The crypto world is recoiling under massive headwinds. Regulatory uncertainty and the current market downturn, including the spectacular crash of TerraUSD, has left the industry reeling. But while market corrections can shakeout unworthy projects and redirect capital more efficiently, unclear guidance about the rules is intransigent. Myopic federal guidance, particularly from the Securities and Exchange Commission (SEC) has hamstrung crypto development for years and hopes for a resolution exist but seem dim. Now the SEC kills crypto.
It didn’t have to be this way.
Four years ago this week, SEC Corporation and Finance Director Bill Hinman spoke at a San Francisco crypto summit and offered a path forward. Recognizing the emerging industry’s potential entanglement with securities laws, Hinman asked, “Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?”
He tentatively said yes, if the project was sufficiently decentralized. “If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract [security].”
Hinman halted the SEC killing crypto
Developers rejoiced dubbing his remarks the “Hinman Test.” Decentralization can be a messy concept that needs further clarity. But Hinman seemed to offer a way forward that captured crypto’s peer-to-peer ethos while prosecuting fraud.
Four years hence, crypto’s rules are less certain than ever and Hinman’s words are the subject of a vicious legal battle. The hope for a straightforward regulatory pathway for crypto is all but forgotten.
Even amid Hinman’s speech, then-SEC Chair Jay Clayton’s tenure lacked focus. A year after the Hinman Test, the SEC produced further crypto “guidance” so impenetrable Commissioner Hester Peirce likened it to a Jackson Pollock painting. Clayton also greenlit the Ripple/XRP litigation on his last day, which has become the SEC’s most arduous crypto battle.
Current Chair Gary Gensler has replaced Clayton’s vacillation with outright hostility. Gensler has unleashed a torrent of legal actions against crypto project developers like LBRY and doubled down on the Ripple case,projects with happy user bases and no hint of fraud. He’s called for plenary authority over crypto and hired scores more attorneys to evaluate each project under the vague and famously malleable Howey test. And he’s threatened virtual marketplaces like Coinbase, while forcing BlockFi and Celsius into fines and settlements to avoid protracted legal battles.
Gensler’s SEC kills crypto
Cynics claim Gensler’s “enforcement only” approach and attendant industry ire is worth the trouble to bolster his profile for ever higher government posts. Regardless of motivation, the results have immensely damaged this century’s most promising technology.
Observers inside and outside the Commission have offered alternatives to the Clayton-Gensler quagmire. Commissioner Peirce has suggested a regulatory sandbox. Academics have offered various solutions including a state-led regime. Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) proffered a legislative solution. None seem likely to be enacted soon.
For now, the judiciary offers the only refuge from the SEC’s regulatory onslaught. Ripple along with individual defendants Brad Garlinghouse and Christian Larsen have cornered the SEC into unforced errors and shifting justifications as discovery battles intensify before trial.
Ripple case shows SEC crypto hostility
Most prominently, the SEC’s turn from Hinman’s speech and the SEC’s unwillingness to reveal the intra-office machinations surrounding it has begot Amber Heard-like court performances. Magistrate Judge Sarah Netburn has grown increasingly frustrated with the SEC’s obduracy.
At one point during a hearing last week she sarcastically directed the SEC lawyer to pull up the speech and explain which parts were Hinman’s personal opinion and which were SEC policy, as the commission darts to-and-fro to avoid yielding information to opposing counsel.
Ripple has the resources to fight a protracted battle that may end at the Supreme Court. The Commission rarely faces spirited opposition, as years-long investigations followed by expensive litigation crush adversaries well before a ruling on the merits.
SEC is losing Ripple crypto case
For once the SEC seems to have the losing hand and not just in the Ripple litigation. Mr. Gensler’s reportedly abrasive style has caused a mass exodus of top-level personnel. The Fifth Circuit recently ruled its administrative law judge system of adjudication that denies defendants a federal court venue is unconstitutional in certain circumstances.
For the crypto world building the next generation economy, the SEC’s troubles are its gain. The industry should use the Crypto Winter to exert maximum pressure on Gensler. Reviving the Hinman Test – and actually applying it consistently – would be a start.
The much-hyped “crypto winter” has emboldened cryptocurrency critics. The usual charges of “Ponzi scheme” (Robert Reich) and “The Big Scam” (Paul Krugman) have returned, more pointed this time. Governments, keen to never let a crisis go to waste, have joined in. One Chinese official, echoing Reich, recently called crypto “The Biggest Ponzi Scheme in History.”
