting the convenience of large financial institutions in this
sector ahead of reality that property laws are purview of the state. It
is very unlikely, to be honest, that there’s going to be a federal money
transmission statute, because states are going to fight it. It usurps
their long-established supremacy over property law and long-established
supremacy over commercial law.”
As it is visible in
this discussion, sometimes debates over blockchain regulation invoke
matters more fundamental than simply the best way to organize
socioeconomic relations enabled by new technology. At times these
disputes spill over to the contested ground of federal-state government
jurisdiction, or to judgments on whether Congress is better equipped to
handle certain matters than state legislatures — the issues as deeply
ingrained in the political fabric of the U.S. as the antagonism between
the democratic and republican principles in its constitution. At this
point, it becomes a matter of deep ideological convictions.
On the
more practical side, Long’s fresh focus on the balance between consumer
protection and prudential regulations with regard to crypto could be a
new way for the industry to articulate and frame its policy woes.
Another thing to watch for is if, as Wyoming
proceeds with its groundbreaking legislation, progressive digital
custody lives up to the hopes that the state’s crypto pioneers have set
on it.
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