By Peter Conti-Brown
The collapse of Sam Bankman-Fried’s FTX empire – and his subsequent arrest in the Bahamas in response to a request from the US Department of Justice – has dominated regulatory discussions about crypto, finance, and much else. But as tumultuous and distracting as the FTX drama has been – and the sex, drugs, and philosophically-inflected altruism of it all certainly make a great story – the dominance of crypto on financial regulatory discussions is not new. Crypto has punched above its weight in these discussions for years.
Conversation and discussion, to be sure, but not concrete action. To date, the crypto ecosystem remains a wild west of sorts.
FTX is likely to facilitate the transition from conversation to action, as well it should. Already on Capitol Hill there is the scent of blood as politicians wonder why regulators didn’t prevent the FTX collapse in the first place. And there are multiple, conflicting bills currently under discussion that suggest that new legislative (and, later, regulatory) structures are on their way.
Tomorrow, Brookings will host a virtual debate between me and Stephen Cecchetti about what, if anything, we should do about the clamor to respond to FTX – or to legislate along the lines that Bankman-Fried himself proposed. I take the view that regulation is (badly) needed; Cecchetti takes the contrary view.
Cecchetti has already summarized his views on this subject in an excellent column in the Financial Times, which I highly recommend. I won’t pregame our debate unduly, but will give him (and interested readers) the same benefit of knowing my general views.
I would propose that all regulatory and legislative efforts that intervene in the crypto space follow these three related principles.
- Do not make technology-specific exceptions for crypto assets.
- Permit banking and securities regulators to enforce existing laws.
- Embrace epistemic humility about crypto’s potential – for good and ill.
In other words, crypto should be tightly regulated – using existing regulators’ expansive (but not unchecked) legal authority to oversee the financial system as it presently exists. It is too early, however, to expand the legislative footprint. What makes crypto such an exciting space is its potential, not its present uses. We don’t yet know where crypto is headed – too heavy a legislative footprint could undermine what it might mean in the future.
Principle #1: The Perils of Technology-Specific Exceptions
There are several pieces of legislation currently circulating through Congress, most of which are bipartisan, many with significant overlap. Almost all of these violate the first principle proposed above: Congress should not introduce crypto-specific legislation. (One bill, the Digital Asset Anti-Money Laundering Act, introduced by Elizabeth Warren (D-MA) and Roger Marshall (R-KS), is an exception, since it reaffirms the application of anti-money laundering laws to crypto).
There are two problems with this kind of legislation (and the regulations that would be based thereon). First, the assumption that crypto, in its mostly inchoate form circa 2022, is in the state of technological development sufficient to justify this kind of institutional expansion of federal governmental authority. When the first federal banking legislation was passed in 1863, the country had had almost a century of experience with banking; when the federal securities laws were passed in 1933, there had been an even longer period of incubation. Crypto arguably has not even reached the point where it should be taken seriously as anything other than a speculative asset class. Most – though not all – of the so-called use cases beyond speculation are still at the level of science fiction, to put it charitably. Casting in amber this state of affairs with a specific regulatory structure would be a major error – they would prevent innovation rather than facilitate it.
Principle #2: Much more aggressive regulation using existing laws
So far, my position sounds very similar to Steve’s – if not “let it burn,” I am very skeptical of new legislative efforts to protect crypto or change existing institutional arrangements to favor it specifically. Where we may part is on the subject of our debate itself: regulation, not legislation.
Here, crypto advocates – in crypto markets and in the halls of Congress – have insisted that somehow crypto is different. This much is yet to be determined. But as legal scholar Morgan Ricks put a related point on Twitter in September 2021, “Once upon a time there was something called banking law that was pretty good. But now all you have to do is say I don’t do banking I do schmanking, and these aren’t deposits they’re schmeposits, and you’re free from it all.” Ricks’s point is that so much of current finance is simply regulatory arbitrage. There is no useful social purpose to performing identical functions by a different name. If the law is bad, we should change the law; we should not relabel obvious functionality by a different name – “tokens” or “crypto” or even “exchanges” – and insist on different regulatory treatment.
My second principle, then, is a call to regulatory arms. Two places are particularly important. First, the SEC – which, under Gary Gensler, has been particularly open to limiting crypto activity under precisely this theory – should accelerate its efforts to force those who would hawk securities to follow the rules applicable to those securities. There is significant legal ambiguity, to be sure, about the extension of some of the securities laws to some parts of the crypto ecosystem. But these can be and have been exaggerated. The SEC should take momentum from FTX to enforce the securities laws, including in areas of ambiguity – if a token or coin or digital asset looks, acts, and smells like a security, the SEC should regulate it as such. This is true even if the inevitable litigation causes the SEC to lose some of these cases. Better to have an SEC that puts all participants in our financial markets on equal footing.
The second instance of this kind of regulatory change will be in the banking sector. When FTX in August 2022 started marketing its accounts as being backed by the FDIC, the FDIC took prompt action and demanded that the exchange stop. (See here for the regulatory letter.) This is a good instance of banking regulators doing what needs to be done to protect the banking perimeter. Laws exist to require those institutions that engage in the business of banking to be chartered banks. What is missing is more aggressive enforcement of these laws.
There are many reasons why banking regulators – principally, at the federal level, the Federal Reserve, the FDIC, and the Comptroller of the Currency – are reluctant to push this line of regulatory action. It is unquestionably aggressive. There is little legal precedent for it. Any such action is certain to result in howling protests from those engaged in the targeted practices, potentially including some of the big guns of industry: PayPal (via Venmo), so-called neobanks, some hedge funds, and others that seek to exploit the benefits of providing banking services without the costs of banking compliance.
The FTX debacle and the crypto winter of 2022 provide this opportunity for some much needed, and very welcome, banking clarity. Incumbent banks regularly protest that they cannot compete against banking providers that do not pay for bank regulation and supervision. They have a strong argument here. Much more fundamentally, crypto exceptionalism in banking and financial services feeds a culture of lawlessness and hostility to government, governance, compliance, and related issues. One need look no further than FTX – originally considered the best of the crypto exchanges on this score – to see the consequences of this culture of noncompliance.
Principle #3: Embrace epistemic humility about crypto’s potential – for good and ill
It is rare to meet someone who follows finance who lacks an existential opinion on the crypto ecosystem. Crypto is either a massive scam or the future of humanity. Rarely do we see room for epistemic humility on its potential – for good and for ill.
Crypto regulation is needed not because we know crypto’s future but because we don’t. There are so many problems that plague our financial system, from financial exclusion to expensive cross-border transfers to problems in international trade to payments inefficiencies to authoritarian control of rapidly depreciating fiat currencies.
Crypto might be a part of these solutions.
Or it might make these problems worse.
Allowing crypto to continue to exist in a corner of finance without any regulatory oversight will be to permit the worst offenders – scammers, delusional dreamers, money launderers, and many others – to thrive. Regulators and regulations exist to combat these efforts. There may well be nothing in crypto’s future in a world where banks are regulated as banks, securities are regulated as securities, and exchanges are regulated as exchanges. But regulation done right will allow those future realities to find their way. For that reason, I hope that at least one core lesson from FTX will be to be aggressive in enforcing the law no matter the innovation while permitting institutional realities to evolve dynamically.
Peter Conti-Brown is the Class of 1965 Associate Professor of Financial Regulation at the Wharton School and the co-director of the Wharton Initiative on Financial Policy and Regulation.