Key points to remember
- Several Recently Proposed Bills and Ongoing Enforcement Cases Could Define the Future of the US Crypto Industry
- If the SEC and CFTC win their ongoing crypto lawsuits, they could set a terrible precedent for decentralized finance and the industry in general.
- However, if the regulatory agencies lose, the crypto could experience a renaissance.
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The US government’s approach to crypto regulation will determine whether the industry evolves to thrive or fade into obscurity.
The US Crypto Regulatory Landscape
Crypto Regulation Is Coming to the United States — and Itit is likely to have a major impact on the future of the industry.
The first key distinction to consider when analyzing the current state of the crypto regulatory landscape in the United States is the difference between the legislative and enforcement approaches of the government. This comes down to comparing what the government says to what it does in practice, which is important because the difference between the two approaches provides valuable insight into the government’s true intentions regarding the industry and the asset class.
On the legislative front, there has been a significant increase in crypto-related bill proposals over the past year, including Senators Cynthia Lummis and Kirsten Gillibrand. Responsible Financial Innovation ActRepresentative Josh Gottheimer’s Stable Coins Protection and Innovation Act of 2022by Senator Pat Toomey Stablecoin TRUST Act of 2022and Senators Debbie Stabenow and John Boozman’s Digital Products Consumer Protection Act 2022. If these bills are passed as proposed, the crypto regulatory and industry landscape will see significant changes, which most industry stakeholders have viewed as positive.
Perhaps most notably, the Commodity Futures Trading Commission would overtake the Securities and Exchange Commission in becoming the primary regulator of the asset class by gaining authority over the cryptocurrency spot and derivatives markets. Until recently, this was seen as a very welcome change by industry stakeholders who are fed up with the SEC’s aggressive “regulation by enforcement” approach.
Another major change that would follow if these bills were passed would be the introduction of much stricter rules for the issuance and management of stablecoins. This could lead to an implicit ban on unbacked, algorithmic, or “endogenously backed” stablecoins and 100% reserve requirements for stablecoin issuers. Stablecoin issuers will likely be required to have bank charters, which are very difficult to acquire, or register directly with the Federal Reserve. This would greatly reduce the risk of depeg in the cryptocurrency market. However, it could also centralize the on-chain economy if the space becomes too reliant on regulated stablecoin providers.
However, perhaps the most significant development on the legislative front is the recent overarching White House framework to regulate the digital asset space. The framework was released Sept. 16 after President Biden signed an executive order on “Ensure responsible development of digital assetsin March. It includes views and recommendations from the SEC, Treasury Department, and several other government agencies on how to regulate crypto assets.
The frame provides the clearest overview yet of how the Biden administration plans to handle crypto, including plans to ramp up enforcement against illegal practices, steering users away from crypto, and toward solutions central government-issued and controlled payment processors like FedNow and CBDCs, amending the Bank Secrecy Act explicitly applies to digital assets and leverages the country’s position in international organizations to promote greater cross-border cooperation in regulation and enforcement of cryptography.
If the administration begins to realize its plans, the US crypto industry will begin to look more and more like the fintech than the grassroots movement seeking to create an alternative financial system that it set out to be. By applying overly stringent regulatory requirements to the industry, its stakeholders could begin to leave the United States for more crypto-friendly jurisdictions, leading to an exodus of talent from Web3 and ultimately America’s submission to the scene. world of cryptography.
Regulation by application
On the enforcement front, there are several critical cases pending which, depending on their outcome, could reshape the cryptocurrency landscape in the country. The most documented of these cases is the SEC vs. Ripple, in which the securities agency is suing the blockchain company for allegedly conducting an illegal security offering by publicly selling XRP tokens. Judging by the latest developments in the case, the matter will likely be settled out of court, which would be a major win for Ripple and the US crypto industry. For the securities agency, losing the case or settling out of court would make it much more difficult for other crypto companies to sue on the same charges, giving crypto issuers and exchanges some much-needed leeway.
The second critical case is SEC vs. Wahi, where the securities firm is suing a former Coinbase employee and two accomplices for insider trading. In a blatant example of “regulation by enforcement,” the SEC claims that “at least” nine of the publicly traded cryptocurrencies were securities. If accepted by the court, this claim could have broad industry implications by making it easier for the agency to sue crypto exchanges for illegally offering unregistered securities.
In another ongoing case highlighting the SEC’s “regulation-by-enforcement” approach, the agency is trying to establish its grip on the industry by making sweeping statements that could have serious consequences for the asset class. Namely, in the SEC vs. Ian Balina In this case, the agency argued that Ethereum transactions should be considered “taking place” in the United States, since more Ethereum nodes are located in the United States than in any other country. For this reason, according to the SEC, Ethereum should fall under its jurisdiction. If the court accepts this argument, the SEC could then attempt to establish jurisdiction over all Ethereum transactions involving tokens that it considers securities, regardless of the location of the transaction’s counterparties.
In another disappointing development for the crypto community, the CFTC – following in the footsteps of the SEC –pursues a decentralized autonomous organization and its token holders accused of operating an illegal derivatives trading platform. The CFTC’s victory in this landmark case would set a terrible precedent for DeFi protocols and token holders by ensuring that they can be held liable for various crimes as “unincorporated associations.” This would effectively ravage DeFi, making it impossible for protocols and DAOs to operate without risking lawsuits.
Finally, the Treasury’s decision to sanction decentralized privacy protocol Tornado Cash stands out as one of the major enforcement actions that has already had an outsized effect on the industry. The move represents the first time a government agency has sanctioned a smart contract – immutable code living on the blockchain – and several key blockchain infrastructure providers, like Alchemy and Infura, have already complied with the sanctions.
Many crypto legal experts, including the U.S.-based crypto advocacy organization Coin Center, call the decision unconstitutional and a gross overjurisdiction and will likely challenge it in court. However, if the Treasury wins a tough lawsuit, the entire crypto economy could suffer, casting doubt on its ability to uphold its core principles such as decentralization, credible neutrality, and censorship resistance.
Depending on whether or not the recently proposed cryptocurrency regulations take effect and how the enforcement cases evolve, the US crypto landscape could look completely different in a few years. The optimistic view is that the SEC and CFTC will lose any lawsuits that could set the industry back while lawmakers pass the more supportive proposed laws that provide regulatory clarity. If that becomes the case – and the odds are pretty high – the US could become the world’s top crypto-friendly jurisdiction, bolstering the entire global industry.
On the other hand, the worst case scenario is that lawmakers take far too long to pass favorable crypto regulations while the SEC and CFTC slowly regulate the space through enforcement. This would severely hamper the remarkable growth of the US crypto industry and any technological innovation that would come from it. Given the outsized international political and economic influence of the United States, such a scenario would also bode ill for the global crypto industry. One of the potential outcomes of a challenging regulatory environment is the fragmentation of DeFi into “RegFi,” consisting exclusively of regulatory-compliant protocols, and DarkFi, consisting of truly decentralized, non-compliant, and censorship-resistant protocols.
Disclosure: At the time of writing this article, the author of this feature owned ETH and several other cryptocurrencies.