Amid the gloom, some positive news emerged from the United Kingdom. The UK Treasury will not require suffocating anti-money laundering rules for crypto transfers between unhosted (self-custodied) digital wallets unless a valid reason exists. In the current hyperbole-filled zeitgeist, in which investor protection virtue signaling carries the day, the UK’s measured approach is welcome. After originally proposing to require these rules, the UK Treasury asked for public comment—and actually listened to the responses.
In light of this feedback, the government has modified its proposals with regard to unhosted wallets. Instead of requiring the collection of beneficiary and originator information for all unhosted wallet transfers, cryptoasset businesses will only be expected to collect this information for transactions identified as posing an elevated risk of illicit finance. … The government does not agree that unhosted wallet transactions should automatically be viewed as higher risk; many persons who hold cryptoassets for legitimate purposes use unhosted wallets due to their customisability and potential security advantages (e.g. cold wallet storage), and there is not good evidence that unhosted wallets present a disproportionate risk of being used in illicit finance.
How refreshing.
UK leads on crypto privacy but EU lags behind
The UK’s approach contrasts with that of its cross-channel neighbors. European citizens are worried about government snooping, as shown by a three-month European Central Bank survey that listed privacy as the biggest concern for a digital euro. Yet, in March, European Union lawmakers voted to scrap all privacy protections for crypto-related transactions, including via unhosted wallets. Thus, someone in Hamburg sending one Satoshi (a cryptocurrency unit equivalent to a 100 millionth of a bitcoin) to someone in Calais would have the same reporting requirements as someone placing 10 bitcoins (worth $232,909 as of this writing) at the current exchange rate quoted on Yahoo! Finance) on a centralized exchange.
Global Financial Regulators trail UK on crypto privacy
Authorities justify their incessant calls for granular reporting to deter illegal activity. Never mind that the blockchain’s pseudonymous nature already enhances transaction traceability. In fact, an April 2021 report from the Bank for International Settlements (the global central banking authority) coauthored by a U.S. Treasury official suggested an alternative explanation:
There is an opportunity to adopt new approaches that take advantage of the inherently data-rich nature of the cryptoasset sector. … New supervisory methods … should allow … more intensive use of data and technological tools like blockchain analytics to improve the effectiveness of their supervisory frameworks.
Many global financial regulators want to integrate the public nature of blockchain transactions to enhance their already granular monitoring of people’s personal finances, even when there isn’t a hint of suspicious activity.
ESG and CBDCs kill crypto privacy
This level of government intrusion combined with environmental, social, and governance, or ESG, measures places Western governments in a position to go beyond stopping illegal transactions to control virtually all transactions. Authorities could do this either through the above practices or by introducing central bank digital currencies (CBDCs)—digital versions of fiat currencies that mimic some aspects of crypto currencies while remaining controlled by the state. The Chinese government has led the CBDC charge with its digital yuan (e-CNY). Is stopping an estimated $11 billion in illegal activity worth the complete loss of our financial privacy and the surrendering of our financial privacy in favor of Chinese-like authoritarianism?
The UK has shown true vision in promoting some degree of financial privacy in the crypto market. The U.S. should follow its lead. As Jerry Brito of Coin Center stated at a recent Federalist Society event, unhosted wallets do not implicate anti-money laundering laws because they don’t involve third-party financial institutions. All governments should take this view. One at least, already seems to be heading in the right direction.
El Salvador Bitcoin problems derive from government
The Laser Eyes that have become a signature MEME of crypto enthusiasts are gone from El Salvador President Nayib Bukele’s Twitter profile—a likely acknowledgement of Bitcoin’s recent price slump. The image-conscious leader is wrestling with his country’s massive Bitcoin investment as he tweets optimism about Bitcoing’ future value, hosts global conferences on cryptocurrency, and tries to stave off the International Monetary Fund’s entreaties against his pro-Bitcoin stances.
But he should also take a hard look at his own government’s increasingly authoritarian monetary policy as the root cause of his problems, not the volatile digital asset’s recent price slump. His best move would be to open the country’s monetary policy completely to all crypto and allow competition to thrive.
Mr. Bukele’s Bitcoin foray placed him on the crypto map when El Salvador declared Bitcoin legal tender last summer, along with grand promises of modernizing the economy, decreasing dependence on the U.S. dollar, and lowering transaction fees from the U.S.-based relatives. The promises invited a clash between a government controlling citizens’ monetary future and Bitcoin’s decentralized, individual-empowered ethos.
