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Recently, the cryptocurrency market capitalization has increased significantly, reaching nearly $3 trillion in 2021, but dropping to less than $1 trillion by the end of 2022. We have also witnessed cheating by many bad guys, from Terra (Luna) to his FTX.
Every asset has volatility, and fraud was not due to flaws inherent in distributed ledger technology (DLT), but due to poor governance and lack of a predictable and rational regulatory framework. In fact, almost all fraudulent activity takes place offshore. This is at least in part because most cryptocurrency companies believe the U.S. regulatory framework is too complex and vague to launch their operations.
Distributed ledger technology, often called “web3” (or new generation internet for short), uses blockchain to provide a way for users to access, record and digitally verify their activity. . Although the process is not necessarily fully decentralized, blockchain is a technology that enables collaboration and economic activity among many geographically dispersed people. Web3 tools include cryptocurrencies.
Because DLT outperforms existing centralized ledger technologies, including financial services, the spread of DLT across all sectors of the economy is inevitable. But the regulatory environment will determine whether the United States can take full advantage of this technology, or whether other countries such as the United Arab Emirates or Singapore will take the lead in attracting investors, entrepreneurs and technologists. It affects whether or not you are silently watching.
We believe there are four key issues that must be reflected in regulation.
- Imposing licensing requirements on centralized cryptocurrency exchanges and other digital currency services that behave like banks.
Just because a company trades cryptocurrencies does not mean that it should be exempt from financial regulation. When a company acts as a custodian of consumer assets and lends those deposits to others, it effectively acts as a bank and is subject to similar regulations based on its size and asset class. must be subject to Sadly, many companies in this space have sought regulatory arbitrage by operating outside the US due to regulatory ambiguity and arbitrage opportunities there. But to make matters worse, then-CEO Sam Bankman-Fried did so in direct conversations and plain sight with regulators who were supposed to be overseers.
What does compliance with regulatory requirements look like? A starting point may include capital requirements in the form set out in the most recent current and projected credit loss frameworks. This framework requires banks to use “reasonable and supportable” projections to derive the amount of capital reserves they should hold if the economy deteriorates. event. Or it might include basic cybersecurity and financial security regulatory requirements, such as SOC 2 compliance.
A centralized cryptocurrency exchange will need to consider the impact its failure will have on the system, and simply arbitrage and circumvent existing regulations as appropriate measures to mitigate future catastrophic consequences. We can provide guardrails.
- Clarify regulations about legal web3 behavior details.
Unfortunately, there is no single source that specifies legal requirements for web3 builders. And in some cases, regulatory guidance is conflicting. Most notably, the Department of Justice refers to tokens as commodities in enforcement actions, while the Securities and Exchange Commission (SEC) refers to tokens as securities and enforces them as such. Creating signposts for legal activity will not only encourage greater innovation as more companies are built within the U.S. regulatory sandbox, but it will also help law enforcement set more legal precedents. It also facilitates more consumer protection as the bright lines of legal activity become clearer.
Clear and consistent regulation is essential for companies operating in the cryptocurrency space. Regulators should strive to create regulations that are easy for businesses to understand and follow, and that do not create unnecessary barriers to entry. An example of clear and consistent regulation is the “BitLicense,” issued by the New York State Department of Financial Services specifically for companies operating in the cryptocurrency space. It sets out clear and consistent requirements that businesses must meet in order to do business in the state.
In the United States, state-level capacities vary, so there is room to experiment with different approaches. For example, the state of Wyoming has passed laws allowing certain types of cryptocurrencies and blockchain tokens to become legal property and has created a new type of bank dedicated to cryptocurrency companies. This allows us to operate in a more permissive regulatory environment. Similarly, Tennessee passed legislation allowing decentralized autonomous organizations (DAOs), a new form of governance leveraging the use of smart contracts and tokens, to be limited liability companies. This provides DAO members with additional areas of responsibility.
- Harmonize international standards.
Due to a strict and stringent regulatory framework, many web3 entrepreneurs and companies are based outside the United States for business or residence. Just as developed countries came together through the G20 annual meeting to coordinate their economic policies, and the OECD issued international guidelines on the ethical use of artificial intelligence, U.S. regulatory agencies are working with other agencies to develop a common set of guidelines. Principles and standards should be identified.
Many look to the SEC for guidance, and they too can learn a lot from their international counterparts. For example, we can work with the European Securities and Markets Authority (ESMA) to share information and coordinate regulatory efforts to combat fraud and protect investors in both regions. Similarly, the United States can learn from best practices in other countries, including Switzerland’s regulatory sandbox. This not only makes the distinction between security tokens and their counterparts clearer, but also ensures safety when piloting tokens as long as the amount raised and traded lasts. on is less than one million Swiss francs.
- Facilitate dialogue with researchers and industry stakeholders.
The cryptocurrency industry is evolving rapidly and it is important that regulators stay informed about the latest developments and trends. Unfortunately, regulations and even the federal hiring process have not moved fast enough to keep up with these trends, so it is important that regulators engage with the web3 community and facilitate dialogue with researchers and practitioners. . For example, the U.S. Commodity Futures Trading Commission (CFTC) can hold regular public meetings with industry leaders, academics, and other experts to discuss the latest developments and trends in the cryptocurrency space.
Fortunately, there are many platforms that facilitate these interactions. For example, the Center for Digital Finance and Transformation at Columbia University frequently brings together industry experts and academics to help convene and engage federal and state policymakers. A policymaker, especially his SEC, CFTC and DOJ, should look for opportunities to work with experts and researchers to find out more.
While these recommendations are certainly not exhaustive, they are a set of recommendations that will improve the economic and social competitiveness of the United States while mitigating the risk of tail outcomes such as those observed in the cryptocurrency community over the past year. It reflects general management principles. Most importantly, it encourages regulators to understand the context, enable experimentation and dialogue, rather than take a one-size-fits-all approach to web3 regulation.
Christos A. Macridis is CEO and Founder of Dainamic, a research affiliate of Columbia Business School, Stanford University, University of Nicosia, and a start-up aimed at democratizing access to AI for small and medium-sized banks . Jay Jog is the co-founder of Sei Labs, his first sector-specific L1 blockchain dedicated to trading. Previously, he was an engineering lead at Robinhood.
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