Are cryptocurrencies and blockchain businesses overregulated or underregulated? Many in the field already feel under attack from the host of awakening U.S. federal and state regulators. Meanwhile, some observers call for Congressional action or a more comprehensive regulatory approach. That should not happen. Nothing about blockchain technology requires new federal legislation. But serious practitioners must learn to navigate existing federal regulations and stay on top of certain state-level developments.
Until recently, the majority of token funding happened outside of the United States, or within the United States but under the radar of market regulators. Blockchain proponents have realized that they cannot ignore the world's largest economy, and the home to major universities, financial markets, infrastructure, governments, and private enterprise.
There is a price of admission, though. U.S. regulators have recognized the importance, and the permanence, of blockchain projects, and have determined that their own mandates apply to this field to protect the public from market risk, fraud, and theft. The Securities and Exchange Commission has stated that the Howey test – to evaluate whether or not an instrument is a security – applies to digital tokens. And it has put some bite in its bark, showing it is not afraid to bring enforcement actions against ICO sponsors for fraud and other violations.
The Commodity Futures Trading Commission, meanwhile, has vaunted its ability to regulate certain digital assets as commodities. It succeeded in obtaining a federal court decision this year recognizing its jurisdiction to do just that.
Other agencies are also not sitting idle. Treasury's FinCEN assessed a fine of over $100 million against an entity acting as a cryptocurrency exchanger, for violation of regulations concerning anti-money laundering and suspicious activity reports. The Justice Department has already prosecuted several misusers of digital assets, and its cybercrime task force is focusing on cryptocurrency strategy. The Federal Trade Commission, the Internal Revenue Service, and even quasi-public FINRA have all set their sights on blockchain and digital assets in the last year.
Meanwhile, state regulators are moving quickly, and sometimes perhaps too quickly. New York's Bitlicense concept has not aged well, as some practitioners simply avoid the state. Other states want to be perceived as crypto-friendly, but it remains to be seen if nascent government efforts such as those in Wyoming, Arizona, and elsewhere actually create useful environments.
If it all seems like a minefield, that's because it is. But these legal challenges are not much different from other regulated industries. If you want to raise money from investors, or market complex services to consumers, or exercise control over large amounts of capital, someone is tasked to look over your shoulder to protect the public from bad actors and incompetence. That is not novel, nor is it unwarranted. When the regulators miss, we get broken banks, or a broken industry, or a broken mortgage market. But when the government applies existing regulations carefully and judiciously – as it generally appears to be doing with cryptocurrency in the past year – it contributes to safe, sensible growth.
Caution to the unwary, however. The application of existing regulations to new technology is tricky business. The regulator must not only master an emerging subject matter, it must also strive to understand the culture driving that technology. It must punish those who are seeking to prey on the vulnerable, and support those who are seeking to blaze trails to find new business solutions. In the government-wary, code-is-law culture of blockchain, that can be a tough distinction to recognize.
Practitioners, meanwhile, must adapt as well. To avoid becoming a test case, it is advisable to understand the regulatory environment, learn how to comply with the relevant rules, and develop collaborative relationships with the bodies overseeing this work. A reckless or hostile approach to government regulators may backfire.
It is no longer realistic for the blockchain and cryptocurrency businesses to stay out of the U.S. market. But they cannot quietly sneak by the bear. Regulators are already out of hibernation. The industry must now demonstrate a capacity for more broadly using business standards and self-policing mechanisms, and for helping form a direction for national policy.
Also read a related client alert, "Taking a Trip Around the Regulatory Block: U.S. Regulation of Blockchain and Digital Assets."
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