El Salvador Bitcoin problems start with government controlled wallet
The biggest rift concerns Chivo, the digital wallet Salvadorians are strongly incentivized to use. Although privately designed, a state-owned company controls the wallet and users’ private access keys. A public trust funds the wallet.
Chivo is, in effect, a state-controlled chokepoint with the potential power to cut off anyone’s funds or perhaps even dictate spending. Thus, it differs only by degree, not kind, to the dystopian nightmare China is imposing with its central bank digital currency (e-CNY). There, party apparatchiks have gleefully described e-CNY as a means for economic control and to enforce party discipline.
Salvadorians are not legally mandated to use Chivo but signees receive a $30 sign up bonus, and compatibility with competing commercial wallets is reportedly difficult. The wallet as an exercise in bureaucracy has been plagued with technical glitches and poor customer service. The country’s chamber of commerce reports 86percent of businesses surveyed had never conducted a Bitcoin transaction.
El Salvador’s dictatorial government harms Bitcoin adoption
Problems don’t end there. One native software programmer who criticized Chivo found himself detained, his phones confiscated and investigated for financial fraud.
This creates an untenable mix: an authoritarian government trying to ensure its citizens a more prosperous future whilst maintaining economic control. While, as in Venezuela, there may be prosperity with high prices—Bitcoin or oil—future prospects remain clouded.
El Salvador should continue opening its monetary system to all forms of currency, including U.S. dollar-pegged stablecoins. (The U.S. dollar is already legal tender.) This would allow further competition and the greatest degree of financial stability. Salvadorians could pick between the most stable or potentially most promising forms of currency.
Another benefit to this policy for Salvadorians is that it may also invite crypto-dollarization. Dollarization essentially exports monetary policy to the U.S., which at least for now, provides more stable money to people outside the U.S. Crypto-dollarization via stablecoins could provide the benefits of dollarization without the confiscatory policies that plagued previous dollarization periods in Latin America. As Mr. Bukele’s Bitcoin foray seems motivated at least in part by anti-U.S. animus, he seems unlikely to welcome it. But excluding non-Bitcoin forms of digital currency puts Salvadorians at the mercy of international markets for a famously volatile asset.
El Salvador Bitcoin problems start with Bukele
If El Salvador’s experiment does fail, the fault will lie with Mr. Bukele and not Bitcoin. Whatever volatility the digital asset undergoes, its fundamentals are solid. Bitcoin is sound, hard, money. Satoshi coded the fixed supply.
Further, Bitcoin has revolutionary aspects that assure long-term viability. It is the first currency form that makes its relationship with energy—the fundamental building block of civilization—explicit. As Bitcoin enthusiast Michael Saylor states, “Money is energy.Bitcoin is the first crypto monetary energy network, capable of collecting all the world’s liquid energy, storing it over time without power loss, and channeling it across space with negligible impedance.”
Despite the recent dramatic price drop, Bitcoin’s possibility for future human development and prosperity are limitless. But its sustainability as an everyday currency is an open question. It’s incompatibility with population-controlling tin-pot dictators, however, is not in doubt. As Human Rights Foundation’s Alex Gladstein remarked, Bitcoin is “nothing short of freedom money.” Attempts at harnessing its potential while maintaining state control will not end well.
Imagine a group of mothers upset about Disney’s opposition to a state parental rights bill in Florida. Instead of merely venting in a Facebook group, the mothers organize around a shared goal: creating alternative programming for kids. start an organization to provide their own educational shows for school kids.
Instead of creating a Limited Liability Company, pitching venture capitalists, and navigating the esoteric world of television they hire a coder. Within hours they have an organizational structure with complete with membership, native tokens, and disbursement rules. The group presents ideas for shows and other content. Token holders vote on the best proposals. Within six months the mom group has an online streaming video channel.
This scenario is possible now and may soon become common. Such “decentralized autonomous organizations” (DAOs) – an outgrowth of decentralized finance (DeFi) and blockchain technology — offer a new way to create businesses without some of the problems that plague corporate America.
DAO coders create the rules that govern its existence, and voting members (who hold digital tokens) decide on where to allocate money. Anyone can propose ideas to be voted on by the larger token-holding community DAOs by their nature are transparent: The rules, finances, transaction history, votes, and members, are all stored on a blockchain for anyone to view.
