There are few certainties in life, but one thing you can count on is the US moving to regulate fast-growing industries including crypto. In 2020 alone, the Securities and Exchange Commission filed 715 enforcement actions – which is fewer than previous years, however, the $4.6bn in penalties and fines collected was record-breaking.
The SEC has earned a reputation for regulatory overreach since it was founded in 1934, therefore It should come as no great surprise that the organisation has claimed that the majority of Ethereum transactions effectively occur in the USA and thus come under their remit.
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SEC chief Gary Gensler views ETH after its migration to proof-of-stake as a security, and believes the US government has jurisdiction over all Ethereum transactions, since most of the network’s validator nodes are clustered in the USA. The space has erupted with opposition at this posturing.
But it would be a mistake to perceive American regulators as a monolith. Chair of the Federal Reserve, Jerome Powell, recently urged caution on regulating DeFi: this behemoth undertaking needs to be done “carefully and thoughtfully” in his view.
Publius (a pseudonym) aptly says, “as leaders in the financial industry, it is our duty to foster an environment that is fair and equal for all in our sector and allows us the freedom to pursue our goals of providing wealth and prosperity for our businesses, employees, investors, and communities.”
Regulatory overreach not only hinders our ability to accomplish the objectives stated, but also does harm by stifling the ability for the industry to innovate towards the objectives that are laid out as the very mission of the government agencies we speak of.
There is precedent for intense regulation from American authorities because they take the view, in many cases justified, that their activities in protecting US citizens should be extended to various countries around the world.
But as “Common Sense” author Thomas Paine states, “common sense will tell us, that the power which hath endeavoured to subdue us, is of all others, the most improper to defend us.”
And in a number of cases, they are already acting to establish case law precedent. By way of example the Commodity Futures Trading Commission (CFTC) recently served Ooki DAO members with a lawsuit via its website chat box because there is no listed headquarters or mailing address for the DAO.
The CFTC wants the court to accept this novel filing approach in what could have lasting implications for the largely decentralised world of crypto.
The CFTC filed this civil lawsuit against Ooki DAO for illegally offering leverage and margin trading thereby violating the Bank Secrecy Act and Commodities Exchange Act. This is one thing, but there is an implication that token holders who participated in voting are also liable. It raises the question of how and why normal community members are deemed to be responsible in the eyes of the law. As contemporaries occupying similar space, if not the same, we should watch this closely.
Positive examples of crypto regulation do exist in the world; Malta lured Binance back onto its shores with various bills protecting technological innovation and the trading of digital assets.
Slovenia doesn’t even tax people on profits made from speculating on cryptocurrencies, the same as in Portugal which has established a “Digital Transitional Action Plan” to promote digitisation and create the environment to unleash technological transformation.
What this highlights is the one crucial difference with cryptocurrencies which renders antiquated regulatory procedures obsolete.
For instance, an investment bank that has established itself in the US means it will always come under US jurisdiction – but epicentres of cryptocurrencies can be readily moved around the globe both in the case of Proof of Work (PoW) and Proof Stake (PoS), which was demonstrated by miners who packed up and ‘foxtrot oscar’d’ from China in a matter of weeks when the People’s Bank of China announced a ban of all cryptocurrency transactions in late September 2021.
Achieving Careful, Positive Regulation
Policy makers know blockchain is a special case, hence why they haven’t rushed in impose regulation too early without fully considering and understanding the implications. Consider how internet companies were given an accelerative environment to flourish in Silicon Valley, because moving to shut things down or control them means deterring innovators from setting up shop.
Blockchain goes even further than the internet in giving a novel issue for authorities to mull over. It’s not at all dependent on the infrastructure available in technology centres, and there is a real fear that stringent regulatory overreach, risks driving people at the forefront of the industry to non-compliant jurisdictions, thus handing over significant power and revenues that cryptocurrencies can offer to places that don’t have strong diplomatic or economic relationships with the US.
In theory, it’s fairly easy to move validators on PoS and miners of PoW to countries not under the vast umbrella of US regulatory power and as a result, drive talent and participants underground.
It’s not only PoS blockchains that are nuanced to become subject to regulatory oversight; soon cross-chain solutions will be widely used in the market, and they will open up seamless movement between different Layer One blockchains.
Not only does this vastly reduce platform risk, it makes jurisdiction lines fuzzy because the DeFi Layer Two protocol can simply allow companies to move to another chain if / when issues arise.
