Digital assets have surged in their market capitalization over the past few years - so much so that they cannot be ignored or dismissed as a side interest. Policymakers are now grappling with how to handle the regulation of digital assets, which is particularly challenging given that they are inherently international and tend to prioritize decentralized governance (at least for DeFi) over centralization.
To be sure, every asset fluctuates in value and the negative aspects of crypto we've seen in recent months has nothing to do with distributed ledger technologies (DLTs) and everything to do with the inherent problem in the human heart that causes people to make bad decisions. Such issues are questions of governance, not DLT as a technology, and predictable and reasonable regulatory frameworks can reduce the frequency and severity of the incidents - but only if they are designed right.
Impose licensing requirements on centralized cryptocurrency exchanges and other digital currency services that behave like banks.
Trading cryptocurrencies does not mean that a company should be exempt from financial regulation. If they serve as a custodian of consumersâ assets, and it lends those deposits to others, the company operates as a bank and should be subject to similar regulations that banks are subject to based on their size and asset class.
And yet, many companies in this space have sought regulatory arbitrage operating outside of the U.S. because of regulatory ambiguity and the opportunity to arbitrage on it. Thatâs exactly what happened with FTX, but whatâs worse is that then-CEO Sam Bankman-Fried did so in plain sight and conversation directly with regulators that were supposed to be watchdogs.
Adherence to regulatory requirements could start with capital requirements of the form laid out in the recent current and expected credit loss framework that requires that banks use âreasonable and supportableâ forecasts to derive the amount of capital reserves they need to hold out in case of adverse economic events. Or it could involve basic cybersecurity and financial security regulatory requirements, like SOC 2 compliance. Each country may have its own standards.
Provide regulatory clarity about the specifics of legal web3 behavior.
There is no single source that specifies the legal requirements for web3 builders and the guidance is more ambiguous in some countries than others. For example, the U.S. Department of Justice has referred to tokens as commodities in its enforcement actions, whereas the Securities and Exchange Commission (SEC) has called them securities and enforced them as such. The community needs guideposts for legal activity and creating them will promote not only more innovation since more companies will build within the U.S. regulatory sandbox, but also more consumer protection since enforcement will have more legal precedent and the bright line for legal activity will be clearer.
Harmonize international standards.
Some international heterogeneity is good and right - indeed, sovereign countries should make their own decisions on governance. But sadly, many entrepreneurs and companies have chosen to locate outside the U.S. for business and residence because of ambiguous and overly rigid standards. One solution is for countries to produce an equivalent of the OECD published international guidelines around the ethical use of artificial intelligence, and the U.S. could help lead.
Another suggestion is to learn from Switzerlandâs regulatory sandbox approach, which not only provides much more clarity on the distinction between security tokens and their counterparts, but also safety in piloting a token as long as the amount raised and transacted upon is below 1 million Swiss francs.
Foster dialogue with researchers and industry practitioners.
It's important for regulators to stay informed about the latest developments and trends. But, regulation and even the hiring process in federal governments does not yet move fast enough to accommodate these trends. One interim solution is for regulatory bodies to participate in the web3 community and promote dialogue with researchers and practitioners. For example, the U.S. Commodity Futures Trading Commission (CFTC) could regularly hold public meetings with industry leaders, academics and other experts to converge on policy solutions.
