Crypto Regulators: Reflections on the SEC Investor Advisory Committee Hearing on Blockchain
Blockchain technologies and tokenized offerings have caught the attention of regulators around the world. With dozens of ICOs raising billions in capital, and bitcoin climbing to record highs, concerns about the possibilities for money laundering and fraud have grown. In many jurisdictions, the regulatory response has been to simply ban ICO and cryptocurrency activity entirely. In the United States, regulators have occasionally been perceived as failing to sufficiently accomodate blockchain technology and token offerings. Calls for greater clarity and understanding accompany claims of outright hostility to both blockchain technology and token markets on the part of the U.S. regulators.
On October 12, the SEC’s Investor Advisory Committee held a meeting to address blockchain technology. (I highly recommend watching; go ahead, I’ll still be here in four hours). Suffice to say what I saw was not what I expected.
My key take-away is that U.S. regulators have an incredibly strong understanding of blockchain technology and related markets, what we might call the ‘token economy’.* Furthermore, the SEC and CFTC are quite sanguine about the future of blockchain technology on the whole. What reservations they have are valid, and reflect genuine problems in the current token economy. By giving the crypto community flexible and reasonable regulatory guidelines, U.S. regulators are looking to the crypto community to prove the value of this technology and emerging sector.
Regulation by Blockchain: From Entities to Activities
Jeff Bandman, until earlier this year the CFTC FinTech advisor, provided a subtle and wide-ranging view of the potential of blockchain technology.
At first noting that blockchain technology could provide much-needed improvement in data security (looking at you, Equifax), Mr. Bandman went rather further. The ability to grant investors full control over their own data and enable “digital self-sovereignty” was explicitly cited as a major benefit of blockchain technology, and came coupled with a clear recognition that the currently private and fragmented digital identity system was undesirable.
In the long run, the vision presented was one in which regulators ceased to regulate entities and instead regulated activities. Rather than rely on retrospective data compiled from reporting entities to assess market concerns, blockchain-based markets offer the chance for regulators to get a ‘real-time view’ of market activity, without the need for potentially self-interested intermediaries. The very openness of many blockchain development projects, in contrast to many traditional financial technology or innovation, is yet another benefit to regulators. As Mr. Bandman noted, Bernie Madoff’s scheme would have been very hard on a blockchain. The regulators would have seen at first glance that the money simply wasn’t there. Similarly — to my own eyes — the requirement after the financial crisis for all derivatives to be traded on reporting exchanges seems like a clumsy work-around to address the lack of transparency that an open blockchain network provides.
Mr. Bandman highlighted that the dispersion of responsibility amongst market participants through a distributed ledger system creates a unique need for investor education and awareness as compared to the current system. Government procurement rules and the disjunct in pace between technology and government remain meaningful issues to be overcome, with pilot programs or “regulatory safe harbors” to encourage innovation within regulatory bodies. Despite these obstacles, his discussion presented a remarkably clear-sighted and hopeful view of the relationship between blockchain technology, markets, and regulators.
New Tech, Old Frauds, and Existential Threats
It was the remarks of SEC Chairman, Jay Clayton, which provided the most striking moment of the hearing. The Chairman’s prepared statements emphasized the need to foster financial innovation, while watching out for and protecting investors. Reasonable, but pretty bland stuff. Then came this:
“…new technologies provide new avenues for bad actors to engage in old frauds.”
At this point, the Chairman deviated in an astonishingly emphatic, earnest plea:
“I cannot emphasize this enough — how important it is that we look and are vigilant about this technology being used for pump and dump and other frauds. If we don’t get that right, we won’t get the benefits of this technology.”
Let’s pick that apart a bit. At first glance, this is a (possibly fair, if veiled) indictment of the ICO market. It’s hard to argue with the Chairman that many ICOs are, at best, subject to enormous problems in areas such as appropriate incentive alignment for founders, and at least some are effectively Ponzi schemes or other small-market-cap fraud. So, the SEC is concerned about retail investor fraud — fair enough, what’s the big deal?
It’s the last bit, about not getting the benefits of this technology, which provides the key insight. It shows that the SEC understands the benefit of this technology, and wants to see it propogate. Moreover, his statement isn’t just applicable to regulators. It is a salutary warning and call to action. This is a crucial issue for the blockchain community as a whole. The adoption of blockchain technology and the token economy by the public at large could be stunted or entirely halted if it is perceived as the realm of money-launderers, charlatans, and fraudsters.
Whence From Here?
Regulators in the US are explicitly encouraging of innovation in this sector, and have laid out a bright vision of true disintermediation and adoption of blockchain technology. The speakers explicitly cited ICOs and “utility tokens” as an innovation with “huge implications for investment and capital formation, for democratizing access for retail investors to new and innovative businesses, and opportunities to incentivize and monetize really interesting ideas at an early stage of their development.” U.S. regulators’ refusal to provide one-size-fits-all rules for ICOs, embodied in the DAO Report and highlighted again in this hearing, in fact reflects a genuine desire to foster innovation. The ball is now genuinely in our court.
If we as a community don’t self-regulate — by developing standards for ICOs, and generally seek to encourage the adoption of better practices across the sector — public trust in blockchain technology won’t grow, and valuable projects will be lost amidst the tokenized weeds. It is incumbent on us as a community to ensure our society is not deprived of the benefits of this technology.
*I sort of hate the term “blockchain”, as it has become something of an empty buzzword. For convenience, I will use it here as an umbrella for the use of cryptographic security, distributed ledgers, and greater or lesser degrees of game theory analysis to solve the problem of trust and verified transactions between strangers. The “token economy” is broader still, and includes tokenized offerings of all types, irrespective of a unique underlying protocol or other distinguishing factor.