Original text: " Regulating Crypto: How we move forward as an industry from here " by Brian Armstrong, CEO and co-founder of Coinbase
Compiled by: Wu Blockchain Blockchain
One of the most common questions I get asked by people in the regulatory governance and policy community is what exactly is regulatory clarity? In this blog, I outline a realistic blueprint to ensure we have clear regulation for centralized players and a level playing field across exchanges, while preserving the decentralized crypto that will bring huge benefits to the world Innovation.
After the FTX debacle, I thought giving a blueprint of where the industry could go would help restore trust and turn the page.
These are fairly simple steps, but they require all of us as companies, policymakers, regulators and customers to move forward together. We should be pursuing early and relatively painless efforts to get new legislation passed rather than waiting to get something comprehensive and complete.
I will describe much of this from a U.S. perspective, but similar steps will need to be taken in every major financial market around the world, as well as other members of the G20.
1. Create regulatory clarity for centralized actors
Over the past 10 years, I have held hundreds of meetings with policymakers to discuss how we can gain regulatory transparency in the crypto space. While there has been some meaningful progress, I am hopeful that the collapse of FTX will be the catalyst we need to finally pass new legislation.
It would be best to first establish regulatory clarity around centralized players in crypto (stablecoin issuers, exchanges, and custodians), as this is where we see the greatest risk of consumer loss, and almost everyone agrees that this should be the case Do. The regulation of traditional finance is organized around ensuring that intermediaries operate fairly and reasonably, and the same principles make sense for cryptocurrencies in the presence of intermediaries. Decentralized organizations (DAO, DeFi, etc.), on the other hand, do not involve intermediaries and have their own set of protections that are in some ways superior, which I will come back to later in this article.
Stablecoin
Regulating stablecoin issuers is a good start because there is widespread interest in DC and we can gain some momentum with quick wins. We don’t need to do anything fancy or cryptographic here; stablecoins can be regulated under standard financial services laws, such as using state trust charters or the OCC national trust charter.
You don’t have to be a bank to issue stablecoins unless you want to do fractional reserve lending. Banking regulation is the strictest because it allows lending of customer funds. But many stablecoin issuers will be required to hold assets at a 1-to-1 ratio and will only be allowed to invest in high-quality assets such as Treasury bonds.
So what are the requirements of a reasonable stablecoin law for issuers:
●Registered as a state trust or OCC National Trust
●If you want to make fractional reserve loans or invest in higher-risk assets, you can become a bank; if not, you can only invest in high-quality liquid assets, such as U.S. Treasury bonds
●Conduct strict annual audits to ensure that client funds are placed in appropriate reserve assets and separated from the company’s cash
●Establish reasonable controls and board governance
●Meet basic cybersecurity standards such as SOC compliance
●Establish blacklist capabilities to meet sanctions requirements
Hopefully we can do that in the first half of next year.
Exchanges and Custodians
Once we have clarity on stablecoin regulation, a set of rules for centralized exchanges and custodians can help prevent bad activity while maintaining innovation. Again, many of these ideas can be borrowed from traditional financial services, so we don’t need to reinvent the wheel.
Here are some potential regulations for centralized exchanges and custodians:
●Implement robust Know Your Customer (KYC) and Anti-Money Laundering (AML) policies and procedures.
● Establish a federal licensing and registration system that allows services to be provided throughout the country by obtaining a license (or like a passport that can travel throughout the EU). In a place like the US, it's fine to keep the option for states to issue their own licenses, but there should be a federal option that allows the US to become a single market.
●The need for strong consumer protection regimes, such as risk disclosure and transparency of fees and conflicts of interest
●Establish effective minimum standards to protect customer assets
●Market manipulation, whitewash trading and other forms of market misconduct are prohibited
Commodities and Securities
Perhaps the most complex point that needs clarification surrounding cryptocurrencies is how to define whether it is a commodity or a security. The CFTC and SEC have been debating this issue in the United States for years, without providing any clear information to the market.
At this point, Congress clearly needs to step in and pass legislation. This can be accomplished through an updated version of the Howey test, which applies to cryptographic tokens that may fall within the definition of an investment contract.
A modern cryptocurrency Howey test might look like this:
●Do you have any money to invest?
If the issuer of a cryptoasset does not sell the asset in exchange for funds to build the project, then it is not a security.
●Are you investing in ordinary enterprises?
For a cryptoasset to qualify as a security, it must be controlled and operated by a centralized organization like a company. If a project has become decentralized enough, then it is not a security.
●Are there any profit expectations?
If the primary purpose of a cryptoasset is some other form of utility (voting, governance, incentivized behavior of the community, etc.), then it is unlikely to be considered a security.
●Does the profit come mainly from the efforts of others?
If profits are expected to come primarily from participants unrelated to the issuance of the asset, then the project is decentralized enough not to be considered a security.
It is important to note that all four of the above points must be met simultaneously for an asset to be considered a security. Meeting a few of these points is not enough. For example, people invest in gold or a Picasso painting with the expectation of profit, but these are not securities because the expectation of profit does not come from ordinary enterprise (or the efforts of others).
We also need to establish a legal precedent for what constitutes “sufficient decentralization.” One lawyer (not speaking for myself or Coinbase) told me that it becomes a rough consensus that they see "5-15% of the token supply distributed" before asset issuers can begin secondary sales of their assets. But this has yet to be tested in court, and we will ultimately need to see how case law develops.
In the absence of clarity from the SEC and CFTC, Coinbase has developed its own detailed legal analysis for each asset being considered for listing, as we can only list items today. I want to open source this analysis (currently being worked on) to see if it can help self-regulatory standards emerge and save other cryptocurrency companies huge legal costs. We would prefer to receive this clarity from regulators, and when there is regulatory clarity we may need to update our analysis, but until then we are happy to present our work and see if it helps.
