Our Innovation Economy

(Under Construction – Please Return As Sam Builds his “Innovation Agenda” in the Weeks Ahead)

Regulating Blockchain and Cryptocurrency: Sensible First Steps

While Congress has dithered, the crypto industry has exploded—and occasionally imploded—largely without any sensible regulatory framework from Congress. The $2.3 trillion digital asset genie is now very much out of the bottle, and the clock is ticking. The SEC has begun to approve several Bitcoin exchange-traded funds (ETFs), widening access to tens of millions of retail investors of widely varying sophistication levels.^[1] The current legislative void has spurred the courts and regulators to jump in, tethering legal theories to outmoded laws with inconsistent outcomes. Congressional action is long overdue.

What is the cost of inaction? The industry is increasingly moving (and hiring) offshore to nations that provide more regulatory certainty. Before wary observers say good riddance, consider that a relatively unregulated, fast-growing fintech industry moving to foreign countries leaves us with the worst of both worlds. That is, American retail investors and consumers face a much greater risk of being duped in a “wild west” regulatory environment, putting bad actors beyond the reach of U.S. authorities and enforcement. Meanwhile, the U.S. economy loses job opportunities and cedes growth abroad.

We need sensible regulation—laws that mandate transparency, accountability, and safety for the tens of millions of Americans who appear increasingly willing to tread into this uncertain landscape. We also need rules that affirm and support technology that can provide a democratizing influence on public finance.

Here are a few logical first steps Congress can take on crypto to bring regulatory certainty to an industry that is clearly here to stay.

Start with Stablecoin

Stablecoin is designed to maintain its value by pegging its price to a stable asset like a fiat currency, such as the U.S. dollar, or to a commodity like gold. Due to its relative price stability, stablecoin offers a better mechanism for payments than more volatile cryptocurrencies like bitcoin.^[2] Stablecoins that digitize the dollar—like USDC and TrueUSD—could provide a long-term advantage to the U.S. economy. Having the world’s principal reserve currency over the last 80 years has provided massive advantages to American businesses, consumers, and our government, enabling us to borrow at a lower cost and making U.S. sanctions more impactful. As crypto becomes more prominent in remittances to family members living abroad, it is important that those transactions occur in dollars.

While regulating stablecoin seems elementary for many in the industry, fears have emerged on Capitol Hill and elsewhere. Some have warned of “Big Brother” tracking every consumer’s expenditure. Yet, relatively standard regulatory measures could adequately protect privacy. Fears of expanding the money supply are mitigated by ensuring that every stablecoin is redeemable with a collateral reserve asset (although some stablecoin use algorithmic formulas, which are supposed to control supply). Obviously, that requires governmental oversight.

The primary obstacle in Congress appears to be the role of states. Some states, such as New York, insist on maintaining regulatory authority, which creates a troubling thicket of regulatory compliance for any company seeking to have its cryptocurrency seamlessly relied upon throughout the world. There is a strong case for federal preemption here, to ensure a uniform set of rules—and consumer protections—across 50 states.

Nonetheless, legislation to regulate stablecoin has languished for a couple of sessions, despite relatively bipartisan support. Digitizing currency can provide an early toe-in-the-water opportunity for Congress and federal regulators. Distributed ledgers created by blockchain technology may offer effective means to digitize stock ownership, government-issued identification, and other instruments of daily life. It’s time for Congress to act.

One Size Doesn’t Fit All: Defining Regulatory Scope

Legislation to assign jurisdiction to federal agencies on cryptocurrency, commonly known as a market structure bill, emerged from committee in 2023. Until Congress passes legislation clearly defining who regulates what, agencies will trip over each other while competing for turf. Congress must also determine whether the Securities Exchange Commission (SEC) has the resources to resolve how to apply 90-year-old securities laws within the crypto ecosystem. The complexity of these questions appears exacerbated by the fact that securities laws, which generally mandate the presence of intermediaries, are a poor fit for crypto, which is defined by its decentralization and disintermediation.

Under longstanding federal law and Supreme Court precedent, the SEC should regulate cryptocurrency only where it constitutes an “investment contract.” Nobody claims that currencies such as the peso or euro constitute an investment contract, because we use international currency markets to facilitate international transactions for goods and services, not to provide returns. Many experts believe that crypto tokens function more like commodities than investment contracts, and that the Commodity Futures Trading Commission (CFTC) constitutes the logical entity for regulating cryptocurrency like Bitcoin and Ether, not the SEC.

Where companies purport to bundle tokens with opportunities for return beyond the currency’s mere fluctuation in price, the cryptocurrency should be treated like an investment contract by the SEC. An example includes Blockchain Capital’s B-CAP, in which investors expect (or hope for) some rate of return for their purchase. Form—and regulation—should follow function.

In summary, when tokens change hands without any connection to an investment contract, they should not be regulated as securities. Too often, we’ve seen the regulatory agencies fail to draw logical lines. For example, the Blockchain Association notes that “the SEC has refused to approve applications from registered securities exchanges to list a spot bitcoin exchange-traded product (ETP) despite approving bitcoin futures ETPs.”^[3] The SEC’s recent overreach in the case against Ripple was ultimately rejected by a federal court—after years of litigation, substantial cost, and market disruption. Astoundingly, federal courts are left to decide about the SEC’s role by resorting to a standard established by a nearly 80-year-old Supreme Court decision, SEC v. W.J. Howey Co., from 1946.

That’s not reassuring. Congress must draw clear lines here—define the turf and accompanying rules to provide some predictability and consistency in crypto regulation. Congress should also heed the call of Treasury Secretary Janet Yellen to close the gaps in regulation. Spot commodities like Bitcoin remain largely unregulated, and Congress must close these gaps while ensuring a coherent regulatory regime for all cryptocurrency.

A Safer “Sandbox”

Finally, there’s little question that cryptocurrency investment poses substantial risks for any retail investor, as evidenced by the wild volatility of currencies like Bitcoin in recent years. To be sure, consumers and retail investors must enter these markets with eyes wide open, but regulatory agencies have a role to ensure transparency—if Congress will clearly authorize them to do so. Some experts have advocated for the creation of a regulatory “sandbox” for retail investors and consumers, within which tokens can only be traded where their crypto sponsors meet very high standards of disclosure and transparency. The establishment of clear rules for the identification of the actual parties engaging in the market—often referred to as “white list systems” for financial institutions—can ensure legitimacy of the transactions and deter participation by criminal organizations. Legislation to create such a regulatory sandbox has languished in Congress.

Working with regulatory agencies and industry, Congress must move. Let’s get it done.

1. Blackstone, Tom. “2024 Cryptocurrency Adoption and Sentiment Report.” Security.org, 10 June 2024. ↑
2. “Stablecoins vs bitcoin: The 3 major differences explained.” BVNK, 22 Mar. 2024. ↑
3. “Securities.” Blockchain Association. Accessed 26 Aug. 2024. ↑