The financial industry has been wading through troubled waters since the start of the pandemic, and its struggle has been exacerbated by the emblematic rise and subsequent fall of fintech’s crown jewel: cryptocurrency. Without a doubt, some of this volatility has been driven by the many front-page crypto news scandals that have rocked the markets recently. While regulators have generally taken a fairly cautious approach, they are finally taking serious action to reign in some of the more egregious actors and business practices. However, this has been largely ad hoc and in response to specific events rather than in the context of a comprehensive regulatory framework. In short, regulators have simply tried to apply existing regulations to what is ostensibly an entirely new financial services paradigm.
For instance, it can be argued that recent actions by the SEC against crypto companies like Coinbase, Ripple Labs, Binance, and most recently, Bittrex, were prompted by FTX’s industry-altering crash last fall. While some policymakers have applauded SEC actions, this “regulation by enforcement” approach has done little to make the cryptomarkets markedly safer in the long run or dampen the “irrational exuberance” shown by their most ardent proponents.
Interestingly, now that they are faced with an uncertain regulatory environment, some crypto purveyors have taken matters into their own hands by filing suit against the SEC moving business operations overseas to other regulatory jurisdictions, establishing cryptomarket standards organizations, and engaging with industry experts to enable risk management strategies.
As regulations ramp up, legal action in the industry increases, and the cryptomarkets continue to boom and bust, we wanted to know: what is next for cryptocurrency players?
A Financial Technology Expert’s Insight
To better understand what types of actions we should expect to see throughout 2023 and beyond, we asked WIT IP Panel Member and top fintech industry expert, Dr. Peter Vinella, for his thoughts on the crypto industry’s legal landscape. Dr. Vinella has more than 40 years of experience in the financial industry as a consultant and executive with leading institutions. Let’s take a look at what he has to say about the state of the market and potential future conflicts.
WIT: Recently, there have been some conflicting accounts on what is to come for crypto, and Bitcoin, specifically. Some sources say that it could surge, while other market players think that the industry is essentially dead. Which line of thinking do you feel is the most accurate? Do you feel we are moving out of the “crypto winter” into a “crypto spring”, or is there still more conflict to come on account of the lack of regulatory framework?
Dr. Vinella: I think any extreme is wrong. I think the thing to consider is that the regulatory frameworks various countries are adopting are still incredibly fluid. Until that gets somewhat settled, I think you’re going to see a lot of volatility in the market because there’s just a huge risk of the unknown.
The IRS has already stated that they don’t care whether crypto is a financial product or not; if you make a dollar gain on it, they’re going to tax you. Through that, regulators have established that they’re limiting the freedom of the cryptomarkets to the extent that they’re saying, “We don’t care what it is but if you’re making money on it, we want our taxes.” So, I think until the regulatory environment becomes somewhat more straightforward, I don’t believe that anything’s going to happen viability of cryptomarket in a big way. When examining the amount of resources universities, fintech companies, and traditional financial services providers are investing in blockchain and cryptocurrency applications, it becomes clear that this technology is here to stay, both in terms of financial investment and practical implementation.
WIT: Do you think that the SEC, and, more specifically, Gary Gensler, is correct in his assessment of the current regulatory environment when he said: “We have a clear regulatory framework built up over 90 years. The exchanges are just a bunch of intermediaries in this market that think they have a choice. They don’t have a choice. They’re noncompliant generally, and they need to come into compliance”?
Dr. Vinella: First, let me say I have a great deal of respect for Mr. Gensler. His MIT course on cryptocurrency is first-rate. However, the US regulatory framework is far from satisfactory. It’s probably the worst of all the developed countries given its highly siloed architecture that is based largely on experiences from the 1930s. I understand that as the head of the SEC, he’s got to say something positive to instill confidence in the markets. However, you can’t simply apply current regulations to crypto. To start with, the US regulatory framework is based on a legal foundation of statutes and common law. There’s a thing called a “security”, it has a legal definition; it’s a legal claim and if a party does something wrong, you ultimately can go to court for recourse. However, a crypto-financial product such as a token or even a cryptocurrency is not a legal claim. It is a piece of code- how do you apply regulations based on laws to that? And when it comes to the law, how do you ensure that “regulation by enforcement” isn’t completely irrational in the case of cryptomarkets which are extralegal by design?
Let’s just take FTX as an example. In court, the government could argue that crypto financial products are securities. On the other hand, FTX can argue that these aren’t securities because they don’t fit the legal definition of a security. Essentially, we are asking the finder of fact to determine what is and what is not a security. And importantly, this then becomes common law unless it is successfully appealed or overwritten through legislation. It seems to me that a much better approach is to carefully construct an efficient and effective regulatory framework that promotes both safety and innovation rather than leaving it up to the courts. Or worse, leaving it up to the SEC, the Fed, and the CFTC to argue over which agency has regulatory authority over the cryptomarkets.
One other thing to consider is that the US essentially sets the regulatory standards for the global financial system by virtue of its size and dominance. So, when people say, “Well if we can’t do it in the US, we’ll simply set up shop offshore,” that really is not viable. FTX was incorporated and operated outside of the US and that did not make them immune to US regulators and law enforcement.
WIT: Thinking of that, do you see crypto companies (like Coinbase) moving overseas en masse if regulators don’t act soon? And if so, where will they head and how will the industry shift?
Dr. Vinella: The cryptomarkets are a completely antithetical financial system to what we currently have in almost every way. As I said, traditional financial systems are generally based on a legal foundation, whether it’s the United States, the UK, or Japan. The cryptomarkets, on the other hand, were designed to be extralegal. There are no laws. There are no borders. There are no companies. They’re software applications without a traditional owner that are running on equally privileged computers around the globe. Now again, this is one of the things that judges are going to have to decide: can you sue an app or a piece of software? And because it’s in the public domain, typically as open source, who are you going to sue? The individual developer?
WIT: Now that Coinbase is pushing back against the SEC about their lack of action, do you think that regulations (and legal action) will start to ramp up?
Dr. Vinella: I think that Coinbase and all the other crypto companies have some justification to claim that current regulations don’t apply to them without some clarity. You’ll see a lot of lawsuits and pushback toward regulators. In fact, traditional financial institutions frequently push back on the regulators. Regulations are constraints that limit what financial institutions can do. However, like speed limits, such constraints are necessary to maintain safe and sound markets. The key is to adopt efficient and effective regulation that promotes safety while still allowing for reasonable profits and innovation.
How Experts Can Help Mitigate Risk
When considering the complications above, let’s evaluate the essential role that experts play in preparing for complex litigation involving cryptocurrencies.
To start, having an established expert on your side that understands how to prepare a company for future litigation is clearly advantageous. The expert can create a risk management program to identify and control a company’s risks in both their financials and operations through planning, testing, and framework implementation. This will help to reduce fraud and determine if a business’s practices are aligned with the greater market.
Further, collaborating with a crypto expert offers insights into blockchain transactions, suspicious activity, and potential breaches of contract. These experts can help your company understand the uncertain regulatory environment currently facing the industry and help promote transparency and accountability among crypto players.
Need help navigating the evolving cryptocurrency market and staying up to date on crypto news? WIT has teams of fintech experts prepared to address incoming disputes in the space. Our expert teams were created to address what we expect to be the key areas of litigation in emerging financial technologies, digital assets, and cryptocurrencies and exchanges.