Why the Regulatory Threat to Digital Assets Is Greatly Exaggerated

Since the Covid-19 pandemic shook markets and monetary policy around the world last year, digital assets like bitcoin and ether have risen from relative obscurity to the rapt attention of many investors.

Some, like Stanley Druckenmiller and Paul Tudor Jones, decided to make their first allocations to this new asset class, while others, like Ray Dalio, were still put off by an old but nagging fear: if crypto gets big enough, won’t governments just ban it?

In a word, no. There is little reason to fear harsh regulatory action in 2021 and beyond.

Regulators Won’t Ban Crypto

The notion that regulators pose an existential threat to crypto finds its roots in a bygone era when many investors first heard about bitcoin — around 2013, when the asset was known primarily for its use as a payment vehicle on darknet markets like the Silk Road.

Back then, during the well-publicized trial of Ross Ulbricht, the financial media painted bitcoin as a tool for criminals and nothing more. Unfortunately, that false image persisted long after Ulbricht’s conviction, as media outlets continued to highlight crypto’s attention-grabbing frauds and failures rather than its exciting advancements and legitimizing successes.

But eight years later, that misperception is finally fading as the crypto industry bears less and less resemblance to those early days.

Recent data from Chainalysis, a leading blockchain forensics company, shows that a tiny fraction of crypto transactions relate to illicit activity — about 1.1 percent, which is less than estimates for traditional payments infrastructure.

Instead of darknet markets and shadowy exchanges, the industry today is characterized by respected financial institutions, software developers, and financial services providers backed by billions of dollars in funding from the world’s premier venture capital firms. In addition to investors like Druckenmiller and Jones, publicly-traded companies like MicroStrategy and risk-averse insurance firms like MassMutual have gotten comfortable buying bitcoin.

Regulators and Legislators Support Innovation

Despite fears of a ban, policymakers have expressed broad support for innovation in digital finance and have worked to promote regulatory clarity for crypto.

For example, the Commodity Futures Trading Commission has granted licenses to crypto derivatives exchanges and authorized trading of bitcoin and ether futures.

The Securities and Exchange Commission has clarified that bitcoin and ether do not constitute securities and has provided guidance on whether and when other digital assets are subject to the securities laws.

The Office of the Comptroller of the Currency has authorized federally-regulated banks to custody stablecoins and use them to settle transactions. Crypto also boasts a number of supporters in both houses of Congress, and on both sides of the aisle as well.

That’s not to say we’ve solved every regulatory issue of importance in the United States — far from it. Like all novel technologies, crypto raises a number of difficult questions that will take a great deal of time and effort to answer. But so far, policymakers have shown no interest in answering those questions with a blanket ban.

To be fair, most investors who fear a crypto ban don’t expect it to happen any time soon. Rather, they worry that policymakers will become hostile in the future if bitcoin or another digital asset someday threatens a government’s monetary sovereignty. This theory may sound plausible at first blush, but it likely overstates policymakers’ desire and ability to enact such draconian measures against a technology that has already achieved mass adoption — like banning the internet after everyone started using email.

It’s hard to imagine elected officials attacking an asset that millions of their constituents own and use, and even harder to imagine courts of law upholding such an attack in a democratic society that defends civil liberties against government infringement.

FinCEN’s Midnight Rulemaking: A Case Study in Effective Advocacy

The ongoing controversy over a recent proposal from the U.S. Treasury Department illustrates how far policymakers are from trying to harshly regulate crypto.

On December 23, FinCEN — the Treasury bureau tasked with implementing and enforcing the federal anti-money laundering laws — proposed a new rule that would force regulated crypto companies to keep records and file reports for certain transactions involving so-called “unhosted wallets.” FinCEN only allowed 15 days for the public to analyze the proposal and submit comments, presumably with the intent of finalizing the rule before a soon-to-be President Biden freezes all pending administrative rulemaking, as he plans to do on January 20.

The industry’s reaction to this attempt at midnight rulemaking was nothing short of extraordinary. 

Despite the holidays, the short notice, and the complexity of the 72-page proposal, FinCEN received a total of 7,477 comments — about two times the number it received on all other proposals since 2008 combined.

Nearly all of the commenters vehemently objected to the rule on both substantive and procedural grounds. The responses consisted of detailed discussions and passionate arguments from a stunning group of influential stakeholders, including exchanges, custodians, developers, investors, academics, trade associations, think tanks, former officials, and sitting members of Congress, among others. Importantly, thousands of individual cryptocurrency users submitted thoughtful comments as well, a grassroots community effort that few industries can muster.

As of this writing, we still don’t know whether FinCEN will implement its proposed rule or abandon it in the face of overwhelming opposition, but either way, the point is this: the crypto industry is no sitting duck for over-regulation.

FinCEN’s proposal is ill-considered, to be sure, but it’s also relatively mild in comparison to the outright ban that investors like Ray Dalio have feared. Nonetheless, the industry is fighting tooth-and-nail against it. If FinCEN decides to move forward, industry leaders have already promised to challenge the rule in court; the Blockchain Association has even retained former U.S. Solicitor General Paul Clement, now of Kirkland & Ellis LLP, to file suit immediately.

If this is the industry’s reaction to new recordkeeping and reporting requirements, imagine what might happen if policymakers proposed a more burdensome restriction, let alone a ban. There’s an important takeaway here for those concerned about a regulatory crackdown: an investment in crypto is more than just the purchase of a digital asset, it’s also an investment in the collective energy of a mature, resilient, well-resourced industry prepared to advocate effectively and fight aggressively for crypto’s future.

There is no doubt that policymakers will play a key role in shaping the future of crypto. But there is also little reason to think they will try to ban it, and even less to expect they might succeed.