Last week, former Chair of the Commodities and Futures Trading Commission (CFTC) Timothy Massad argued that despite DeFi enthusiasts claiming they replace traditional intermediaries, they provide an incomplete service. He was participating in an OMFIF panel discussing cryptocurrency regulation alongside SEC Commissioner Hester Peirce. Also debated was what a crypto regulatory framework might cover, where the current gaps exist, and whether or not there’s a need for a new crypto regulator.
Talking about DeFi, Massad stated, “It’s like me saying I can build a car that can get much better gas mileage than anything Ford or GM can produce because I’m not going to put brakes in. Obviously, that doesn’t work.” He was emphasizing the need for the same risk, same rules approach, and centralized entities currently perform KYC, investor disclosure, reporting and other protections.
At a big picture level, Massad agreed with Peirce that it’s much better to regulate through rules rather than enforcement and also agreed it would be better for the SEC and CFTC to work together to arrive at common standards. However, he said that many DeFi companies misunderstand the regulator’s responsibilities.
“Since when is it the responsibility of the regulator to tell the innovator that we have these laws and you’ve got to comply,” he said. “It is the responsibility of the regulator to make sure that the application of those requirements are clear.”
No action letters and a possible crypto regulator
The potential for a regulatory sandbox was discussed, with both Massad and Peirce viewing it as unnecessary for the SEC and CFTC. Instead, both organizations have the tools of no-action letters and exemptive orders. The two avenues are similar, but exemptive orders are more specific to a situation and don’t set a precedent for other firms.
However, Peirce acknowledged that no action letters take too long and perhaps the SEC needs to devote more resources to it. What she thought might be handy is a general regulatory sandbox that spans across government departments and addresses the uncertainty over which department has jurisdiction.
Regarding the need for a crypto regulator, she noted that the regulatory space was already crowded. But the demand was understandable because “the existing regulators have really kind of made a mess of things, I think.” Peirce can see some advantages for a self regulatory organization that could adapt as the technology evolves.
Massad highlighted that there are significant gaps even if the two regulators get together. The SEC covers securities, but the CFTC only has the authority to regulate commodity derivatives, not the cash trading of crypto-assets that are not securities. The two that are not considered securities are Bitcoin and ETH and a significant proportion of crypto activity is around that cash market.
As an example, he provided the lack of regulatory oversight over cryptocurrency exchanges. A Coinbase regulatory filing last week carried a paragraph about what might happen in the event of a bankruptcy. It stated, “the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”
Massad highlighted, “that’s very different than what happens with a broker/dealer where we have SIPC protection and other things.”
Key issues to address in a regulatory framework
Peirce was asked about the key considerations for a potential regulatory framework. She believes the primary issues to be addressed are:
- investor protection, including providing sufficient information to make decisions and understand risks
- financial stability considerations
- when is a token sale considered part of a securities offering? And will securities laws apply to it for the rest of its life?
- numerous questions around custody
- how financial institutions interact with cryptocurrencies
- how traditional finance and cryptocurrency will intersect.
On this latter point, there’s a need for industry to be allowed to experiment, which may require adjustments to how the rules apply. While not mentioned by Peirce, this could be a nod to the DLT pilot regime in Europe for security tokens and something similar in the UK.
First amendment issues
Peirce has some concerns that regulations could attempt to go too far. She noted that if someone just wrote code and wasn’t involved in running a DeFi solution, then there could be some first amendment implications around stopping people from coding.
Massad responded that if Bernie Madoff had used a piece of autonomous software to perpetrate his Ponzi scheme, “we wouldn’t say ah well Bernie, there’s no centralized entity, so Bernie should get off.”
Steve Kokinos, Algorand CEO, warned that blockchains have many applications beyond finance. There’s a danger of regulations drawing in digital assets with little or no financial application.
