The Ghosts of Regulation Past, Present, and Future

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Katherine Wu - December 13, 2018

What a year it’s been. From the roller coaster high of "Everyone Is Getting Hilariously Rich and You’re Not” to the more recent markets nosedive and sentiment reversal, it’s been equal parts exhilarating and nauseating.

(we’re not rich anymore, and the sweaters are no longer hilarious.)

The "crypto winter” is especially chilly in the U.S., where the ecosystem has been hamstrung by the SEC’s regulatory crackdown.

The crypto community has called for clearer regulatory guidance for years now, yet each passing day seems to lead us further into new gray areas than clarity. Yesterday, we wrote about Basis’ shutdown. CFTC Commissioners are openly questioning whether developers can be held liable for code they develop that is then later misused. Hundreds of subpoenas have been issued and are still being addressed by ICO teams, their advisors and investors.

There are numerous enforcement actions, private lawsuits, and controversies that will unwind in the months ahead.

What are the regulators thinking? Can’t they see the importance of these experiments, and the value of re-designing a more open and efficient financial system?!

A couple of things to keep in mind heading into 2019 as you navigate outside the cryptopia filter bubble:

First, crypto is still a very tiny part of the overall financial system. Sure, there was a rush of global retail investor enthusiasm last year. And this year there have been a couple of wins from large institutions (ICE, NASDAQ, Fidelity, etc.), but the overall institutional sentiment is still heavy with skepticism. The crypto market may be starting to professionalize, but compared to traditional markets, it’s a hot mess. (e.g. remedial things like market surveillance, and reliable price discovery remain unsolved, one reason why the ETF approval may be unlikely.)

The glacial pace of regulatory traction may be frustrating to entrepreneurs, but most regulators to date have largely focused on “doing no harm,” and taking their time with decisions related to this emerging asset class because it not (yet) critically important to the financial system. Things could be worse.

Second, and perhaps more importantly: regulators are not blind, deaf, or dumb. Nor are they omnipotent. That cuts both ways: deliberations and decisions may take forever, but dissent in the industry’s favor also has more time to percolate up the highest ranks of our regulatory agencies.

At the SEC, each enforcement action goes to a five Commissioner vote (of which no more than three may be from the same political party). And I recently stumbled across a speech (thanks to Jesse for sending it to me!) from SEC Commissioner Hester Peirce, who seems to get us. I found myself saying “YES!!” at multiple points.

Peirce has been nicknamed “Crypto mom” due to her strong dissent on the SEC’s rejection of a proposed rule change that would have led to the approval of the Winklevii ETF. Her speeches do not necessarily reflect the thinking of everyone at the SEC, but she has one of the five votes over enforcement decisions carried out by the Commission, and hers sounds like a pretty friendly (and festive) take on crypto:

“We ought also to be doing a better job communicating with new participants in the marketplace we regulate rather than acting as though entrepreneurs need to have the resources to hire a thousand-dollar-an-hour Wall Street lawyer to bring innovations to, or even to do business in, our markets. We cite the Howey Test for determining whether something is a security as if we expect every crypto-entrepreneur to know what it is and how courts and the Commission have applied it over the years. Even the securities lawyers many of these entrepreneurs cannot afford are struggling to apply the test."

Um, SAY THAT LOUDER FOR THOSE IN THE BACK.

The Howey Test isn’t a legal precedent you can understand and apply from a single paragraph in a reddit post. Even many of the industry’s top lawyers may have royally screwed up their interpretations of Howey when providing ICO guidance last year. If securities litigation and transactions are one of the most complex areas of law (not to even get started on derivatives) for the seasoned attorneys and regulators themselves, why would well-intentioned entrepreneurs be blamed for their counsel’s bad advice or a lack of clarity around existing rules.

Even Peirce admits that: “enforcement actions ought not to be the means by which we tell the marketplace what we are thinking.”

It may take some time and patience, but can we at least agree it’s a good thing that these regulatory bodies are keeping their doors open, and have openly acknowledged that law almost always lags behind technology? Can we appreciate that crypto in the U.S. isn’t dead, it’s just corrected? That the SEC and CFTC might not want to kill it, just reign in some of the stupidity of 2017?

The Q4 crypto headlines have been bad. But before rage-quitting crypto in the U.S., we’ve got a good opportunity to rip ourselves outside of our bubble, and work to collectively try to bridge the information gap between the crypto community and the “real world”, who are looking pretty rational amidst the 90%+ crash of most cryptos this year.

One place to start?

The CFTC is earnestly seeking public comments on a range of questions related to the underlying technology, opportunities, risks, mechanics, use cases, and markets, related to Ether and Ethereum.

Let’s show them how it's done.