No Laws, No Policy, No Clarity: The Parlous State of Crypto Regulation

Everyone has something to say about crypto policy. But so far, no one has managed to pass any laws. 

As crypto companies continue to plead for regulatory clarity, the only thing that seems truly clear is that federal agencies and elected officials are not on the same page.

Now industry members are questioning if they are even trying. 

Congress, the Federal Reserve, the Treasury, the Securities and Exchange Commission, and the Commodity Futures Trading Commission — to name a few parties involved in the conversation — all have different things to say about crypto. Even regulators within the same agency are taking opposing sides. 

The central bank and the Treasury are questioning the role of a central bank digital currency, while the SEC and CFTC are having a turf war over Ethereum tokens, and Congress has yet to get a single crypto bill out of committee. 

In the past 18 months, President Biden issued an executive order, Congress held hearings, the SEC issued enforcement actions, crypto companies sued the SEC, the Fed started researching CBDCs and bills have made their debuts on the House and Senate floors.

But tangible policy is nowhere to be found.

“There needs to be a very clear direction from the very top of the administration about what the position is on crypto right now,” said John Rizzo, senior vice president of public affairs at Clyde Group and former senior spokesperson at the Treasury. Rizzo, appointed under the Biden administration, also worked on the Hill for Sen. Chuck Schumer (D-NY) and former Sen. Bob Casey (D-PA). 

The Congressional docket

Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., co-sponsored the Responsible Financial Innovation Act, first introduced to the Senate in June 2022. With midterm elections and an unfortunate lack of committee interest, the bill stalled. A revamped version of the proposed law will land on Senate desks in mid-April, Lummis said earlier this month, but it will face headwinds.

Sens. Lummis and Gillibrand need committee chairs, ideally those from finance and banking, to take an interest in the bill, and the odds are not in their favor. Lummis is a minority member of the Senate Banking, Housing and Urban Affairs committee, which is led by crypto-skeptic Sherrod Brown, D-Ohio. 

Crypto investment vehicles are “speculative products run by reckless companies, we know that’s true,” Brown said during the committee’s February hearing about the fallout of FTX.

“It would require, certainly, a change in approach for the Banking Committee to move forward with markup,” Lummis admitted during a panel discussion at the Milken Institute Future of Digital Assets Symposium in March.

Gillibrand is a senior member of the Senate Armed Services Committee, where crypto has never been a top priority. 

While Sens. Lummis and Gillibrand tout bipartisan cooperation, Republicans and Democrats are undeniably at odds when it comes to crypto regulation at the national level, Rizzo said. 

“The industry’s biggest problem right now is that it’s becoming a partisan issue in which Republicans are interested in it and Democrats view it as just another thing about Wall Street or finance that they don’t like,” Rizzo said. “That’s a really dangerous place to be.” 

The new House Subcommittee on Digital Assets, Financial Technology, and Inclusion, under the House Financial Services Committee, could help make crypto a priority for lawmakers, but broad bipartisan support is a long way off, he added. 

The SEC’s agenda 

SEC Chairman Gary Gensler has made crypto a top priority for the agency in recent years. But opting primarily for a “regulation by enforcement” strategy has not earned him many friends in the industry, and many argue it’s an approach that has only slowed progress. 

The SEC has brought actions against Ripple, Kraken, Nexo and BlockFi, to name a few. Ripple took their case to court while Kraken, Nexo and BlockFi opted to settle. While generally accepted as the cheaper and faster option, settlements cannot set precedents. 

Ripple’s multi-million dollar lawsuit over its XRP token has entered its third year. A summary judgment is expected sometime in 2023, but if the court does not rule in Ripple’s favor, it’s back to the drawing board for a lengthy appeal process. 

Grayscale also moved forward in a suit against the SEC for failing to approve a bitcoin ETF. Oral arguments began this month in Washington, D.C. Donald Verrilli Jr., a former US solicitor general who Grayscale hired last year as a legal strategist, reiterated that the SEC’s approval of ETFs investing in CME-traded bitcoin futures, but not for proposed ETFs that invest in spot bitcoin directly, is discriminatory.

In 2022 alone, the SEC charged a total of 79 defendants or respondents in cryptocurrency enforcement actions, accounting for more than 60% of the agency’s total crypto-related actions since its first in 2013, according to data from Cornerstone Research. 

