Power confuses itself with virtue and tends also to take itself for omnipotence. Once imbued with the idea of a mission, a great nation easily assumes that it has the means as well as the duty to do God’s work.
Fulbright, J. William (1966), The Arrogance of Power, New York: Random House
Decentralized Finance (DeFi) has become under regulatory fire… again. Just before (or perhaps in anticipation of) the October 1st National Day holidays, China has effectively banned all cryptocurrencies, expelling miners and warning that any employment with such ventures may be deemed illegal. On the other side of the Pacific, champions of DeFi have discovered a greater beast yet — the partisan politics of Capitol Hill. Politico has already declared that “Crypto becomes partisan”[1].
While China’s regulatory action is disconcerting, it remains consistent with the grand empire’s governance philosophy. The United States, however, presents a much more complicated picture. Democrats want more oversight. Republicans resist on grounds of stifling innovation. The SEC chairman, Gary Gensler, yearns for more jurisdiction. The DeFi world has been learning to play the Capitol Hill game — by throwing money at lobbyists[2]. What regulation is or may be good for, however, whimpers in the cacophony.
Regulatory intent
On the surface, the political fireworks in the recent congressional hearing focused on the role of SEC, and in particular, the designation of cryptocurrencies as securities. Chairman Gensler firmly believes that they are securities under US law. DeFi proponents such as Republican Congressman Tom Emmer argue that they are currencies and commodities, and hence the “SEC is not involved.”[3]
But why?
One typical argument, true for virtually every piece of financial regulation, is investor protection, so that small investors, in particular, will be shielded from fraudsters, scammers, misinformation, etc. Indeed, the Securities Exchange Commission was christened in 1933 in the aftermath of the 1929 crash for that very reason. The SEC Act of 1934 endowed the Commission with broad powers, including an extremely broad definition of what constitutes a financial security:
Any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a ‘security’; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
In practice, virtually any publicly tradable financial asset (including derivatives) may be deemed a financial security in the United States. From this definition, Chairman Gensler begets tremendous regulatory power.
Suppose cryptocurrencies — and for argument’s sake, all digital assets — fall under this definition. They are still digital and native to blockchain technology. Does the SEC even have the proper apparatus and competence to regulate them? If the intention is to protect investors, especially small investors, there are surly other ways to require disclaimers and disclosures, rather than saddling the entire bureaucracy of SEC on the DeFi sector.
Yet another oft cited noble goal is financial inclusion. DeFi can indeed benefit the unbanked and the underserved in the current financial regime. If the intention is to bank every bankable citizen, especially those in poverty and rural areas, then lawmakers should push cryptocurrency platforms to assist low-income earners to open accounts, regulate them as digital wallets, and promote the use of tokens for small payment transactions. This, by the way, falls under the jurisdiction of the Federal Reserve, not the SEC.
So why?
Non-members of the political class could only speculate. Perhaps in the minds of the technocratic geniuses running these institutions, a grand vision of DeFi with appropriate laws and regulations is conjured. Or more pedestrian motives may lurk in the belly of those involved. Elected officials seek re-election. Senior regulators lust for more jurisdiction. Or perhaps each official is genuinely acting out of public interest. Each considers the actions undertaken virtuous. Each believes in having the necessary powers to do this duty because this is how it has always been done, for example, by stamping out all forms of private money like stablecoins. (See The Conundrum of Stablecoins II.)
That would be the greatest regulatory risk.
As observed in the earlier article On the Sustainability of Decentralized Finance, the very lack of trust in sovereign governments drove the development of DeFi in the first place. Unlike Wall Street bankers who traverse in the same corridors of power, and swing through the same revolving doors between New York and Washington DC, the DeFi world does not come from the same stock. The bankers on Wall Street may complain about regulation and compliance costs, but they never really doubted the credibility of Capitol Hill. The same cannot be said of the DeFi world. Regulatory framework that seeks to coerce DeFi into the current regime only proves the point.
That is not to say that every DeFi participant is inherently an anarchist, but deep in their mythology lies a despair towards existing power structures, and a deep disappointment that current institutions have failed to serve the public good. The propagation of DeFi is also the propagation of that worldview, and not just within its original core circle. As the bickering of whether blockchain is fundamentally Republican or Democrat continues, the debt ceiling farce played out. The US government would not run out of money again… until December 3rd this year[4]. Capital holders are watching, and likely wondering how the same game of chicken could perpetuate before their grandchildren reached adulthood. Whether cryptocurrencies are securities is a relatively minor point. The point is that cryptocurrencies are not run by the same characters who are now gambling with their grandchildren’s financial future.
Decentralized and borderless
The United States is a nation of a laws, and so long as Congress makes the laws, the citizens on this soil must abide by them.
But what about … not on this soil?
Financial institutions, with their corporate headquarters, compliance departments and legal teams, could not just pick up and relocate across countries. They could set up subsidiaries in Ireland for taxation “management”, but an exodus outright cannot be easily pulled off. On the other hand, digital nomads with portable hard drives and bits of code on various blockchains do not face the same constraints. The DeFi world conceives business continuity planning in a very different manner.
New DeFi platforms are increasingly turning away from the United States, and now locate themselves across multiple jurisdictions without clear headquarters. This is especially true for those experimenting with deep financial innovation, such as the open derivatives protocol CLEAR. As derivatives and fixed income markets emerge in a maturing DeFi ecosystem, this trend will likely continue. Capital holders will also welcome this move.
This is not to say that the DeFi world would resist all laws and regulations, but DeFi players will almost certainly select jurisdictions compatible to their worldview, and regulators that will not just bring them into the fold by force. The lobbying and bickering may rage on in Washington DC, but how much is left to regulate in the decades to come? Twilight falls not with a bang, but shade by shade as the violet hour darkens. Who survives the heap of broken images shall live to tell the tale.
[1] https://www.politico.com/newsletters/morning-money/2021/09/15/crypto-becomes-partisan-797614
[2] https://www.coindesk.com/policy/2021/10/18/crypto-learns-to-play-the-dc-influence-game/
[3] https://www.ft.com/content/1c999f26-5fc9-4008-84bb-1f706c6251a7
[4] https://www.reuters.com/world/us/biden-signs-bill-raising-us-debt-limit-averting-default-2021-10-15/
