Commentary / STEVEN LOFCHIE
While the Brookings report runs some 60 pages, plus 4 pages of footnotes, it may be summarized as follows: There is stuff that could go wrong in some way with the production, trading or ownership of crypto-assets; therefore, crypto-assets ought to be regulated in some unspecified way, which would make the bad stuff less likely to happen. (The other 59 7/8th pages, plus 4 pages of footnotes, amplify on this theme.)
To be chary of Mr. Massad’s report is not to dispute that some bad things will happen as to investments in crypto-assets. It is a safe guess that a good number of retail investors will lose money. Beyond saying that “something” should be done, Mr. Massad might have offered us something more, perhaps by starting with an explanation as to why what currently exists is insufficient and how new rules will solve the problem.
As a starting matter, Mr. Massad should better define and distinguish what he means by “crypto-assets.” Presumably, he is referring to initial coin offerings (“ICOs”). (Note, he quotes SEC Chair Clayton to the effect that all ICOs are “securities” (see fn. 54 and surrounding text)). Therefore, he should explain the deficiencies in securities regulation as applied to ICOs. Unless Mr. Massad believe that there should be one scheme of regulation for securities held through DTC and another for securities in crypto-form, all he is saying is that there should be more enforcement of the securities laws as applied to ICOs. That is reasonable; but it is not clear why any more laws or rules are required. It appears that he just wants more cops on the beat.
If by crypto-assets Mr. Massad means cryptocurrencies, he should say so, and explain how cryptocurrencies should be regulated. If he wants them prohibited, he should say that. Rather, he argues that Bitcoin mining is so “highly energy intensive” is so bad, that – by comparison – he would “long for a return of Lehman Brothers” (at 11). That statement certainly suggests that he favors prohibition. If that is the case, then recommending the imposition of a recordkeeping regulation is somewhat beside the point.
Finally, if by crypto-assets Mr. Massad means assets that give a person a “right to use . . . some sort of blockchain based application or service” (at page 29), he owes us an explanation as to what type of regulation he imagines the SEC or CFTC imposing and to what purpose, and what will be the anticipated effect on blockchain businesses.
Mr. Massad’s suggestion that the Financial Stability Oversight Council (“FSOC”) direct the production of a report for the regulation of crypto-assets, albeit in some unknown way and to an undefined end, demonstrates a potential for abuse by FSOC of its all-too-ambiguous powers. FSOC was supposed to be focused on “gaps in regulation that could pose risks to the financial stability of the United States.” There is zero evidence that crypto does that. The purpose of FSOC is not supposed to be to evade the “formal notice and comment process used for rule making.” FSOC has neither expertise with respect to crypto-assets nor any focus on most of the potential problems raised by Mr. Massad; e.g., energy usage by Bitcoin miners or suitability issues. That Mr. Massad thinks FSOC should be used as a device for rushing through regulations without “formal notice and comment process” is probably a better argument for eliminating FSOC (what exactly has it accomplished to date?) than it is for regulating crypto.
Ten years of experience with Dodd-Frank, much of which is still not implemented because it was neither practical nor useful, should offer some lessons. Throwing out a laundry list of issues, and then demanding regulation with no consideration of specifics, is unlikely to get you where you want to go. It may even take you in the wrong direction. “Too-big-to-fail” was, by way of example, supposedly a cause of the financial crisis. Yet following on Dodd-Frank, increases in regulation and resulting cost have likely only increased concentration.
To advance the discussion of the regulation of crypto-assets, Mr Massad has to define: (i) what are the assets or transactions that he wants to regulate; (ii) does he favor a single scheme of regulation that would cover all cryptocurrencies, ICOs, and assets that create a right of use; (iii) what is the specific problem he is trying to solve (is it energy usage or suitability or just the absence of governmental control); (iv) what are the requirements (whether imposed by statute or rule) for which he advocates; and (v) what does he predict is the likely effect of imposing those requirements (meaning why would it solve the problem, and at what cost)? He should address whether he is trying to regulate or trying to prohibit. It’s fair to demand such specificity of a former senior regulator.
In a Brookings Institute working paper, former CFTC Chair Timothy Massad urged Congress to bolster regulation of crypto-assets.
Mr. Massad pointed out that new crypto exchanges and trading platforms are not held to the same standards required of securities and derivatives market intermediaries, resulting in weak investor protection. In part, this has allowed crypto-assets to be used to circumvent sanctions, and to facilitate payment for illegal activities.
Mr. Massad argued against deferring to state law with respect to regulating crypto-assets. He recommended that Congress:
pass legislation giving the SEC or the CFTC “authority to regulate the offering, distribution and trading of crypto-assets”;
provide more resources to the SEC and the CFTC to regulate crypto-assets;
adopt legislation around “core principles,” which address, among other things: (i) protection of customer assets, (ii) governance standards, (iii) conflicts of interest, (iv) recordkeeping and reporting, (v) trade execution and settlement, (vi) pre- and post-trade transparency obligations, (vii) anti-fraud prohibitions, (viii) disclosures to customers regarding fees, order types and execution practices, (ix) risk management, business continuity and cybersecurity, (x) capital, and (xi) AML and KYC requirements;
direct the relevant agencies to establish regulations to implement the core principles;
grant the relevant agencies authority to determine whether non-U.S. platforms that provide access to U.S. investors should be required to meet U.S. standards, comply with comparable standards or disclose that they do not meet U.S. standards; and
direct the relevant agencies to decide whether there should be alternative ways for centralized and decentralized platforms to comply with the core principles.
Mr. Massad called on the Financial Stability Oversight Council or the U.S. Treasury Department to provide a report recommending Congress to enhance regulation in the crypto-assets sector. He also encouraged the industry to continue developing its own self-regulatory standards.