Crypto executives like Coinbase’s Brian Armstrong must accept that existing regulations apply to them as well

Brian Armstrong is wrong: Staking is a security and the US Securities and Exchange Commission (SEC) just proved it. He has simply misunderstood their position. This is where the lack of understanding of regulations on the crypto side starts to become worrisome. If we saw the same level of ignorance of the law in bank boardrooms as we’ve seen with crypto executives, we’d be excused for withdrawing most of our money and putting it in a safe.

Timothy Cradle is director of regulatory affairs at Blockchain Intelligence Group.

Based on the responses from Armstrong and other crypto leaders and regulatory policy makers, it is clear that many of them do not seem to understand that they are providing regulated services in a non-compliant manner. In the specific case that Armstrong responded to before the facts were in, the SEC charged Kraken because it paid interest on deposit accounts. It is a regulated activity for which the SEC provides certain exemptions, such as banks not having to register with the commission to pay interest on a savings account; it is certainly not the case that crypto companies are exempt from registering to pay interest to depositors simply because the deposits are in crypto, as Brian Armstrong seems to assume.

Not only is that not the case, but this is also not the first time the SEC has successfully pursued this case in the form of an enforcement action. In 2022, BlockFI was fined for providing a similar service – paying interest on deposits – without registering with the commission. Coinbase itself received a letter from the SEC warning them against offering a similar service to BlockFI. So why is it that Coinbase’s CEO doesn’t seem to remember this and doesn’t think the rules that apply to other financial services apply to his financial service?

It is either willful ignorance or literal ignorance. Both are a concern when the future of a multi-billion-dollar financial company is at stake.

The problem is the pernicious concept in crypto that goes by the name of “regulation by enforcement.” We need to remove this phrase from crypto, not only because it’s imprecise, but because it’s simply not a thing. Regulators in the US do not create new rules; they enforce existing rules. Perhaps crypto leaders need a quick refresher on the law and regulatory process:

2. The bill goes to committee

4. The bill has been signed into law

5. Regulators write rules that match the intent of the law

6. A comment period is open to the public (no tweets accepted)

7. A final rule is written and published in the Federal Register

There are several nuances to the process, but that’s it in a nutshell – it’s a multi-year process on average, and that’s how regulations are made. A precedent may be set with litigation from the regulators, but again, this action is not regulatory; this enforces existing rules.

If regulators have so far been successful in getting enforcement, this should be a big wake-up call to the crypto industry that financial transactions in crypto conform to regulated financial transactions and as such the existing rules apply. If their legal counsel is telling them otherwise, it’s time to get new legal counsel because this is a multi-million dollar lesson that the industry continues to learn and will continue to learn until they change their strategy. A new lawyer won’t cost that much.

We’re starting to get a growing list of crypto services where one can ask: Is it regulated? And based on the enforcement actions, we can say: Yes, unequivocally. Here are some examples:

Staking: Kraken’s enforcement action 2023

Rewards: BlockFI enforcement action 2021

Lending: Coinbase legal warning from SEC 2021

Token Issuance: Telegram (TON) settlement with SEC in 2020

Crypto-based derivatives trading: Ooki DAO Lawsuit by Commodity Futures Trading Commission 2022

All of these enforcement actions involve regulated activities; and there will be more settlements and enforcement measures.

Soon we will see definitive proof that tokens themselves are unregistered securities when the SEC wins the Ripple case. As if we didn’t already know that via several comments from SEC officials.

In the coming year, we will have more concrete evidence that certain crypto services are unregistered futures and derivatives exchanges – based on comments from CFTC Chairman Benham as he ramps up the enforcement division of the commission to set precedents by targeting non-compliant crypto. exchange.

Will it take more business failures to convince the crypto industry to mature and take their regulatory reality more seriously in the US? Possibly. What we’ve seen in recent months from regulators are existential challenges to the crypto industry: The Office of the Comptroller of the Currency and Central Bank is warning banks away; and Kraken and BlockFI have received stop-and-go orders for product lines in the past year. In the past month, we have also seen the TZero crypto app (an Overstock product) decide to discontinue services due to regulatory challenges related to errors in their customer data.

There is one argument in crypto regulation that makes sense: the need for regulatory clarity – but even this is diminishing with increasing enforcement actions. We may need to replace the bad phrase “regulation by enforcement” with “regulatory clarity by enforcement.” The latter is at least somewhat less difficult to argue against. In other words, why not just keep asking regulators to make clear what the rules are instead of begging them to stop suing you?

Regulatory clarity is an easy hurdle to clear. We have seen this with money laundering regulation. In 2019, FinCEN issued FIN-2019-G001, FinCEN’s guidance on “Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies.” Since 2019, there has been nothing in the US with the same level of explicit detail that says how rules apply to crypto and under what circumstances. As a result, we see that every crypto company, with few exceptions, is registered as a money services business and complies with the five pillars of the Bank Secrecy Act (BSA).

With the SEC and CFTC, where there is no such explicit guidance, we continue to see non-registration and subsequent enforcement actions, settlements and cease-and-desist orders. There is a clear causal link here between guidance and compliance.

Therefore, it’s time for crypto leaders and decision makers to think critically about regulations, stop complaining, hire better legal and compliance staff who will tell them the hard truths (you’re regulated, time to register), and have a more productive dialogue with regulators than they have had to date.