The industry is currently focused primarily on trading crypto commodities, but a robust market for registering and issuing crypto securities should also exist in the United States, which could be a real improvement over the traditional way securities are issued. Under current rules, this would require a broker-dealer authorized by the SEC to trade crypto securities and a separate national securities exchange. But these rules don't fit right now. While the SEC can amend its own rules to ensure customers are truly protected, Congress may need to act to make this happen.
Congress should also require the CFTC and SEC to clearly publish their classification of the top 100 cryptoassets by market capitalization within 90 days of the enactment of the above legislation, stating whether each asset is a commodity, security, or "other" (such as a stablecoin). Courts can resolve edge cases if asset issuers disagree with the analysis, but this will serve as an important labeled data set for other industries to use as millions of cryptoassets will ultimately be created.
2. Strengthen a level playing field
Clarity on regulation would be a good first step, but if we do not enforce these rules simultaneously at home and abroad, we will have no path forward.
One of the challenges is the focus of regulators and law enforcement on the domestic market. In most cases, they do not have international authorization or the ability to regulate or investigate offshore companies. If the entity is not registered, where will they send the legal notice? What door are they knocking on?
This creates perverse incentives, with some crypto companies choosing to provide services around the world in “favorable” overseas jurisdictions, while companies trying to comply domestically are penalized. A good example is FTX, which is based in the Bahamas but serves customers in many countries (including some US citizens) due to weak KYC controls. It seems to me that the FTX.US entity is partly genuine, but also partly an attempt to distract U.S. regulators from its main business.
It is an open secret in the crypto industry that there are still a few questionable actors who do not adhere to the above rules. We will continue to see problems in the crypto space until regulatory clarity emerges and fair competition is enforced.
What does it mean to enforce a level playing field? This means that if a country were to issue laws that all cryptocurrency companies would need to comply with, those laws would need to be enforced not only domestically, but also against foreign companies serving domestic citizens. Don’t take a company’s word for it, but check to see if these companies are actually targeting domestic citizens despite what they claim to be. If there is no authority to stop the activity, cooperation with international law enforcement will be required. Otherwise, there will be an inadvertent incentive for companies to serve the country from overseas in order to evade regulation. Countries that didn't realize this have lost tens of billions of dollars in wealth over the past few years, and now millions of customers have been lost due to the collapse of FTX.
3. Let innovation happen in decentralized cryptocurrencies
Listed above is a good set of steps to regulate centralized players in the crypto industry. But we have an opportunity to use the decentralization of cryptocurrencies to create stronger consumer protections.
First, self-hosted wallets allow customers to store their own cryptocurrencies in a trustless manner. Technological improvements such as multi-party computation and social recovery will make it easy for anyone to store their cryptocurrency easily and securely without trusting a third party.
Second, smart contracts supporting DeFi and Web3 applications are public and open source by default. This means anyone can audit the code to see if it actually does what it claims to do. This is the final form of disclosure. Instead of “Don’t be evil” (Google’s famous corporate value), we can have “Don’t be evil” where you can trust mathematical laws rather than humans.
Third, as we build more organizations "on-chain" using DAOs and smart contracts, we will see the emergence of on-chain accounting and will be able to fully transparently view the solvency, Financial statements, taxes, etc.
This is the future that self-hosting, DeFi and Web3 can deliver, but to get there we need to maintain the innovation potential of this technology. Self-hosted wallets should be treated as software companies rather than regulated as financial services businesses because the wallets do not take possession of customer funds. Likewise, creating a decentralized protocol or hosting a website on IPFS should be equivalent to releasing open source code, protected by free speech in the United States. People can send money through a web browser or internet protocol, but we don't regulate these as financial services businesses and the same concepts apply here.
The role of financial regulators should be limited to centralized players in cryptocurrencies, which requires additional transparency and disclosure. In an on-chain world, where this transparency is built in by default, we have the opportunity to create even stronger protections. With the internet, we have better regulation than taxi licenses through Uber's star rating system. Crypto has the potential to take this idea further by encoding on-chain trust in a cryptographically provable way.
in conclusion
Through regulatory clarity for centralized players, a level playing field, and the preservation of decentralized crypto innovation, the crypto industry can bring tremendous benefits to the world. Right now, the industry is too distracted by bad actors causing harm, and we all need to take responsibility for improving this. I am optimistic that we can make significant progress on the above and pass crypto legislation in 2023. Coinbase will work to help make this happen, and our doors remain open, so if you are a policymaker looking to work toward the goals above, please contact us.
*1 Objectively, KYC and AML have largely failed to prevent criminal activities. The United Nations estimates that only 0.2% of illicit funds are recovered, and the study estimates that "compliance costs exceed recovered criminal funds by more than a hundred times." It also violates customer privacy, results in higher customer fees, discourages entrepreneurship and innovation, and harms financial inclusion. Despite these issues, there does not appear to be a clean sweep of KYC and AML rules during Overton's debate window, so the most likely path is for KYC and AML rules to apply to centralized cryptocurrency exchanges and custodians, while distributed crypto Currency wallets and protocols represent the forefront of innovation, bringing tremendous value and protection to consumers.
*2 To be honest, the biggest obstacle to solving commodity and security issues is politics. Some regulators don’t want crypto regulation to be clear because they are actually trying to restrict the industry. Harsh rhetoric and enforcement regulations, without clear rules for everyone to follow, have pushed much of the industry outside the United States, harming American investors and businesses.
