A Case for 'Rules of the Road' Fostering Crypto Innovation

For the majority of Americans, the ability to store and transfer funds via traditional banking services is an aspect of daily life that we take for granted. But more than 8 million U.S. households – encompassing over 14 million adults and 6 million children – had no checking or savings accounts in 2017, according to a report published by the FDIC. An additional 24 million American households went “underbanked” in 2017, meaning they had a checking or savings account but also used alternative financial services like money orders or payday loans.

A significant portion of Americans, then, is currently “unbanked” or “underbanked.” And according to the FDIC, these rates “were higher among lower-income households, less-educated households, younger households, [and] black and Hispanic households.” Some of the most fundamental characteristics of bank accounts – like transaction fees and minimum balance requirements – only reinforce these groups’ inability to access or maintain consistent banking services.

A viable alternative to traditional banks could soon exist in the form of cryptocurrencies or digital assets that function as a secure medium of financial exchange. Many of the features inherent to this new monetary breed might make up for the deficiencies of traditional banks, serving as a much-needed resource for historically underserved communities.  Cryptocurrencies go far beyond speculative assets like Bitcoin, which get all the public attention.  There are over 2,000 digital assets that have been invented, many of which are known as utility tokens because they were designed to make financial transactions faster, cheaper and more transparent.

For an industry that’s moving so quickly, it might not be surprising that regulation has yet to keep up. But a lack of regulatory framework has been the cause of increasing concern among industry experts. The questions everyone seems to be asking – How will authorities such as the Securities and Exchange Commission (SEC) approach cryptoassets? And what effect that will have on their development?

When traded over online exchanges, cryptocurrencies can serve as both a form of wealth storage as well as a secure, seamless medium of exchange for goods and services. These assets rely on open, distributed transaction ledgers called blockchains to verify and record each exchange, obviating the need for a central authority (like a bank) and ensuring that mutual trust is at the core of any given asset. As industry expert Chris Dixon succinctly put it, “Cryptocurrencies—coins and tokens built into specific blockchains—provide a way to incentivize individuals and groups to participate in, maintain, and build services.”

But as the recent QuadrigaCX saga – in which the currency’s founder Gerald Cotton passed away unexpectedly, taking with him a password to access as much as $190 million in funds – demonstrated, the digital nature of cryptoassets creates some vulnerabilities. Regulation may safeguard individual investments against this type of incident while also preventing fraud embodied by scam “initial coin offerings” and deterring illicit criminal activity.

To date, the SEC has not developed any overarching guidelines, instead offering piecemeal opinions on which cryptocurrencies classify as securities and how they might be regulated. These haphazard pronouncements virtually all rely on decades-old regulatory law such as the “Howey test” first outlined in 1946 by the SEC to define securities. Over 70 years later, it’s hard to envision how the application of that test might work out concerning 21st-century digital assets, particularly utility tokens which were not designed for investments or speculative trading.  

To complicate matters further, regulation at the state level varies widely. To foster growth in the industry, certain states like Wyoming have introduced legislation to clarify the legal position of cryptoassets and safeguard utility tokens from regulatory overreach. The majority of U.S. states, however, have issued no guidance or regulation whatsoever, leaving a minefield for crypto companies to navigate. 

Industry advocates have argued that this disorganized approach is debilitating to innovation in the space, forcing companies in the industry to divert resources to navigating treacherous regulatory waters rather than focusing on bringing new products to market.

But a key SEC figure appears to have taken note. In recent remarks, SEC Commissioner Hester Peirce suggested that applying the Howey test to cryptocurrencies would be “overly broad.” Commissioner Peirce went on to note the negative impacts of a slow approach to regulation, concluding that it would be important to get regulation right in a timely manner so that “innovators and entrepreneurs can spend their time and attention on making better products, providing better services, and revolutionizing the way we interact with one another.”

Will the cryptocurrency industry receive the guidance Commissioner Peirce has outlined, and industry experts have advocated for? It would certainly appear that crypto’s most innovative aspects – especially for those Americans most in need of alternative financial options – would benefit from guidelines.