Should Crypto be Regulated?

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The demise of FTX, the Bahama-based cryptocurrency exchange, has ignited the call for expanding federal oversight of this often-unregulated market activity. What can and should be done, and by whom?

Suffice it to say that virtually all commercial activity is subject to some degree of regulation. Business entities can’t operate fraudulently or lie and cheat, for example. The real question at hand is whether activity relating to cryptocurrencies requires any specific regulation pertaining solely to that activity. It seems reasonable that the Securities and Exchange Commission (SEC) would be a reasonable candidate to take the lead on this issue, given its mandate to assure fair, efficient, and orderly markets in connection with investment activities.

Gary Gensler, the chairman of the SEC, seems to think that he has that authority already, as he believes that cryptocurrencies qualify as securities. That assessment, however, is subject to some debate. Not everyone agrees as to what, exactly, qualifies as a “security.” The Howey Test appears to be a common reference point. This test came out of a supreme court case decided back in 1946 (SEC v. W.J. Howey Co.). It posits that an instrument is a security (and hence should be subject to the SEC’s authority) if it involves an investment of money in a common enterprise where there’s a reasonable expectation of profiting from the efforts of others. Reasonable people disagree as to whether cryptocurrencies meet this standard; and as a result, regulatory coverage for this industry is spotty, at best.

It seems to me that whether cryptocurrencies satisfy this definition or not is a bit of a distraction. The fact is, a host of markets for cryptocurrencies are currently operating, and the recent debacle of FTX certainly challenges the view of these markets as being fair, efficient, and orderly. Given that starting point, it seems appropriate for some agency of the federal government to serve as the cop on the beat — if not the SEC, then perhaps the Commodity Futures Trading Commission (CFTC), or some combination of the two.

I don’t have all that much concern or sympathy for speculators in these markets who’ve put their money on the line and lost it, but I am concerned about the use of cryptocurrencies as a medium of exchange in connection with illegal activities, which are facilitated by the anonymity of the players. In virtually every other financial arena, regulatory gate keepers identify those responsible for large transactions as an element of market surveillance, which is necessary to assure that markets aren’t being manipulated or otherwise sabotaged.

It’s useful to realize that markets are made up of end-users (in this case cryptocurrency speculators), dealers (i.e., firms that set themselves up to buy and sell from customers for their own account), and brokers (i.e., firms that act as agents that bring buyers and sellers together but bear no direct exposure to the price of the cryptocurrency, itself). Each of these categories is regulated in virtually every other financial market operating in the US today, and that same kind of oversight is appropriate in these markets, as well, subjecting these roles to requirements relating to disclosures, registration, and reporting in connection with cryptocurrency activity of a certain size. The SEC and CFTC both have rulemaking experience with all of these categories. Extending that experience to cover enterprises that deal with cryptocurrency shouldn’t be hard.

Although I think it’s time to bring some greater regulatory discipline to cryptocurrency markets, I come to this conclusion reluctantly. Truth be told, I’d rather see this whole industry crumble and fade away, thereby obviating the need for regulation altogether. Cryptocurrency markets and their infrastructures appeal to two audiences: criminals and a certain class of speculators. Neither are particularly deserving of any special consideration.

Criminals who use cryptocurrencies as a medium of exchange in their illegal activities are a clear threat to our social order. Cryptocurrency speculators may not be as nefarious, but neither are they particularly meritorious. These speculators are using these markets solely to transfer wealth from one speculator to the next, with no consideration of any other social or economic consequence. Given the plethora of speculative opportunities out there where capital can be allocated in a manner to create a larger economic pie, it’s hard for me to view speculation in cryptocurrencies as anything other than a mark of decadence. I’d like to think that we’re better than that; but since we’re apparently not, more stringent regulation seems to be the way to go.

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