Everyone except Securities and Exchange Commission (SEC) chair Gary Gensler sees the federal government’s approach to crypto is a mess. Various cohorts, including academics, SEC Commissioners, and lawmakers, have offered alternatives to Mr. Gensler’s “Enforcement Only” approach. Unfortunately, some proffered solutions would worsen the problem.
Paul Watkins and Danielle DuBose recently published an academic article suggesting the states should lead the crypto regulatory charge amid federal intransigence. This approach would fail for several reasons including the lack of motivation for states to cooperate and the hardships it would produce even if they did cooperate. A better solution would be to remove digital assets from the purview of investment-contract analysis and allow private ordering as the most successful security exemption already does.
Watkins and DuBose propose a two-part state-led solution. First, states should exercise their anti-fraud powers to pursue bad crypto actors. Second, they should provide a two-part safe harbor from state-level securities law and reciprocity between cooperating states. But the states are unlikely to agree to this venture. Some like New York have burdensome and onerous crypto regimes, others seeking crypto investment like Wyoming provide issuer-friendly rules. States with vastly different approaches likely won’t cooperate on standardization. Watkins and DuBose point to state adoption of the Uniform Securities Act while noting Arizona, California, Florida, Illinois, New York, North Dakota, Ohio, Tennessee, and Texas have refused adoption. Some important states are on that list.
States cannot agree on anything
It is even worse for money transmission laws. Peter Van Valkenburgh, Research Director at Coin Center notes only 12 states have adopted the model money transmission law developed almost two decades ago. There would likely be similar reluctance for a crypto safe harbor given the divergent regimes already in existence, the natural competition between states, and the fact many struggle to define crypto’s basic concepts. Issuers would have to comply with each state that declined the safe harbor by either registering with that state or observing its particular exemption—a legal nightmare.
Yet, even in the unlikely scenario all or almost all the states agreed to the proposed framework it would still be unfeasible. The paper proposes two ways crypto issuers could attain the safe harbor. First they could qualify through one of six statutory qualifications. Second issuers could seek an exemption via a government official which through reciprocity other states would accept.
State crypto lead would not preclude federal involvement
The authors specifically designed the safe harbor to survive a federal court challenge rooted in the Howey test and other cases that determine whether a particular instrument is an “investment contract” and thus a security under federal law. “The statutory qualifications and factors for the state official to consider are designed to exempt tokens that do not meet the definition of security under federal law as interpreted by Supreme Court precedent.” Thus, the framework is a federal analysis that doesn’t include or bind federal regulators.
The folly of this approach is shown by the arduous analysis issuers must traverse to qualify for the safe harbor. This is particularly under state-bureaucrat exemption. A nightmare of factors stacked like cordwood each making the existence of a federal security “more likely” or “less likely.”
Particularly bemusing is the strict admonishment against profit, or potential profit seeking and instead the focus on consumption. The authors may rejoin their multifactor analysis is what federal precedent requires. And they are tailoring disclosures to be more germane to crypto issuers than those required under the 1933 Act.
This may be true, but it shows why regulators need new thinking. It is likely. as the authors suggest, their disclosure regime focusing on the token itself, source code, transaction history and other factors better protect investors than disclosures required by traditional registration. But that hardly moves the ball forward.
Private ordering works, not state crypto rules
If their suggested disclosures are important, investors would demand them without the expense and ambiguity of wading through endless factors. This is how Regulation D 506(b) works. The government mandates no disclosures, but Private Placement Memorandums provide what investors consider most important. The success of this exemption—limited essentially to accredited investors—is undeniable. It outpaced the entire public market by itself in 2019.
Congress should remove “investment contract” analysis from the definition of security for digital assets. The Howey test and its progeny have no place in determining assets unfathomable when W.J. Howey, an enterprising salesman, offered orange grove plots to Florida tourists decades ago. The market will demand the information necessary. Some issuers will lie, some offers will be fraudulent. But decades of mandated disclosures have done little to deter scammers as scholars Stuart Cohn and Gregory Yadley lamented in 2007, “[Ex]amination of the securities violations . . . reveals that no amount of technical exemption requirements will hinder the fraud artists from their endeavors. . . . Fraudulent and deceptive schemes have unfortunately continued unabated and independent of formal registration or exemption requirements.” Those still unconvinced can visit the SEC’s website on any given day and view the commission’s ten most recent press releases.
States should lead on fraud prosecutions
States do have a role to play in crypto. It is prosecuting fraudsters. Stiff penalties and jail time are the best deterrent not incompressible new multifactor analyses.
This webinar explores the potential of stablecoins as a payment instrument, the inefficiencies of the current payment system, and the appropriate level of regulation that allows for beneficial innovation in this sector.
