How the Feds Could Regulate Crypto (and Why All Is Not Lost for Investors) Threats of impending cryptocurrency regulation have dominated headlines in recent months, but all is not lost for crypto investors. Here are a few protections that stand in the way of a federal crypto showdown.
By Chad D. Cummings Edited by Kara McIntyre
Opinions expressed by BIZ Experiences contributors are their own.
Each day seems to carry with it a new, ominous headline propounding the imminent demise of cryptocurrency. The death of Bitcoin has been predicted more than 450 times as of this writing. And yet, it seems to have staying power: more than $23 billion of Bitcoin has changed hands in the last 24 hours. Seasoned crypto investors — and their detractors — have weathered ups and downs, and there are doubtlessly more to come. But with each crash (and subsequent boom), the war drum of federal regulation increases in fervor and proximity.
In November, following the well-publicized collapse of FTX, Treasury Secretary Janet Yellen chastised the crypto world in a threat that sent markets in a steep plunge: "The recent failure of a major cryptocurrency exchange and the unfortunate impact that has resulted for holders and investors of crypto assets demonstrate the need for more effective oversight of cryptocurrency markets." The specific areas of concern she identified included "comingling of customer assets, lack of transparency and conflicts of interest," which she claimed "was at the center of the crypto market stresses observed over the past week."
While a precise federal framework of crypto regulation has not yet been codified into law, she made it clear that the writing is on the wall: "Where existing regulations apply, they must be enforced rigorously so that the same protections and principles apply to crypto assets and services. The federal government, including Congress, also needs to move quickly to fill the regulatory gaps the Biden Administration has identified."
The consensus within the industry is that some bill — which will likely garner bipartisan support — will make its way to the president's desk, although there is little agreement about what it might look like. While we're waiting, it might be helpful to review the existing crypto regulatory universe and then survey some of the roadblocks the Feds must first traverse en route to crypto regulation.
The lay of the land: Existing crypto regulations
Crypto might not be the wild west it was 10 years ago, but it is still one of the least-regulated asset classes in the modern era. Whether that is an asset or a liability depends upon whom you ask. For starters, there is no single entity or person at the federal level responsible for the regulation of crypto.
The Federal Reserve, for example, does not regulate individuals' cryptocurrency holdings directly, but it does exercise oversight on crypto holdings owned by banks. The SEC, which regulates securities, has previously said that Bitcoin and other large-cap coins are not securities — for lack of a "common enterprise" — but that many hypecoins and ICOs likely fall within the ambit of the definition of "security," which is the central issue in current and future attempts by the regulator to exert control.
Other entities, like the Financial Crimes Enforcement Network (FinCEN), are concerned with reining in malicious and clandestine use of crypto; for example, its use in money laundering and other financial crimes.
At the state level, some states, like New York, already require the registration and regulation of cryptocurrency and have essentially banned mining. Multiple state attorneys general are investigating crypto and have taken an interest in it, ostensibly under the banner of consumer protection. Many states are taking a wait-and-see approach for fear of pre-emption at the federal level by forthcoming legislation.
In short, it is wholly inaccurate to say that crypto is unregulated. In fact, there already exists a patchwork of federal and state regulations and case law that purport to regulate crypto; what's missing is a comprehensive federal law, akin to the Securities Acts of 1933 and 1934.
Related: 5 Things to Expect from Crypto in 2023
You can't get there from here: Constitutional safeguards for crypto
Economists and attorneys far smarter than me have already confronted this topic with varying degrees of success. Justin Wales, the head of legal at Crypto.com, penned what is probably the most cohesive and enlightening take on the constitutional safeguards protecting cryptocurrencies.
In short, he argues — convincingly, I might add — that the Bitcoin blockchain is a form of protected expression and is therefore entitled to security under the First Amendment to the Constitution. His writing is illuminating for those endeavoring to understand the regulation of crypto — as it exists today and what is likely to transpire — from both an academic and practical perspective. It is also an interesting facet of the free speech arguments that have dominated headlines as of late.