This cannot be feasibly controlled by governments of any country. Regulators have an important role to play, and need to strike a balance in order to foster the conditions that are required for financial innovation and growth.
Applying the logic of previous strategies to protect US retail investors from losses caused by both malevolent actors and market forces at the same time, becomes considerably harder to enforce in decentralized environment that blockchain technology promises to deliver.
The cryptocurrency industry needs a positive regulatory framework that encourages innovation and creativity. There is potential for blockchain to be incredibly disruptive, valuable technology but it must be allowed to grow in a conducive environment. Otherwise, regulators run the risk of driving it underground and driving it into the hands of bad actors.
Blockchain's Evolution
It is the nature of bleeding-edge technology to rapidly evolve alongside changing circumstances and an improved ability to better serve the needs of consumers and businesses.
Rhetoric from the SEC on Ethereum post-Merge runs counterintuitive to this notion; if they disincentivise Proof of Stake, then it only serves to hold back progress as blockchains should be rewarded by the free market for finding solutions to obstacles to mass adoption, such as environmental sustainability.
New players bringing revolutionary solutions to the market would operate freely in the USA in an ideal world. This is not just about tax revenue, it’s about which nation provides the best environment for innovation entrepreneurship. There is a great track record stateside for bringing out the best in tech, and crypto could deliver untold economic and social advancement.
There is much work to do yet. Now authorities say a suspicious activity report (SAR) could be filled out on participants in the Ethereum network; this would mean each IP address used to send crypto can result in a SAR.
Previously within the banking system, a SAR can be issued to individuals who will then have each digital transaction over $600 scrutinised (it used to be $10,000). Again, this is a remarkable intervention which risks holding back expansion of what may be the defining technology of this era: one in five of Americans are reported to have invested in, traded or used cryptocurrencies. Would all of them be subject to a SAR in the near-future?
Regulators should in fact welcome PoS: it is less pseudonymous, though there are protocols which specifically maintain privacy. Ergo the Merge, the crypto validation system became measurable and far easier for a regulator to say, “all these validators are in America.” When push comes to shove, if the SEC follows through on its threats, validators will be rapidly moved out of the United States.
There is some good news from other authorities in the US, however. The Financial Stability Oversight Council (FSOC), a US regulatory panel comprised of top financial regulators, recently recommended that Congress pass legislation to improve oversight of crypto spot markets and stablecoins. This may offer a level of stability that the industry could definitely benefit from.
Expect negotiations to happen behind closed doors and the authorities with hard stances to slowly soften. Cryptocurrencies are far too valuable and hold such great potential to change lives and livelihoods, it seems unlikely the US would be interested to pass the golden chalice to other nations as a result of suffocating oversight.
The Nature Of Crypto
Cryptocurrencies are at their core decentralised and community-focused with a major inclination towards censorship resistance. There is a reasonable expectation that it (or parts of it, as an industry - in addition to specific use cases) will never fall under the control of governments and regulations.
It is a de facto quality of the peer-to-peer nature of cryptocurrencies to find a place firmly outside of the grip of regulatory frameworks and centralised entities. And like grasping sand, the tighter you grip, the faster it runs through your fingers. They will always retain these vital properties because it’s an inbuilt feature of the technology, not a superfluous choice to evade regulatory attention.
Moreover, there will always be privacy-driven protocols to fulfil the necessity of privacy; people from all walks of life as well as organisations actually need this to function and one should be careful not to immediately jump to the conclusion that a requirement for privacy naturally equals wrongdoing.
Less clear is how this will play out with regulation, but the community reaction to the sanctions on Tornado Cash is instructive. Coinbase is even jumping in to fund a lawsuit to challenge the US Treasury Department amid a tidal wave of support.
Central Bank Digital Currencies (CBDCs) aren’t the answer either; no matter what any government does with the technology, it will never possess the same decentralised properties which has made cryptocurrency such an attractive proposition for investors and users around the world.
The eventual regulatory landscape will be hard to predict, but it’s an increasingly hot topic which may need to be addressed sooner rather than later. Now is the time to cast a light on these issues and further the dialogue to eliminate draconian enforcement.
But it’s clear to observers, and increasingly serious investors, that cryptocurrencies are not likely to see a brutal crackdown despite occasional fiery statements from certain institutions. The debate now centres around protecting aspects of the technology that are pivotal in forging a brighter future.