“The SEC is engaged in a political campaign more so than an actual, genuine enforcement campaign,” Rizzo said. “They’ve taken a political view that they don’t like crypto and so they’re going to try to enforce it out of existence.” 

Gensler has made his point clear: he sees all tokens aside from bitcoin as securities. It’s an opinion some legal experts say should bar him from voting in future enforcement actions. Regulators need to consider if Gensler is impermissibly tainted, Stuart Alderoty, chief legal officer at Ripple, said in response to Gensler’s comments. 

“The credibility of the SEC as an agency… if they want to get back to a point where they are a fair and even-handed agency, and I think they’ve lost that narrative, the agency themselves should be asking these questions, fellow commissioners should be asking these questions,” Alderoty said.

Gensler at war

Even the SEC is not fully supportive of Gensler. SEC Commissioner Hester Peirce has been vocal about the securities regulator’s proposed custody rules, claiming they harm investors by limiting access to crypto.

Underlying Gensler’s agenda is an apparent turf war between the SEC and CFTC, which has purview over commodity derivatives trading, like futures and swaps. The ongoing argument over token classification – security or commodity? – has made the jurisdictional lines blurry. 

The CFTC, as supported by federal courts, says Ether and stablecoins are commodities. The SEC, also with court support, says most cryptos are securities.  

“The two agencies work very collaboratively,” said ​​Valerie Szczepanik, director of the Strategic Hub for Innovation and Financial Technology (FinHub) office at the SEC, during a panel discussion at the Digital Asset Summit in September. “From my perspective, the agencies really want to get it right. It’s all about investor protection and market integrity and our two agencies want to cover the landscape so those goals are achieved.”

Throughout the enforcement actions, criticism and inter-agency conflict, Gensler has maintained that the SEC’s top priority is protecting investors. The crypto industry is the “wild west” he said during a Twitter spaces event with the US Army on responsible investing. 

“Most of these 10 or 15,000 tokens will fail,” Gensler added. “That’s because venture capital fails, new startups fail —  but also because history tells us that there’s not much room for micro currencies, meaning, you know, we have the US dollar and Europe has the euro and the like.” 

Operation choke point 2.0? 

After weeks of industry members insisting there is a coordinated effort to isolate crypto from the banking system, regulators became involved last week. 

After weeks of uncertainty surrounding its stability after being faced with a flood of FTX-related withdrawals, Silvergate Bank announced plans to liquidate on March 9. Regulators then took possession of Silicon Valley Bank on March 10 and Signature Bank, what was known as the last man standing for crypto banking, went under FDIC control on March 12. 

In a series of interviews Monday, former Rep. Barney Frank, who served as a Signature board member, said the bank’s struggles began during the FTX-fueled run. Frank headed the House Financial Services Committee during the 2008 financial crisis.

But, he said, the NYDFS targeted Signature in an effort to make its opinions on crypto clear, although the FDIC has since clarified that buyers will be able to assume all assets and liabilities from Signature, including the crypto business.

The New York Department of Financial Services opted to hand over control of Signature to the FDIC because of concerns over the bank’s business operations and its ability to meet client needs, a spokesperson told Fortune on Tuesday.

Despite New York regulators denying that crypto had any role in Signature’s downfall, the current banking crisis could impact industry oversight and ensuing policy, experts say. 

“There is a split in terms of who policymakers say is at fault, leading to a growing partisan divide,” said Ron Hammond, director of government relations at the Blockchain Association, an industry-supported lobbying outfit. “The fear among those in Congress is that this growing partisan push could trickle to other policy priorities of the banking committees that aren’t related to the current crisis. Stablecoins in particular come to mind.”

The closures are not the first hurdle for crypto’s access to banking services, though. 

Wyoming-based crypto bank Custodia says there has been a concerted effort to keep crypto companies away from the banking system for years. The bank was denied membership to the Federal Reserve, based on concerns the central bank had regarding Custodia’s risk management practices. 

“Custodia is surprised and disappointed by the Board’s action,” Caitlin Long, Custodia’s CEO, wrote in a statement. “Custodia offered a safe, federally regulated, solvent alternative to the reckless speculators and grifters of crypto that penetrated the U.S. banking system with disastrous results for some banks.”

Banking options for crypto banks have always been limited in the US, suggested Nic Carter, a long-time crypto supporter and venture capitalist in a blog post last month. Signature, up until this week, would have been seen as a viable option, but the crypto-friendly bank had already begun distancing itself from the asset class. 

