Crypto Regulation—Let's Begin and Begin Slowly | Opinion

Now that cryptocurrencies are flourishing, with tens of thousands of mainstream investors and blue-chip companies incorporating blockchain technology, policymakers are starting to talk more seriously about creating regulations to protect investors. I share their concerns for consumers who are being buffeted by volatile Bitcoin prices and fly-by-night crypto investment scams. At the same time, we need to be careful how much we regulate such a nascent market. We need some regulation to protect investors, but not so much as to stifle entrepreneurship, innovation and investment.

Like the internet in the early 1990s, the crypto sector is still in its infancy. We don't know what a flash-in-the-pan will be (Google Reader, anyone?) and what will become fundamental to our lives, like social media or the iPhone. Regulating too expansively would be like regulating the internet before we understood how online commerce was going to function in the world. Back in the early days of the internet, Congress could not have predicted the role that personal data mining and political disinformation would play, much less how to protect consumers against it. At the time, the industry was pushing for an open internet where anyone could put up a web page.

Recently, the crypto industry has rallied together to call their senators over the current language in the infrastructure bill. The language that broadly defines "brokers" would certainly kill the industry if miners to software developers had to worry about know-your-customer (KYC) management. The intent is to tighten tax enforcement, but there would be onerous unintended consequences if the language stayed as is. This bill could be voted on as early as Aug. 9. The entire industry is watching to see what happens with this language. It's hopeful that a compromise in the language can happen so as to better enforce tax payments while still not killing an industry with a poorly constructed definition of what a "broker" is in crypto.

Part of the difficulty with regulating crypto assets is that they can evolve. There are times in the lifecycle of a crypto asset when it is more like a security and others when it is more like a commodity, or even something else altogether. Because of this, there is confusion as to what body has the jurisdiction to regulate it. Another complicating factor: Many are under the impression that crypto assets are all the same, but this is incorrect. There are several distinct classes and models, ranging from cryptocurrencies to governance tokens. Each comes with unique risks, governance, purpose of use, ways of accruing value and role in the larger ecosystem. Cryptocurrencies were designed to be a store of value and a medium of exchange. An investor can buy them, sell them, purchase things with them and lend them out to generate yield through an interest rate similar to sovereign currencies. In contrast, governance tokens give the holder a right to vote on how to manage, upgrade and govern a crypto-network. Regulators need to recognize this complexity and tailor new rules to the distinct types of crypto assets.

One idea that regulators are considering is temporality—the concept that an asset could start out as a security and then change to a commodity over time. I support this approach.

bitcoin crypto currency.
A physical banknote and coin imitations of the Bitcoin crypto currency. OZAN KOSE/AFP via Getty Images

The U.S. Securities and Exchange Commission (SEC) has communicated that tokens from an initial coin offering (ICO), where the builder is looking for investment up front, before the product and the network are built, should be considered a security. However, when the crypto-network is built, and the token is "sufficiently decentralized," it is not. This direction came in the form of opinion interpretations from two no-action letters from the SEC in 2019. These distinctions have wide implications and should be written into law. Regulatory opinions can change with each administration.

If light regulation is the best way to start, then we should support H.R. 1628, known as the Token Taxonomy Act. Introduced by Representative Warren Davidson (R-Ohio) in March of 2021, the bipartisan Token Taxonomy Act seeks to establish clarity for businesses, consumers and regulators operating in the emerging U.S. blockchain ecosystem. Davidson understands that if the U.S. doesn't establish a common-sense regulatory structure, many companies and entrepreneurs will seek to locate their businesses elsewhere.

The act excludes digital tokens from the definition of a security under federal securities laws, for example, defining a "digital token" as a token that is created pursuant to rules for which the creation and supply are not controlled by a central group or single person, among other requirements.

H.R. 1602, known as the Eliminate Barriers to Innovation Act of 2021, was introduced by Representative Patrick McHenry (R-N.C.) with the same goal in mind: clarity. H.R. 1602 would require the SEC and Commodity Futures Trading Commission to establish a joint working group to study the properties of digital assets and publish a report with recommendations. I like this approach, along with the Token Taxonomy Act, because it initiates regulation from the legislative branch, which provides the direction the industry needs while not being too heavy-handed.

The U.S. Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Economic Policy invited several digital banking experts to testify on the question of a central bank digital currency (CBDC) in the U.S. They took testimony from a range of experts, including Neha Narula, the director of the Digital Currency Initiative at the Massachusetts Institute of Technology.

"The potential promise of a CBDC goes beyond payment efficiency and financial inclusion. Digital currency is an opportunity for a ground-up redesign of our legacy payment systems. If designed in the right way, a system to create and support a digital dollar might increase competition and standardize disparate data models, leading to more interoperability and creating a platform for innovation in payments, much as the internet created a platform for innovation on top of the transfer of information," said Narula, acknowledging the potential drawbacks of such a system.

Former CFTC chair Christopher Giancarlo, aka Crypto Dad, has also expressed the importance of a digital dollar many times, saying the Fed needs to "wake up" to the need of the digital dollar.

Good crypto regulation should reflect U.S. values, including privacy, security, freedom and sovereignty. If we leave it up to other countries, such as China, we could be tied to a system built on entirely different values—tracking, surveillance, central authority and lack of public transparency.

I understand the impulse to crack down—the world of crypto is confusing and volatile. I don't particularly enjoy watching new Bitcoin investors take huge losses every time Elon Musk decides to tweet. But it's critical that policymakers slow down and study our markets in far more detail before rushing to legislate or regulate. We must strike the right balance between protecting consumers and stifling innovation.

Jake Ryan is author of Crypto Asset Investing in the Age of Autonomy and chief investing officer at Tradecraft Capital.

The views expressed in this article are the writer's own.