The Crowdfunding Lawyers founder Paul H Jossey publised a major paper on Central Bank Digital Currencies (CBDCs) for the Competitive Enterprise Institute. In it he argues CBDCs will not live up to the promise government proponents suggest.
Many CBDC promoters have sat at the pinnacle of financial power for decades. The post-World War II global order endowed domestic and international financial regulators with immense power, with mixed results. But private competition is exposing flaws that become exacerbated in times of high inflation and pandemics. Citizens have seen mismanaged currencies and incompetence or abuse by civil servants, and doubt that any benefits would outweigh the potential costs. Private cryptocurrencies, especially stablecoins, are solving problems, innovating, and creating opportunities in a way that central bankers cannot.
Western nations should scrap CBDC plans and promote stablecoins as the answer to perceived threats to global financial stability posed by authoritarian regimes and big technology companies.
“A CBDC could fundamentally change the structure of the U.S. financial system.” The Federal Reserve’s recent paper on whether to adopt a central bank digital currency (CBDC) included candid assessments on its macro-economic risks but less on individual citizens.
The proffered benefits of this gamble involve hazy feel-good sentiments about inclusivity, aiding entrepreneurs, propping up the dollar internationally, and smoothing cross-border transactions. But design choices, governmental priorities, and prevailing attitudes erase these benefits whilst leaving the risks. Instead of entering the digital currency race, the government should encourage private innovation already afoot via stablecoins (digital assets pegged mostly but not exclusively to the U.S. dollar).
As I detail in a new paper ‘Central Bank Digital Currencies Threaten Global Stability and Financial Privacy,’ CBDCs provide little value for mature financial systems like the U.S. where banks, payment providers, and stablecoin issuers provide consumer options. Conversely, they invite huge risks through digital bank runs, distorted monetary policy, transaction monitoring, involvement in contentious social issues, and international strife. The paper admits these risks are real and inadvertently agrees design choices make them likely.
CBDCs don’t live up to the hype
The most prominent supposed CBDC benefit is financial inclusion, providing the unbanked access to central bank money. Currently around 5 percent of the U.S. population lacks a bank account, and more “underbanked” use expensive options like money orders. But a CBDC alone would help little. As the paper admits, CBDC accounts would be “intermediated”—administered through the existing fee-charging financial system. Thus, it would not quell major reasons people forgo bank accounts: lack of minimum balance requirements, mistrust of banks, and high or unpredictable fees.
The paper also asserts smoothing the archaic cross-border payment system as a potential CBDC benefit. This also has little merit. First, the paper admits it would require “significant international coordination.” Yet even accomplishing this Herculean task would only provide limited benefits because, as the Bank Policy Institute states, the real culprit is insistence on Anti-Money Laundering/Combatting Financing of Terrorism (AML/CFT) reporting.
The paper’s other proffered benefits of helping entrepreneurs and maintaining the dollar’s global status carry even less purchase. Dollar-pegged stablecoins with their functionality and flexibility already fill this role. At least before the latest crackdown they were very popular in authoritarian China and the rest of East Asia, as well as providing needed purchasing power in socialist-torn countries like Venezuela. A U.S. CBDC requiring tedious international agreements will never achieve this global utility.
CBDC risks are off the charts
But where benefits shrink risks explode. CBDCs would be liabilities of the Fed not commercial banks. This means banks could administer CBDC accounts but not lend them out like ordinary deposits. Thus the $10 trillion in currently outstanding loans would fall, raising rates on what’s left. This would affect the economy in good times. Economic stress would invite the further issue of digital runs—panicked conversions into CBDC from other money for its perceived safety. The paper counters it could temporarily limit access to CBDC, which would invite political outrage and quick reversal. If foreigners convert in large numbers, international tensions will follow.
Problems would not end there. CBDCs would require enlarged Fed balance sheets with possibly riskier assets, distorting credit markets and monetary policy. It may also force the Fed into contentious political issues if CBDC purchases include unpopular products like firearms or donations to disdained political groups or causes.
None of this necessary.
But the biggest downside would be privacy infringement. The ability to surveil is the ability to control. China make no secrets its CBDC will help enforce party discipline. The paper avers “consumer privacy is critical,” yet immediately follows with the need for AML/CFT monitoring. The government would have access to every CBDC-conducted transaction. Appropriate protections would supposedly ensure limited bureaucratic access. But after repeated leaks of sensitive information and oppressive behavior toward everyone from blue-collar Tea Party activists to the President, should anyone trust them? CBDCs solve no problem stablecoins don’t already address but they invite intervention and abuse on an unprecedented scale. The Fed roundaboutly admits this. The CBDC conversation should stop there.
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