In the middle of a chilling crypto winter, US regulators need to turn up the heat
The crypto industry is being poorly managed, but that’s no big surprise. Unfortunately, this year’s predicted “crypto winter” will continue to get colder if key players don’t mitigate the risks, policymakers don’t provide clearer guidance, and regulators don’t start adjusting their enforcement strategies.
Before we discuss solutions to this predicament, let’s start with a primer on the crypto winter and the shady practices occurring within the crypto space. Since the onset of the pandemic, the crypto industry has experienced a gold-rush-esque, Wild-West-level explosion that was bound to result in plateaued growth.
The previous crypto winter started in 2018, with the market flatlining or even showing negative results for nearly three years, so investors are rightly concerned that their expectations for a continued upswing were highly unrealistic.
What is equally concerning is the collapse of the cryptocurrency exchange FTX, founded by Sam Bankman-Fried (SBF). The House Financial Services Committee held a hearing on Dec. 13 following SBF’s arrest for money laundering as well as conspiracy to commit wire and securities fraud.
Crypto is not experiencing its finest hour. In addition to the FTX collapse, Celsius and Voyager (two major crypto companies) have declared bankruptcy, and investors and consumers have suffered enormous losses. All cases occurred not because of the technology itself, but because people have used the hype of the technology to cover poor management, perhaps even crimes. For instance, what caused the collapse of FTX appears to be just old-fashioned fraud; it has almost nothing to do with cryptocurrencies or blockchain.
So, what can be done to prevent this from happening again?
Several industry bigwigs, investors, academics, and legal professionals have suggested enacting brand-new laws. However, we need to stop ignoring the enforcement of current laws and regulations (like the fiduciary duties under the existing corporate law), and start being mindful of the potential negative impacts of hasty regulatory and legislative responses.
The fact is that key players in the blockchain and crypto industries appear to have been skirting the existing rules. For instance, U.S. companies are required to act in good faith, disclose any potential conflicts of interest, and keep records of their financial and accounting documentation, but many crypto firms apparently failed to do so.
Some crypto firms are issuing securities and, considering many cryptocurrencies are commodities, the firms should have complied with securities law and the Commodity Exchange Act. Other firms have intentionally registered their companies overseas to avoid anti-money laundering and know-your-customer rules, while still having a business presence in the U.S.
Strict and quick regulations won’t solve the problem either. Lawmakers should not create new regulations just because the industry is calling for them — at least not without conducting sufficient cost-benefit analyses and impact assessments.
There are multiple ways to regulate the crypto industry. One is to regulate crypto as “a new asset class,” like the European Union’s crypto-asset regulatory framework (known as MiCA), and formulate rules around it. Additionally, Self-Regulatory Organizations (which exercise some degree of authority over various industries) should also formulate the rules for crypto industry participants to follow.
Specifically, there should be adequate licensing rules regarding who can acquire licenses to run crypto businesses. Beyond that, there should be rigorous client-asset segregation rules, rules on proof of reserves, investor warning models, clear corporate structures, sophisticated risk management mechanisms, records of on-chain and off-chain assets and transactions, and rules on bundling multiple services.
In addition, there needs to be more collaboration when it comes to rulemaking — not only domestically, but also internationally, between regulators and lawmakers. Much of what has happened in the crypto industry has been because U.S. regulators have limited jurisdiction over offshore crypto companies, but those businesses still have an economic impact on U.S. territories and citizens. There is undoubtedly a lesson to be learned here.
The Wild West ultimately didn’t remain wild, and neither will the current crypto chaos.
How the regulators will handle the outlaws remains to be seen, but — for the sake of investors and consumers — let’s hope their solutions are as smart as they are swift.
Jiaying Jiang, S.J.D. is an assistant professor of law at the University of Florida’s Levin College of Law. Her research focuses on policies and regulations regarding emerging technologies, including artificial intelligence, fintech, blockchain, cryptocurrencies and central bank digital currencies.