Where do we go from here? Reactions to recommended U.S. crypto market regulation

In a recent Wall Street Journal article, Jay Clayton, a former chairman of the Securities and Exchange Commission (SEC), and Timothy Massad, a former chairman of the Commodity Futures Trading Commission (CFTC), shared their thoughts about U.S. cryptocurrency regulation.

Clayton and Massad’s missive reflects an appreciation of the difficulties in regulating in the space. For example, the nature of certain crypto assets is unclear — complicating the selection of the appropriate regulatory regime to govern these assets. Additionally, while legislation is making its way through Congress, achieving consensus may be difficult given divergent views about crypto in general.

While Clayton and Massad propose that U.S. regulation in the industry not rest on a particular view of crypto (i.e., critic or enthusiast), they appear to blame crypto proponents for the slow pace of regulation. Clayton and Massad claim that crypto proponents try to exploit the fragmented U.S. regulatory system by arguing that most digital assets should be treated as commodities where the spot market has “no federal regulator.” The authors also claim that certain market participants cite regulatory uncertainty as a reason for noncompliance with existing regulations, noting that this is simply a pretext in order to avoid the costs incurred with compliance. 

While the authors’ views about crypto proponents may be painting the industry with too broad of a brush, it is fair to say that some market participants view the CFTC as a friendly regulator with weaker authority to oversee market activity. To be sure, Clayton and Massad are using the phrase “no federal regulator” loosely (as the Commodity Exchange Act and related rules grant the CFTC jurisdiction to police manipulation and fraud in spot digital asset transactions) — likely an intentional choice of words to emphasize the CFTC’s lack of overall oversight with respect to spot market transactions.

To address the inadequacies of the current U.S. regulatory regime, Clayton and Massad propose that U.S. regulators consider the following three recommendations:

1. Require intermediaries to abide by standards that protect customers, including standards (1) requiring the segregation of customer assets, (2) imposing limits on lending, (3) imposing restrictions on operating conflicting businesses and (4) prohibiting fraud and manipulation;
2. Impose rules governing the usage of stablecoins; and
3. Continue rigorous enforcement of the law.

While these recommendations certainly dovetail with other market commentary, the authors omit any reference to the approaches other jurisdictions have adopted. For example, Japan’s Financial Services Agency, in response to the hack of Tokyo-based Mt. Gox in 2014, adopted stringent rules for crypto exchanges — including a requirement to undergo a yearly audit.

Despite the shortcomings of the article, it is difficult to disagree with Clayton’s and Massad’s conclusion: the digital asset space should be subject to a strong regulatory framework — one that even applies to DeFi activities — despite what some say about innovation moving outside of the United States.

For more on the regulation of cryptoassets and decentralized networks, view our report “Crypto and DeFi – Understanding the risk landscape” published last week.