Areas for Crypto Regulation

Previously, we talked about the high level goals of cryptocurrency regulation. Here, we’ll outline the areas of the crypto ecosystem most in need of regulation.

There are a large number of parts of the cryptocurrency ecosystem that are in need of further and clarified regulation. We see three primary areas as the first priorities: stablecoins, token issuances, and markets.

In this post, we will give a brief overview of possible regulatory frameworks for each of these areas. In future posts we will dive into greater detail on each.

As always: regulators, lawmakers, and other key decision makers ultimately have a large breadth of experience, perspective, and authority on market regulation, and we welcome their feedback and proposals.

Stablecoins

At its core, a stablecoin is a cryptocurrency token which is backed by a stable asset–usually the US Dollar. You can generally send in $1 to create 1 stablecoin token (‘create’), and send back (‘redeem’) 1 stablecoin token to receive \$1.

As of now, there is significant uncertainty about which regulators will ultimately play the largest role in overseeing stablecoins, and what the standards will be; we are mostly agnostic about which agency–or combination of agencies–takes the lead on registering a stablecoin issuer or the stablecoin itself. There has been considerable debate on whether a stablecoin issuer should be treated more like a payment-system operator, a bank, or a securities issuer. On these specific policy decisions, FTX US is again mostly agnostic, so long as the core areas described below are addressed.

We see three core areas of stablecoins that would benefit from a full regulatory framework:

Reserve risk. If the reserves of a stablecoin drop below the number of tokens issued, they are in danger of losing their \\$1 peg. This poses both consumer and systemic risk.

• Financial crimes. There need to be some controls to prevent stablecoins from being used to finance illicit activities.

• Redemption risk. It is crucial for consumer protection that stablecoin issuers honor their commitment to allow users–conditional on sufficient AML/KYC thresholds–to redeem the stablecoins 1:1 for US Dollars.

• Cross-Border Regulatory Harmonization. Stablecoins facilitate fast payment settlement, and they do so on a global, borderless scale. To fully realize the benefits achievable through payment technology, key global regulators should cooperate on a practical and harmonized approach to regulation - whether through parallel rulesets, mutual recognition regimes, or other similar constructs.

We think that a registration and transparency based regime that mandated periodic audits, daily transparency on the composition of the reserves, blacklisting of blockchain addresses and persons associated with financial crimes, and policies around honoring redemptions would go a long way towards addressing these concerns.

We also think that stablecoins are a crucial part of the growing crypto ecosystem, and that it’s important to allow that growth to continue, as long as the above goals have been met. As the U.S. crypto ecosystem grows, the blockchain promises of transparency, settlement efficiency, innovaction, and value creation can be realized. Furthermore, we believe that fostering a safe, efficient stablecoin ecosystem in the U.S. is crucial to maintaining USD as the reserve currency of the cryptocurrency ecosystem and the increasingly digital economy. Today most of the cryptocurrency ecosystem is U.S. stablecoin denominated; inhibiting stablecoins risks that liquidity moving over to other base currencies. Stablecoins have also presented fast, cheap, efficient methods of transferring value, which have enabled greater capital efficiency and user transparency.

You can read more about our thoughts on stablecoin regulation here.

Token Issuances

One of the powerful, valuable, and risky parts of the crypto ecosystem has been the ease with which new assets can be minted or created. Any user with an internet connection can create their own ERC20 token.

We think it’s important to allow the crypto ecosystem to continue experimenting with new assets. That being said, as SEC Chair Gensler has emphasized, there is a large need for regulation around the issuance and sale of digital assets to US consumers.

We’ll focus here on digital assets with security-like properties. Some of these are clearly securities; others may or may not be, and may share some but not all common attributes of traditional equities.

For security tokens that fully replicate the properties of traditional equities (e.g. EXOD) there exist traditional avenues for registration, and we encourage the efforts of market participants working with the SEC to build and provide trading traditionally registered venues and related services for these digital assets - even where the technological plumbing does not resemble traditional securities markets infrastructure.

However, for tokens that resemble traditional equities less closely, the current regime is, in practice, not ideal: the tokens mostly either avoid the U.S. or claim to not be securities; many of them may, in fact, be held to be securities (should a court do the analysis), thus representing unregistered securities offerings to U.S. retail consumers. However, there isn’t a clear registration process for a token associated with a decentralized on-chain protocol with no associated company receiving the revenue and paying expenses. This creates a combination of noncompliance, enforcement, and the bulk of the industry moving offshore–with U.S. consumers accessing unregulated offerings.