DAOs are not woke by design
The DAO structure solves two major problems in the current politicized corporate environment. –
First, because governance derives from DAO token holders there are no managers deciding corporate direction. Corporate managers can act in their own self-interest rather than the corporations. This principal-agent problem has become exacerbated in the age of ‘stakeholder capitalism’ where financial metrics recede in favor of other more ephemeral goals like community goals and environmental consciousness.
DAOs also curtail rent seeking— manipulating public policy to gain market share, usually by increasing regulatory barriers against smaller competitors. DAOs don’t have lobbying arms or need for them. Their sole focus is written into the code. (Lobbying for political advantage would be extraneous to their coded purpose. Token holders would have to approve any such expenditure, which at least in this stage of their evolution seems unlikely.)
DAOs focus on commerce not woke politics
Thus DAOs are a great, market-based form of capitalism, especially compared to stakeholder capitalism in which activists and multinational corporations try to “leave their mark” on the world. DAOs can depoliticize business functions, in other words.
That’s not to say there aren’t potential problems. For instance, DAOs tend to be unwieldly and slow because token holders decide corporate actions democratically. The lack of a CEO calling the shots impedes decision making. the lack of centralized management and their democratic governance makes them slow and unwieldy. They can also be driven away from their mission through nefarious purchase of governance tokens. Coders are starting to solve these for instance forms of proxy voting and multi-token DAOs.
DAOs becoming bigger part of the economy
Meanwhile, DAO growth is so far impressive. DAOs currently hold around $11 billion in cryptocurrency. Their total value was 40 times greater at the end of 2021 than it was at the start. Well known tech entrepreneurs like Peter Theil are pouring millions into the concept. Thiel-funded BitDAO the largest current DAO is designed to “promote and propel the mass adoption of open finance and decentralized tokenized economy.”
DAOs are starting to go mainstream. Wyoming has passed a DAO LLC law that gives DAOs limited liability protection similar to that of other business entities. The Marshall Islands and Australia have also shown interest in the legal framework. As the DAOs gain traction, community-driven alternatives to Disney and other corporations that position themselves as “woke” can organically form and compete in the marketplace. The woke capture of much of corporate America did not happen overnight and will likely take many avenues of attack to return them to their profit-making functions. But DAOs are a promising vehicle to help that push along.
Crypto and crowdfunding could spur new U.S. economy
Crypto and equity crowdfunding (Reg CF) are two relatively new concepts that are combining to create new economic models that could overtake current economic paradigms.
Both decentralize older models of value transfer and capital raising. Crypto began with a pseudonymous programmer apparently fed up with the current financial system and trying to create a “new electronic cash system that’s fully peer-to-peer, with no trusted third party.” From humble beginnings in an obscure computer programmer list serv, crypto has blossomed into a multi-trillion-dollar industry. In 2021, the overall crypto market burst from $500 billion to almost $3 trillion. Reg CF originated from Title III of the JOBS Act of 2012. The JOBS Act, which has been a deregulatory success recently celebrated its ten-year anniversary. JOBS Act provisions Reg A+ and Reg CF opened private-company capital raising beyond the world of venture capitalists and angel investors to the public. After a slow start Reg CF has blossomed, aided by deregulatory moves from the Securities and Exchange Commission (SEC) in the Trump administration’s waning days.
Crypto and Crowdfunding are spurring U.S. economy
Now new research from Crowdfund Capital Advisors (CCA), which curates Reg CF data, shows these two distinct but related industries are starting to coalesce. According to CCA:
YTD, 28 blockchain/crypto issuers have raised $31.7 million from more than 28k investors
Since 2016, 131 blockchain/crypto issuers have raised $62.7 million
The enterprise value of all blockchain/crypto issuers is $2 billion.
Valuation of Q1 blockchain/crypto issuers was up 230% over 2021
Whilst these numbers are still relatively small the potential to create wealth for ordinary investors and economic prosperity for the country is limitless.
But for equity crowdfunding and crypto to meet its full potential Congress must remove some current roadblocks that hinder growth whilst providing little investor protection.
Congress must act to deregulate crypto and crowdfunding
Congress could start by removing crypto projects from the definition of “investment contract” and beyond SEC jurisdiction. This would allow the token economy to thrive absent the heavy hand of securities regulation.
For crypto issuers that wish to raise capital by issuing company equity via tokens, these fall within the straightforward definition of “security.” Issuers should conduct them through registration or an exemption like Reg CF.
