On The Tug of War Between Innovators and Regulators in Crypto Markets
In mid-August 2018, we find ourselves at a familiar juncture in the cryptocurrency space, with the latest hype cycle seemingly driven by the hope that regulators were willing to ‘play ball’ and begin the slow process towards recognition of digital assets as a real asset class — in particular, that one of a number of ETF proposals on their table would be pushed through, ushering in a wave of institutional money that has been patiently waiting on the sidelines for just such an opportunity. If only it were so easy!
Unsurprisingly for many market watchers, the decision on the VanEck/SolidX ETF (full text of proposal here) was recently delayed — at least until September. I say unsurprising because as the drama unfolded on this particular application, another potential ETF familiar to anyone in the space was resurrected into the popular cryptoconsciousness with an announcement that it was rejected again — that of the Winklevoss brothers. Interestingly, the crypto market dumped relatively briefly in reaction to the Winklevoss rejection (despite the facts outlined in the rejection itself, which were rather sweeping in their scope and unlikely to be resolved quickly, to say the least) before retracing a good portion of the collective down move. On the other hand, a mere delay of the VanEck ETF seems to have set off a rather more persistent and deep sell-off that at the time of this writing has Bitcoin barely off YTD lows, with many altcoins settings new lows for the year altogether. Seemingly, the market was holding onto hope that despite the very real concerns raised vis a vis the Winklevoss rejection note (full text here) the VanEck ETF would somehow avoid a similar fate. And to be fair — it still might. There are reasons the two ETF filings are different. After all, the SEC in its judgment could have outright rejected the VanEck application just the same as it has done with a number of cryptocentric ETFs in the past. The decision to exercise a delay instead of doing so could be telling in its own way. This is especially true in light of the dissent issued by Commissioner Hester Peirce which has turned the Commissioner into somewhat of a crypto celebrity of late (full text here — I encourage strongly to read this in full, even the footnotes are enlightening to the process). Just a few notable excerpts from the dissent:
“The Commission’s mission historically has been, and should continue to be, to ensure that investors have the information they need to make intelligent investment decisions and that the rules of the exchange are designed to provide transparency and prevent manipulation as market participants interact with each other…”
“The Commission steps beyond this limited role when it focuses instead on the quality and characteristics of the markets underlying a product that an exchange seeks to list…”
It is heartening to see an open-minded perspective coming from the SEC (and regulators more broadly) on this matter. After years of taking a ‘wait and see’ approach to the development of the market, it has become clear that some sort of action is inevitable at this point — and not just around approving or rejecting ETFs as per the current focus. Given the heavy handed reactionary approach we have seen from the likes of India and China, this may worry some participants in the market. But for those who are in this space for the right reasons and have subscribed to its long term potential, this should actually be a welcome development. Why? Because that is the only way this whole thing is going to work!
The original Bitcoin whitepaper did much of the work setting the stage and defining the ideals which would eventually take central stage in any debate about crypto and its potential — with decentralization and an elimination of the need for trusted third parties at the absolute core. These are noble ideas — potentially game changing, even — but we have seen time and again how much of a double edged sword a complete lack of regulatory oversight can ultimately be. For those who have been investors for any amount of time, consider yourself very lucky if you have avoided altogether the exchange hacks, 51% attacks, smart contract bugs, or even the outright cash grab exit scams which have been an unfortunate near-daily reality. Short of acrimonious hard forks in certain cases, there is typically zero recourse if you draw the short stick in one of these types of situations. And that’s to say nothing of simply misplacing or losing a private key, essentially locking you (and everyone else) out of your coins for all time. Some of this is just the nature of the beast — if we ascribe to the mantra of decentralization and “code is law” it is difficult to simultaneously be provided with the protections we are used to within the status quo (which, needless to say, come with their own explicit and implicit costs, most of which we have just taken for granted at this point). Technology will no doubt go a long way towards solving many of these problems — confusing and buggy CLI wallet programs will eventually be replaced by slick, sophisticated and secure solutions (as is underway already) and some of the above issues will simply go away through these innovations. And to be clear, I do not believe regulators should or even could have much influence as it relates to some of the nitty gritty details of the underlying blockchains themselves. Yet if we look at where we are today, at this substantial inflection point where crypto is still trying to move away from its hobbyist/hacker roots and realize its promise, it is clear that the industry as a whole will need substantial regulatory investment and support to move forward.
For all the talk about institutional money waiting to jump in, there is little reason to believe any substantial amount of capital is going to enter the fray prior to addressing at least some of the issues brought up in the SEC rejections of crypto ETFs so far. First and foremost is probably the issue of custody and relatedly, insurance of held assets — both of which are admittedly very tough nuts to crack, but also fortunately two areas that are being very actively addressed by some of the biggest names in cryptocurrency. The list does not end there, but these and any remaining issues will almost certainly be solved with time. The bigger picture idea here is that the concerns of the regulators are the concerns of the institutions and therefore should be the concern of any investor in the space. While regulatory focused headlines have seemingly dominated much of the 2018 news cycle already — both positively and (seemingly more often) negatively, this dance will continue to be a critical one for investors to follow as it evolves with time. Because once a playing field has been created where some common sense oversight is in place to protect investors both large and small, we can hope to see this space truly flourish to its full potential.
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