Key takeaways
- Several recently proposed bills and ongoing enforcement cases could define the future of the crypto industry in the US
- If the SEC and CFTC win their ongoing crypto lawsuits, they could set a terrible precedent for decentralized finance and the broader industry.
- However, if the regulatory agencies lose, crypto could enjoy a renaissance.
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The US government’s approach to crypto regulation will determine whether the industry evolves to thrive or flounder in obscurity.
The US Crypto Regulatory Landscape
Crypto regulation is coming to the US – and itsay is likely to have a major impact on the future of the industry.
The first key distinction to consider when analyzing the current state of crypto’s regulatory landscape in the US is the difference between the government’s legislative and enforcement approaches. This is similar to comparing what the government says with what it does in practice, which is important because the difference between the two approaches provides valuable insight into the government’s true intentions regarding the industry and asset class.
On the legislative front, there has been a significant increase in crypto-related bill proposals over the past year, including Senators Cynthia Lummis and Kirsten Gillibrand’s Responsible Financial Innovation ActRepresentative Josh Gottheimer’s Stablecoin Innovation and Protection Act of 2022Senator Pat Toomey’s Stablecoin TRUST Act of 2022and Senators Debbie Stabenow and John Boozman’s Digital Goods Consumer Protection Act of 2022. If these bills pan out as proposed, the crypto-regulatory and industry landscape will see significant changes, most of which industry stakeholders have hailed as positive.
Perhaps most importantly, the Commodity Futures Trading Commission will take precedence away from the Securities and Exchange Commission by becoming the primary regulator of the asset class by gaining authority over cryptocurrency spot and derivatives markets. Until recently, this was seen as a highly welcomed change among industry stakeholders fed up with the SEC’s aggressive “regulation by enforcement” approach.
Another major change that would follow if these bills are passed would be the introduction of significantly stricter rules for the issuance and management of stablecoins. This could lead to an implicit ban on unbacked, algorithmic or “endogenously guaranteed” stablecoins and 100% reserve requirements for stablecoin issuers. Stablecoin issuers will likely be required to hold bank charters, which are very difficult to obtain, or register directly with the Federal Reserve. This will significantly reduce depeg risks in the cryptocurrency market. However, it could also centralize the on-chain economy if the space becomes too dependent on regulated stablecoin providers.
But perhaps the most significant development on the legislative front is the White House’s recent comprehensive framework for regulating the digital asset space. The framework was published on September 16 after President Biden signed an executive order on “Ensure responsible development of digital assets” in March. It contains the views and recommendations of the SEC, the Treasury Department and various other government agencies on how to regulate crypto-assets.
The framework provides the clearest overview yet of how the Biden administration plans to deal with crypto, including plans to step up enforcement actions against illegal practices, push users away from crypto and toward government-issued and controlled centralized payment solutions like FedNow and CBDCs, amending the Bank Secrecy Act to expressly apply to digital assets, and leveraging the country’s status in international organizations to promote greater cross-border cooperation on crypto regulation and enforcement.
If the administration begins to carry out its plans, the US crypto industry will begin to look more and more like fintech than the grassroots movement that wants to create an alternative financial system that it aims to be. By imposing excessively stringent regulatory requirements on the industry, its stakeholders may begin to leave the US for more crypto-friendly jurisdictions, leading to an exodus of Web3 talent and ultimately America’s subservience on the global crypto scene.
Regulation by enforcement
On the enforcement front, there are several critical ongoing cases that — depending on their outcome — could reshape the cryptocurrency landscape in the country. The most documented of these cases is the SEC v. Ripple, in which the security agency is suing the blockchain company for allegedly conducting an illegal security offering by publicly selling XRP tokens. Judging by the latest developments in the case, the case is likely to be settled out of court, which would be a huge win for both Ripple and the US crypto industry. For the security agency, losing the case or settling out of court would make it much more difficult to prosecute other crypto companies on the same charges, giving crypto issuers and exchanges much-needed respite.
The second critical case is SEC v. Wow, where the security agency is suing a former Coinbase employee and two co-conspirators on insider trading charges. In a flagrant example of “regulation by enforcement,” the SEC alleges that “at least” nine of the cryptocurrencies listed on the exchange were securities. If accepted by the court, this claim could have broad industry implications by making it easier for the agency to pursue crypto exchanges for illegally offering unregistered securities.
In another ongoing case highlighting the SEC’s “regulation by enforcement” approach, the agency is trying to establish its hold over the industry by making broad claims that could have serious implications for the asset class. Namely in the SEC vs. Ian Balina case, the agency argued that Ethereum transactions should be considered “occurring” within the US because more Ethereum nodes are located in the US than in any other country. For that reason, the SEC says, Ethereum should fall under its jurisdiction. If the court accepts this argument, the SEC could then seek to establish jurisdiction over all Ethereum transactions involving tokens it considers securities, regardless of the location of the transaction counterparties.
In another disappointing development for the crypto community, the CFTC – following in the SEC’s footsteps –sue a decentralized autonomous organization and its token holders on charges of operating an illegal derivatives trading venue. The CFTC winning this landmark case will set a terrible precedent for DeFi protocols and token holders by ensuring that they can be held liable for various crimes as “unincorporated associations.” This would effectively ruin DeFi, making it impossible for protocols and DAOs to function without risking prosecution.
Finally, the Treasury’s move to sanction the decentralized privacy protocol Tornado Cash stands out as one of the top enforcement actions that has already had a major impact on the industry. The move represents the first time a government agency has approved a smart contract — immutable code that lives on the blockchain — and several key blockchain infrastructure providers, such as Alchemy and Infura, have already complied with the sanctions.
Many crypto legal experts, including US-based crypto advocacy organization Coin Center, consider the move unconstitutional and a gross jurisdictional violation and are likely to challenge it in court. However, if the Treasury wins any challenging lawsuit, the entire crypto-economy could suffer, casting doubt on its ability to uphold its core principles of decentralization, credible neutrality, and censorship resistance.
Look ahead
Depending on whether the recently proposed cryptocurrency regulations go into effect, and how the application cases go, the US crypto landscape could look very different a few years from now. The optimistic view is that both the SEC and the CFTC lose all the lawsuits that could set the industry back while lawmakers pass the more favorable proposed laws that provide clarity when it comes to regulation. If that happens – and the chances are quite high – the US could become the world’s leading crypto-friendly jurisdiction, supporting the entire global industry with it.
On the other hand, the worst-case scenario is that lawmakers take too long to pass favorable crypto regulations, while the SEC and CFTC slowly regulate the space through enforcement. This would severely hamper the US crypto industry’s remarkable growth and any resulting technological innovation. Given the USA’s excessive political and economic international influence, such a scenario would also have a negative impact on the global crypto industry. One potential outcome of a difficult regulatory environment is DeFi’s fragmentation into “RegFi”, which consists exclusively of regulatory-compliant protocols, and DarkFi, composed of truly decentralized, non-compliant, censorship-resistant protocols.
Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.