Here again Congress could simplify the process by further deregulating Reg CF. First, it could make security tokens along with other Reg CF securities instantly tradable. Currently, Reg CF investors must wait one year to trade their tokens (limited exceptions apply). Secondly, Congress should preempt secondary trading from state-level compliance. The SEC previously considered such preemption in its Trump-era deregulation but demurred—no doubt with pressure from the North American Securities Administrators Association, which opposes any form of state preemption—stating it “merits careful consideration and an opportunity for market participants to receive notice and comment on a specific proposal.”
SEC is blocking progress on crypto and crowdfunding
Such proposals are unlikely under the current SEC regime. However, instant liquidity is simply a prerequisite for any crypto-related venture. And as Congressman Patrick McHenry stated, is itself a form investor protection, allowing “individuals whose financial situation has changed to exit . . . investments in times of need.”
These changes would spur an explosion in decentralized, crypto-centered economic activity, all under federal anti-fraud protections. New economic models are possible and fast approaching. They can catalyze unprecedented prosperity. But they will not fully thrive without Congressional help.
New research from the Bank for International Settlements (BIS) reveals countries are plowing ahead with central bank digital currencies (CBDCs) despite little public appetite and crumbling rationales for proceeding.
CBDCs are knock-off versions of cryptocurrency run by central banks. According to a just-released BIS survey, nine of ten countries are exploring CBDCs and more than two-thirds state they will or might likely release one in the short to medium term.
CBDCs lack public support worldwide
CBDC alacrity comes despite little evidence of public clamor for digital versions of fiat money. For example, in the European Union public response has been intense and “overwhelmingly negative.” Two weeks after the European Commission invited public comment, over 11,000 responses poured in, few in support.
Similarly in the U.K., a recent poll showed 30% believe a “Britcoin” would be more harmful than beneficial and 24% think it could be beneficial. The rest were unsure.
In both instance fears over privacy and security topped the reasons people were distrustful of CBDCs.
In the U.S., the Federal Reserve released white paper in January that invited public comment. Privacy is likely to top concerns over a digital dollar as well. Americans’ fear would be justified. Just recently news reports revealed the FBI conducted as many 3.4 million warrantless searches of Americans in 2021. Moreover, the Center for Disease Control paid for data on millions of Americans cell phone locations.
Western populations do not support CBDCs
Adding to unease, justification for CBDCs are crumbling, particularly in the U.S. The Federal Reserve white paper revealed some expected, but not officially resolved design choices, that reduces supposed benefits.
For example, the Fed admits a U.S. CBDC would be “account based” (like credit cards as opposed to cash) and intermediated through private banks instead of direct Fed accounts. These design choices counter oft-asserted CBDC rationales. First, financial inclusion. Being intermediated through the private banking system means CBDC accounts will bear fees and will not mitigate the existing mistrust many unbanked people have toward banks and large institutions. As the Bank Policy Institute (BPI) stated:
Under an intermediated CBDC model, [unbanked] people would be required to establish an account at a bank or other financial company (including going through a full Know Your Customer process as required under anti-money laundering and sanctions rules), upload a digital wallet to a phone or computer, and then have their transactions monitored by the bank and perhaps by the government as well. No one has yet explained why a person reluctant to sign up for a bank account would embrace such a relationship. (Emphasis Added).
Further, Fed insistence on account-based CBDCs and attendant Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) monitoring would stifle another CBDC rationale: more efficient cross-border payments. As the BPI explains, AML/CFT requirements currently slow cross-border payments and using the different medium of CBDC would not solve this. Further CBDCs would have to be converted to local currency at each stage, this would come fees. A CBDC-to-CBDC system or multijurisdictional CBDC is years away.
Only global financial bodies support CBDCs
The BIS survey admits countries’ rationales for plowing ahead with CBDCs have little to do with stated reasons. They fear competition from cryptocurrencies, particularly stablecoins. Nearly 80 percent of advanced economies surveyed stated stablecoins had hastened their foray into CBDCs. Central bankers believe stablecoins pose risks to financial stability.
Yet authorities must weigh this fear against the financial instability CBDCs themselves would create. The Federal Reverse admits CBDC-triggered financial instability is a real concern:
Because central bank money is the safest form of money, a widely accessible CBDC would be particularly attractive to risk-averse users, especially during times of stress in the financial system. The ability to quickly convert other forms of money—including deposits at commercial banks—into CBDC could make runs on financial firms more likely or more severe.
When weighing CBDC pros and cons, the verdict should be clear. The public does not want them, official justifications lack credibility, and the potential downsides are not worth the risk.
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