Other constitutional antidotes of varying strength that might imperil an attempt by the Feds to ban crypto outright include the Fifth Amendment (the government can't take something for public reasons without compensation), the Contracts Clause (the government is limited in its ability to impair and negate existing contracts) and the Due Process Clause (requiring the government to give citizens their metaphorical day in court before depriving them of liberty or property). Similar safeguards exist at the state level in the various state constitutions.
With all those speedbumps, do not be lulled into a false sense of security. Don't misunderstand: I am not suggesting that crypto is regulation-proof — because it isn't. If one thing is certain, it is that the federal government will attempt to regulate everything it can, down to the requirement of wearing pants (not shorts) while riding a moped into Fort Stewart. The Feds will use the Commerce Clause — which allows them to regulate virtually anything implicated in interstate commerce (and crypto is most certainly that) — to implement a regulatory framework. Whether that regulatory effort is effective in attaining its laudable goal — namely, consumer protection — will be a question for a later date.
Related: White House on Crypto: More Oversight is Needed to Avoid 'Harming' Americans
Next stop: Central bank digital currencies
Ironically, the most effective effort by the federal government to chill cryptocurrency might not come from its legislative activities, but instead, by creating its own: "if you can't beat 'em, join 'em."
Lael Brainard, vice chair of the U.S. Federal Reserve, hinted that a fed-backed Central Bank Digital Currency (CBDC) is not just possible, but inevitable. She explained: "The dollar is very dominant in international payments, and if you have the other major jurisdictions in the world with a digital currency, a CBDC offering, and the U.S. doesn't have one, I just, I can't wrap my head around that." Fed Chair Jerome Powell previously testified in Congress that research has been underway for some time on the pros and cons of what some have termed "FedCoin" and that a report is forthcoming.
There can be no doubt: The introduction of a federally-backed CBDC will be the make-or-break moment for all cryptocurrencies. Whether cryptocurrency survives as an asset class will depend, in large part, on whether FedCoin sinks or swims. Crypto proponents will point out — correctly — that any federal CBDC will likely suffer from the same disadvantages of the fiat U.S. dollar: most notably, inflation and a lack of supply discipline.
It is difficult to predict the success of a federal CBDC with any degree of specificity, at least until the Fed promulgates some detail on their forthcoming coin. The Fed has likely studied the apparent shortcomings of China's CBDC — the digital Yuan (e-CNY) — and will attempt to ameliorate those in whatever package it brings to market.
There are also substantial privacy concerns surrounding the introduction of CBDCs which will need to be addressed. These privacy concerns will make anonymity (or something close to it) a selling point for the continued viability of non-CBDC cryptocurrency.
Related: Fed and Bank Regulators Issue Warning Over 'Significant' Risks of Crypto Assets
As Florida attorney Anessa Allen Santos explains: "a CBDC would result in greater centralization of our current financial system. Currently, when the government wants access to a person's financial records, it must do so through serving a subpoena on the financial institution. A CBDC system, on the other hand, will disintermediate that process to enable the federal reserve to directly access every person's financial history for total surveillance and control. While this would support the faster distribution of government funds into citizen accounts, it also means the administration can shut off anyone's account at any time, leaving the account holder with no recourse."
In summation, a Congressional attempt at federal regulation of cryptocurrency is on the horizon, and the introduction of one or more CBDCs is the wildcard. While there exist numerous avenues of potential regulation at the federal level, and at least as many at the state level, there are several guardrails in place that would likely prevent an outright ban on cryptocurrency.
As of now, the cryptocurrency market remains liquid, and for some, quite lucrative, notwithstanding the recent FTX implosion. Crypto speculators — and their detractors — would be well advised to keep abreast of changes in regulation and scrutinize any proposed legislation for impacts on their investing thesis.
Disclaimer: My thoughts expressed in this article are general in nature. They should not be construed as legal or tax advice, are not relevant or applicable to anyone's particular circumstance or fact pattern, and should not be relied upon in the absence of formal advice from a qualified professional.
