Cryptocurrency Musings: A Tale of Two Approaches
If you live in New York City, you recently might have noticed taxicabs with a peculiar advertisement perched on their roofs. Gemini Trust Co., the cryptocurrency exchange founded in 2014 by the Winklevoss twins, placed ads in the beginning of 2019 calling for “crypto without chaos.” Perhaps a first, a cryptocurrency company is seeking regulations to clarify the requirements for operating cryptocurrency exchanges and the status of various cryptocurrencies as securities traded on its platform. Gemini, in essence, is betting that new regulations from Congress, the SEC, and the CFTC will boost investor confidence in cryptocurrencies and quell market concerns over blockchain technology products.
Gemini’s regulatory success so far is mixed. Their quest to launch a bitcoin-backed ETF earned serious doubts from the SEC because of market manipulation concerns. But Gemini’s launch of the Gemini Dollar, its proprietary stablecoin regulated by the New York State Department of Financial Services, was the first successful launch of a secure, audited, and regulated cryptocurrency pegged to the U.S. Dollar.
A cryptocurrency exchange publicly embracing regulations raised eyebrows in the cryptocurrency and blockchain industries (see my other article here regarding the need for cryptocurrency companies to effectively lobby for changes). Gemini’s approach is unique in an industry that has traditionally skirted regulations, drawing criticism from the SEC for offering unregistered securities. The SEC is increasingly targeting cryptocurrency exchanges in enforcement actions, although the SEC recently indicated that it might require further legislative powers to properly regulate cryptocurrency exchanges to protect consumers.
Many cryptocurrency exchanges, however, are now either cleaning up their acts to comply with recent SEC rulings or finding legal loopholes to skirt SEC regulations. The consensus among many market participants is that “a clear regulatory environment that fosters innovation while protecting investors is an important step.”[1]
But what is the best pathway forward for cryptocurrency exchanges like Gemini and its competitors? Should they continue to operate under dubious standards and practices until the SEC knocks on (or down) their door?
There are two strategic pathways that cryptocurrency companies can follow; the “slow and steady” approach or the “forgiveness later” approach. The “slow and steady” approach gives companies a chance to understand (and potentially mold) regulations, but requires patience and time. The “forgiveness later” approach operates on the fringes of regulatory oversight, but may reap higher rewards if companies mature before regulators catch up.
The Slow & Steady Approach
Some companies, such as Gemini, have approached an uncertain regulatory environment with cautious optimism. Certain industry participants are actively engaging with legislators and regulators to develop rules that apply specifically to cryptocurrencies (and ICOs). Frustration over the regulation delays is growing, with legislators noting:
“[The SEC and CFTC] have not proposed rules regarding the regulations of cryptocurrency and other digital assets and instead have relied on information rulemaking or enforcement actions.”[ 2]
The previous statement, made by U.S. Representative David Scott, occurred during a hearing asking cryptocurrency industry experts exactly what regulations the SEC and CFTC should pass. Reliance on the industry to help Congress and regulators understand, define, and organize cryptocurrency regulations is a key benefit of the slow and steady approach. A seat at the table, from the perspective of a disruptive company, provides an opportunity to ensure fair and comprehensive regulations.
Much of the issue remains that the SEC and other regulatory agencies are just beginning to grasp the idea of cryptocurrencies operating within the broader financial markets and how to define such activities. Because these agencies are inherently enforcement-related, the short- to medium-term focus will be enforcement activities against brazen offenders of existing regulations.[3]
In tandem with the desire for robust regulations, Gemini and its counterparts are actively working to mitigate risks relating to the cryptocurrency exchanges and products. Gemini notes in its white paper that licensing from regulators builds trust in the market by requiring issuers of stablecoins to maintain certain standards, much like banks and other financial services providers. Companies argue that transparency, although burdensome, is necessary to provide both regulators and investors with confidence in cryptocurrencies.
“We want to help ensure that the technology’s incredible benefits are not inadvertently stifled by regulatory or legal missteps.” [4]
New regulations will follow in the long-term once legislators and regulators are aligned. Cryptocurrency exchanges and other industry participants need to be patient, proactive, and productive to ensure regulations are appropriate for the industry. cryptocurrency regulations passed should not stifle the industry’s incredible growth and potential.