Signature shrunk its crypto deposits by $13 billion from their previous peak in 2022. 

“What began as a trickle is now a flood: the US government is using the banking sector to organize a sophisticated, widespread crackdown against the crypto industry,” Carter said. 

With mounting regulatory pressure across the board, it’s hard to imagine banks, traditional or otherwise, putting in resources to establish new on and off ramps, said Cody Carbone, vice president of policy at the Chamber of Digital Commerce. 

“[Bitfury CEO] Brian Brooks put it best…the point of a bank and banking regulation is not to keep risk out of the market, it is to provide a safe and secure place for those risks to be contained,” Carbone added. “My hope is that as public interest in crypto increases, so will bank activity to adhere to customer demands.”

The Fed’s stance continues to evolve, but it seems they are not interested in giving digital asset banks access. In a policy statement issued in January the central bank restricted banks from certain crypto-related activities, even though an earlier statement was at pains not to discourage or prohibit dealings with crypto companies. 

The statement also “broadens their authority to cover non-FDIC insured state-chartered banks (a reaction to Wyoming Special Purpose Depository Institutions (SPDIs) like Custodia, which can hold crypto alongside fiat for its banking customers),” Carter said. 

Ring-fencing US crypto — separating it from banking rails — echoes the DOJ’s Operation Choke Point from the last decade, Carter added. 

In 2013, the Department of Justice advanced a similar goal: to cut off “undesirable” business sectors from the banking system, like payday lenders with a reputation for enabling money laundering and fraud.

“Operation Choke Point has had a demonstrable chilling effect on commerce,” wrote Iain Murray, vice president for strategy and senior fellow at the Competitive Enterprise Institute in a report. “Most such banks cannot afford the extra supervision that comes with a Choke Point subpoena. Thus, they often face no other choice but to drop payment processors and designated ‘high-risk’ clients altogether.”

A workaround some crypto firms are considering is to launch their own crypto banks, as Kraken is attempting. The issue at hand doesn’t change though, Carbone said; the Fed will still deny membership and master account access. Plus, he added, getting a banking license is no small feat. 

State-level progress 

As federal regulators struggle to get on the same page, local politicians have been busy. In state governments, the party lines are less clear on crypto, and with smaller legislatures and more homogenous populations, progress comes faster. 

“We are so much more nimble at the state legislature and get along with our colleagues so much more than on a federal level,” Illinois state Representative Margaret Croke (D-12th district), said. “It’s funny because on the federal level for some reason we’ve gotten to this weird sentiment of ‘Republicans are pro-crypto’ and ‘Democrats are anti-crypto.’” 

Fort Worth, Texas became the first city to run a public bitcoin mining operation in April and Colorado now allows residents to pay state taxes in crypto. Efforts are underway in California and Arizona to make bitcoin legal tender, although legal experts are skeptical the plans will lead anywhere. 

According to the Constitution, defining “legal tender” is not the domain of state lawmakers, said Preston Byrne, former partner at law firm Anderson Kill.

“The move is largely symbolic,” Byrne said. “The coinage clause of the Constitution means that the power to determine what is and isn’t legal tender in the United States is the exclusive province of Congress.”

Missouri, Mississippi and New York have all advanced bills surrounding cryptocurrency mining, with New York’s new law recently signed in by Governor Kathy Hochul. The proposals in Missouri and Mississippi focus on protecting individuals and businesses looking to mine while New York’s new law limits proof-of-work operations. 

Regulation… but on whose terms?

States are limited in their power though, Byrne and other industry members point out. There are local differences when it comes to banking charters and taxes, but without clear federal direction, the regulatory environment is not going to improve. 

“Congress has to try to find a way to reach consensus on crypto this year,” Rizzo said. 

As for the industry leaders calling for clear guidelines? Rizzo says be careful what you wish for. 

“Sometimes ‘we want regulation’ means ‘we want regulation on our terms,’” Rizzo said. “Every industry wants that; that’s the job of industry, to create and craft policies and promote policies that improve their bottom lines.” 

The future of crypto – where in the world the industry is based, who has access, what products look like – rests in large part on what US regulators and legislators decide to do. Whatever Gary Gensler says, clarity is not a word that most industry participants would use to describe the current mess of interpretations, loopholes, proclamations and arbitrary statements.

Regardless of timing, though, crypto businesses should understand that some rules are going to change, and their operating procedures are going to have to adjust accordingly.