Schrödinger's Regulation: Why We Do and Don’t Need New Crypto Regulation

The collapse of FTX is believed to be the fastest corporate collapse in US history. And it continues to toxically ripple through the industry. Unfortunately, it’s being used by overzealous lawmakers calling for draconian regulations on the industry, even though as we’ve pointed out, the FTX fraud had very little to do with crypto itself – it was an old-fashioned Bernie Madoff-style Ponzi scheme complete with political payouts, stealing from depositors and old-school money laundering. In the big picture, crypto was almost ancillary to the swindle.

But oddly, some are using FTX to say the industry doesn’t need a new regulatory framework. In principle we agree – too often law enforcement and regulators attack crypto rather than the criminals who use crypto to commit crimes, simply because it is easier than doing good, old-fashioned police work at the financial level. Crypto is simply the tool used by these malefactors they cite, whether it’s traffickers or fraudsters.

Take this situation in Washington state as an example:

The real surprise, said (Roberta Hollinshead, the Director of Banks for the Washington State DFI), was the fall of FTX. “It’s astounding,” she said, “it’s exposing weaknesses in the regulatory oversight of these companies.”

“I hope SBF is held criminally and civilly liable,” Hollinshead said.

…

 “We’re limited in what we can do now,” she said. “I hope Sam Bankman-Fried is held criminally and civilly liable.”

“I can’t do anything about someone sitting at home dreaming about a crime to commit,” said Fazio. “The laws in Washington are robust, I don’t need any new laws to catch the bad guys.”

But when Protos reached out to a former regulatory lawyer for comment, they gave a contrasting view. “The only thing that [regulators] should be doing is sitting around and thinking about how people are committing crimes. That is the primary job of a financial services regulator.”

The lawyer, who asked not to be named but spoke to Protos on background, continued: “If you see a major foreign entity purchase a small bank, that should immediately raise red flags.”

“It triggers a responsibility to review that with the closest scrutiny. The other job regulators have is not just to ferret out who’s committing crime, it’s to obtain enough documentation so that the regulator can act quickly and efficiently when it becomes clear a crime has been committed.”

However, the fact is the industry does need regulatory reform. Existing securities law, for instance, are optimized for the older, 20th Century Wall Street funding model, which moves at a stately pace and requires the amount of red tape that entire financial services companies are built to service. The Securities and Exchange Commission has done a great job since 1934 ensuring relatively stable and protective traditional financial markets.

What existing securities and commodities laws are not optimized for is the Silicon Valley, high-tech, high-speed, low-drag model of fundraising and finance. The crypto space needs a more agile, clear and forward-looking regulatory regime that allows actors to move fast and take more risks, while at the same time it is able to shut down what are obvious frauds in the making quickly, such as FTX. Our favorite example of such a regulatory reform is, of course, SEC Commissioner Hester Peirce’s Token Safe Harbor Proposal 2.0 which would provide regulatory protection and oversight while still allowing innovation to thrive. The bottom line is there are better ways to protect both innovation and investors and users in the crypto space.