How U.S. Regulators Could Race To The Bottom For Crypto

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Since September 30, 2019, two major blockchain networks received major announcements from U.S. regulators. On September 30, 2019, a company called Block.one paid a $24 million fine to the SEC for an unregistered securities offering. In return, the EOS cryptocurrency, a native token of the EOSIO blockchain network, can be used publicly without risk of any securities law violations. The Initial Coin Offering for EOSIO raised a reported $4 billion. Soon thereafter, on October 10, 2019, the CFTC declared Ethereum was a commodity, solidifying certainty that it was not a security.

What is more interesting is that EOS opened an office in Arlington, Virginia, right next to Washington D.C., with numerous politicians including the Virginia Governor at the opening of the office and with Block.one indicating the potential of up to 200 blockchain jobs. As I reported earlier this week, Ripple just opened up a major political and regulatory affairs office in D.C. as well.

The opening of the Block.one office shortly before the SEC settlement (8 days prior) and the appearance of the General Counsel of Block.one speaking at the CFTC’s Technical Advisory Committee the day after the settlement, hints at the concept of a “race to the bottom”.

A race to the bottom indicates that regulators – or countries – attempt to lower the threshold on regulations to attract businesses to its jurisdiction. For example, the Libra Association established itself in Switzerland rather than the United States, perhaps as a result of the Swiss law for nonprofits that makes it easier and less likely to face stringent regulation. In fact, many in Congress asked Libra why not or to please consider re-establishing itself in the U.S.

For U.S. regulators, a race to the bottom will occur when an agency may lower its standards in some ways to attract more businesses to be under its purview. While this may seem counterintuitive, the many regulators in the U.S. do have a healthy sense of competition between each other and can equal measures of power and influence in D.C. Indeed, regulators facing a lower amount of entities to regulate translates to budget and job cuts for the regulators of that agency.

The Global Financial Crisis showed a textbook example of the worst kind of impact from a “race to the bottom”. The Office of Thrift Supervision served as the regulator of Countrywide, IndyMac, Washington Mutual, and AIG – all headline-grabbing bank failures. When a bank fails that is of a significant amount, there is a statutory “Material Loss Review” (MLR) investigation of the regulator and the facts and circumstances of the bank failure. In the case of IndyMac bank, one of the most egregious examples of a regulator placating a bank it was responsible for examining was noted in the MLR below:

“…OTS allowed IndyMac to record an $18 million capital infusion from the holding company, received in May 2008, as though it was available on March 31, 2008. This allowed IndyMac to inappropriately report that it was at the well capitalized level as of March 31.”

Department of the Treasury, OIG, Material Loss Review of IndyMAC Bank 2009

A race to the bottom can lead to the regulator taking the side of the industry it regulates. This is another concept known as regulatory capture, a symptom of this race to the bottom.

For cryptocurrency companies, the idea of regulators lowering their standards is probably a breath of fresh air. Indeed, the many regulators in the U.S. economy can make for a costly and confusing dilemma for these companies. With some of the rhetoric in Congress lately on cryptocurrency and blockchain, the idea of a race to the bottom for this industry is actually a much-needed solution to the potential stifling of this innovation that sends U.S. companies overseas.

As regulators embrace cryptocurrency and blockchain innovations, the true test will be in the actual, ongoing work of regulating these companies once better clarity is established and the dust settles. Congress and the public relies upon the regulators – and the inherent trust placed in them – to ensure that, as leeway may be offered providing at times “light-touch” regulation, that these do not mean either ignoring the failings of a company to comply with regulators, or in the very worst case with IndyMac bank, being complicit in falsifying regulatory reports on the status of a particular company’s financials.

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