“I hate to say what I told you” is a phrase that is often repeated, but rarely sincerely. It’s a delightful feeling to claim credit for warning you of a problem ahead of time. This is a liberties I take with the federal financial regulators at the US Securities and Exchange Commission.
In January of this year, as a member of the SEC’s Investor Advisory Committee, which advises SEC Chairman Gary Gensler on crypto and other matters, I filed a petition with the SEC. I asked them to open a formal public discussion about the unique issues surrounding crypto and other digital assets. I have pointed to conflicts of interest related to the custody of cryptocurrencies and intermediaries as key issues that the SEC must address.
I have called this new start the “Genesis Digital Asset Regulation Block”, which will help the SEC improve crypto regulation. The SEC aggressively ignored me.
When my term on the SEC advisory committee ended last week, I took the opportunity to say some strong words to Chairman Gensler about his misuse of digital assets. See Gensler’s answer. pic.twitter.com/3oa5xJU1Ch
— JW Verret, JD, CPA/CVA (@JWVerret) March 15, 2022
The failure of the SEC and US banking regulators to adapt the rules to crypto intermediaries did not directly lead to the collapse of FTX. However, their failure to create working rules for U.S. crypto intermediary exchanges to hold crypto created an environment in which scammers like Sam Bankman-Freed could thrive abroad.
Let’s start with the basics. The point of crypto is not to trade a new product within the traditional financial system. Cryptocurrency is a revolution in finance that empowers asset owners.
The fact is that people get the same control over their assets as Goldman Sachs partners when they transfer, lend and exchange cryptocurrencies in a decentralized financial system.
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Doing it right is a huge responsibility for new users. This requires knowledge of the smart contract code you are interacting with, familiarity with cold storage wallets, and basic operational security for encryption keys.
A complete revolution will take time. JPMorgan won’t bring you a revolution (so don’t buy JPMorgan coin). However, most new users will first enter crypto through custodial intermediaries, which are a bit like traditional financial intermediaries.
Intermediaries that store crypto for retail novice users need a set of rules to protect customers from conflicts of interest and shell games, such as the FTX/Alameda playbook. However, formulaic application of the rules promulgated for paper stock under the 1933 and 1934 laws simply won’t help.
Federal bank and securities regulators have created artificial friction for banks and brokers trying to hold crypto assets in line with existing regulations. On the other hand, they insist that federal regulation is necessary to protect clients. While cryptocurrency exchanges have wove between a rock and a hard place created by US regulators, the FTX scam has flourished overseas.
Cryptocurrency exchanges need smartly designed custody rules. While this would not solve the problems on overseas FTX exchanges, it would instead help more international retail flow to the US.
Efforts by existing crypto exchanges to get clarity from the SEC regarding the holding of cryptocurrencies have hit a brick wall. States such as Wyoming have developed a way to bank hold cryptocurrencies, but the Fed is refusing to give these banks access to the Fed’s main accounts.
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The Federal Deposit Insurance Corporation told banks that any attempt to store cryptocurrencies would require the bank to explain to its bank inspectors. This regulator expression means “do not touch”. Many crypto exchange lawyers tell a similar story about filing with the SEC for a license for an alternative trading system that was a slow pace to death.
We will soon hear regulators complaining that if they had a little more power and a little more funding, they could protect customers from crypto. This style of illusionist misrepresentation is no different from Bankman-Fride’s evading investors’ pleas for discretion.
Keep an eye on my beautiful assistant (not the one under the table).
Cryptocurrency needs protection from regulators. Crypto innovators are developing solutions such as multi-signature wallets and Merkel tree-based reserve verification that are light-years ahead of customer protections in traditional banking and exchange custody. Just because Bankman-Freed didn’t use them doesn’t mean they aren’t real.
If the SEC and banking regulators want to be part of the solution and not part of the problem, they must do two things. First, launch the Genesis Block digital asset regulation process in agencies. Then, when securities and banking lawyers for crypto intermediaries knock on the door with good ideas on how to comply with the adapted rules, listen up.
JW Verret is an associate professor at the George Mason School of Law. He is a practicing forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Advisory Board of the Financial Reporting Standards Board and a former member of the SEC’s Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting to change policy to preserve freedom and privacy for developers and users of cryptocurrencies.
This article is for general informational purposes and is not intended and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are those of the author only and do not necessarily reflect or represent the views and opinions of .