The Forgiveness Later Approach
The other pathway that some cryptocurrency advocates are embracing follows the typical disruptive startup adage: it's better to beg for forgiveness than to ask for permission. Startups eager to be “disruptive” in their industry sometimes ignore, or are blissfully unaware of, regulations that may apply to their business model. Cryptocurrency companies and exchanges are no exception, with many exchanges operating in regulatory gray areas or in other countries.
“[Startups] frequently underestimate the importance of integrating regulatory strategies when starting a business.” [5]
There is no shortage of examples of companies that have run ahead of regulations, only to be reigned back in by new laws, congressional hearings, and regulatory fines. Uber, Airbnb, Facebook, and Google are the most well-known examples of disruptive companies facing increased, and unwelcome, scrutiny because they operated outside of existing regulations.
Begging for forgiveness after the fact has its downsides. The SEC has levied exacting fines against several cryptocurrency companies in the past year. Some cryptocurrency companies have cut between regulations or ignored warnings from the SEC regarding securities regulations, prompting the SEC to heavily enforce existing laws.
Disruptive companies in other industries have faced similar costs. Uber was fined over $160 million across the globe, without including law suits, labor disputes, and continued regulatory scrutiny. And Facebook, despite its success as a public company, faced fines of hundreds of millions of dollars and is currently facing a record $1.6 billion fine in Europe.
In addition to fines, disruptive companies risk encouraging reactionary regulations in response to public or industry outrage (think Dodd-Frank and other post-crisis regulations). Reactionary regulations and policies are borne out of fear or misunderstanding, and are often onerous and damaging to a company’s business. The cryptocurrency industry, in its quest to out-pace regulations, may find that “forgiveness” is not a primary concern for legislators when drafting new laws.
[1] Coinbase Blog, Coinbase’s Written Testimony for the Subcommittee on Capital Markets, Securities, and Investment, Medium (Mar. 13, 2018), https://blog.coinbase.com/coinbases-written-testimony-for-the-subcommittee-on-capital-markets-securities-and-investment-47f8a260ce41 (quoting Mike Lempres, Chief Legal & Risk Officer, Coinbase).
[2] Aaron Wood, US Congress Divided on Crypto: From ‘Regulation is a Wet Blanket’ to “crypto is a Crock’, Coin Telegraph (Mar. 16, 2018) https://cointelegraph.com/news/us-congress-divided-on-crypto-from-regulation-is-a-wet-blanket-to-crypto-is-a-crock (quoting David Scott, U.S. Representative of Georgia).
[3] Ali Qamar, Policymakers on Crypto Regulations During Ripple Swell and the Effects on the Market Now, Global Coin Report, (Oct. 15, 2018) https://globalcoinreport.com/crypto-regulations-ripple-swell-effects-market-now/. (quoting Michael S. Didiuk, comments from the Ripple SWELL Conference (Oct. 2018).
[4] Coinbase Blog, Coinbase’s Written Testimony for the Subcommittee on Capital Markets, Securities, and Investment, Medium (Mar. 13, 2018), https://blog.coinbase.com/coinbases-written-testimony-for-the-subcommittee-on-capital-markets-securities-and-investment-47f8a260ce41 (quoting Mike Lempres, Chief Legal & Risk Officer, Coinbase).
[5] Jonathan A. Knee, Review: Why Start-Ups Need a Regulatory Strategy to Succeed, NY Times (Sept. 11, 2018), https://www.nytimes.com/2018/09/11/business/dealbook/fixer-regulatory-hacking-review.html.
About the Author
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Jared Arcari is a third year law student at Fordham University School of Law. Jared currently serves as the president of two student organizations, the Fordham Business & Law Association and the Entrepreneur Law Society. He is also a Notes & Articles Editor at the Fordham Journal of Corporate and Financial Law. When he isn’t writing about blockchain-related legal issues, Jared enjoys serving as a research assistant to prof. Bernice Grant researching entrepreneurial topics including non-compete alternatives and improving access to capital. To contact the author, please email him at [email protected].
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