Regulators Need to Find the Sweet Spot Between Rules and Clarity

Despite the, pun intended, inflammatory headline “In the middle of a chilling crypto winter, US regulators need to turn up the heat,” what Jiaying Jiang, assistant professor of law at the University of Florida’s Levin College of Law, writes this week in The Hill is not as objectionable as one might think.

Jiang argues that the existing regulatory structure is failing the crypto industry. And yes, she agrees, there are obvious bad faith actors in the industry who have clearly abused the system and are consequently making headlines that are unfairly detrimental to everyone in the space.

We certainly don’t agree with everything she suggests, and we would want to see the details on how other suggestions would be implemented, but we give her credit for thinking beyond the usual, alarmist and knee-jerk demands for regulation for regulation’s sake. This is far from perfect but it’s a starting point for discussion.

What are some of Jiaying’s ideas?

Several industry bigwigs, investors, academics, and legal professionals have suggested enacting brand-new laws. However, we need to stop ignoring the enforcement of current laws and regulations (like the fiduciary duties under the existing corporate law), and start being mindful of the potential negative impacts of hasty regulatory and legislative responses.   

The fact is that key players in the blockchain and crypto industries appear to have been skirting the existing rules. For instance, U.S. companies are required to act in good faith, disclose any potential conflicts of interest, and keep records of their financial and accounting documentation, but many crypto firms apparently failed to do so.  

Some crypto firms are issuing securities and, considering many cryptocurrencies are commodities, the firms should have complied with securities law and the Commodity Exchange Act. Other firms have intentionally registered their companies overseas to avoid anti-money laundering and know-your-customer rules, while still having a business presence in the U.S.

Strict and quick regulations won’t solve the problem either. Lawmakers should not create new regulations just because the industry is calling for them — at least not without conducting sufficient cost-benefit analyses and impact assessments.

There are multiple ways to regulate the crypto industry. One is to regulate crypto as “a new asset class,” like the European Union’s crypto-asset regulatory framework (known as MiCA), and formulate rules around it. Additionally, Self-Regulatory Organizations (which exercise some degree of authority over various industries) should also formulate the rules for crypto industry participants to follow.  

Specifically, there should be adequate licensing rules regarding who can acquire licenses to run crypto businesses. Beyond that, there should be rigorous client-asset segregation rules, rules on proof of reserves, investor warning models, clear corporate structures, sophisticated risk management mechanisms, records of on-chain and off-chain assets and transactions, and rules on bundling multiple services.  

In addition, there needs to be more collaboration when it comes to rulemaking — not only domestically, but also internationally, between regulators and lawmakers. Much of what has happened in the crypto industry has been because U.S. regulators have limited jurisdiction over offshore crypto companies, but those businesses still have an economic impact on U.S. territories and citizens. There is undoubtedly a lesson to be learned here.