A new paradigm for digital assets might include registration, disclosure, audit, oversight, and accountability requirements, but differently scoped so that they are fit for purpose in the digital- asset context. The reality is that investors need to be adequately informed before investing in a digital asset, but the type of that information is not the same as what has become the standard for traditional securities because they are not being issued by traditional corporate structures and are not designed only to raise capital.

For instance, a digital asset associated with a protocol might need to disclose what relationship, if any, exists between the asset and the protocol; and further disclose all relevant metrics of the protocol (e.g. fees/revenue), keeping those up to date for prospective investors. There would need to be clarity around who, if anyone, could be held accountable if there were material misstatements made about the asset or its associated programs, disclosure around what recent token sales have happened, and on large holders of the token. That is, there will be important questions around who or what is liable for the registration, reporting, disclosure, and other obligations. The lack of an associated company for many of the tokens renders many of the standard requirements difficult.

We think it may rightly be one or a combination of the creator of a given token, a core developer community that elects to support the token network, and/or an exchange marketplace that elects to list the token (or a related derivative) for trading. The right party to take on the responsibilities will depend on the status of the network. The important outcome, from our perspective, is that some party is assigned and/or has assumed these obligations - a party that is identifiable and has the ability to be accountable.

This could give regulators the oversight they need to prevent scams and misinformation, and give consumers the relevant and accurate information they need to make informed investment decisions.

This is likely something that–at least for tokens which are securities or have security-like properties–the SEC would take the lead on regulating, possibly with some involvement from other agencies (e.g. the CFTC).

We will post a more detailed discussion on token issuances later.

Markets

The current regulatory landscape for crypto markets regulation is fractured in the U.S. BTC and ETH futures–more generally, crypto commodity futures–are regulated by the CFTC; digital assets that are securities are regulated by the SEC; and other spot markets (e.g. BTC/USD spot markets) do not have any direct markets regulator. The CFTC has broad anti-market- manipulation powers, and states each individually regulate money transmission, but no agency is tasked with registering or licensing BTC/USD spot markets from the perspective of healthy market practices.

The single thing we believe most strongly is that there should be a unified regulatory framework for crypto markets. This is for a number of reasons:

• Cross margining. Users should be able to use crypto assets as collateral for crypto futures. This requires most crypto assets to live in the same clearing/custody regime.

• Spot and future integration. Users should be able to trade digital assets currently held as collateral for futures contracts; this requires the spot markets for crypto assets to live in a compatible regime with futures clearing.

• Standardized reporting; coordinated and integrated surveillance. Analyzing, detecting, and addressing unhealthy market practices is much easier if crypto markets follow standardized parameters and reporting requirements; this is much more difficult if futures and spot markets on commodity, security-like, stablecoin, and security digital assets end up in different trading and markets regimes.

• Regulation and iteration. It is much easier to implement and refine regulator regimes for crypto assets if it doesn’t need to be done separately in many different paradigms.

• Implementation. Actors in the industry will be able to do a better, more thorough job of implementing and enforcing regulations if there is a unified framework rather than a fractured one.

Both the SEC and the CFTC play important roles in markets regulation, and so any regime for crypto assets would likely need to be at least somewhat of a joint one. It will likely have to interface with SEC regulated security registration requirements, and with CFTC regulated exchanges and clearinghouses, as well. In a framework that involves both market regulators, which FTX US believes is the likely as well as preferred outcome in the U.S., we think policy makers should leverage the unique expertise that both agencies possess.

For example, the SEC, not the CFTC, historically has implemented and enforced a disclosure regime to ensure investor protection. It would make sense to ask the SEC to do the same in a unified market-regulatory regime. The CFTC has developed vast expertise implementing and enforcing a principles-based regulatory structure that delivers on the key policy goals for safe and orderly markets, but through a less prescriptive set of regulations that seem especially appropriate today for an asset class that is still nascent and evolving rapidly. FTX US believes the two market regulators should look to precedent for when they have cooperated and jointly supervised certain products and entities before and build from that precedent a model that creates a singular regime involving them both.

Perhaps the SEC could take the lead on regulating issuances, the CFTC on regulating exchange trading environments and clearinghouses and margin, and a joint framework on markets and listing.

We will have a more detailed post on markets regulation later.