A national alternative to onerous state-by-state regulation of cryptocurrency intermediaries

Increasingly, policymakers on Capitol Hill and at federal regulatory agencies are asking us whether Congress should develop a comprehensive national regime to regulate cryptocurrencies. We have always and will always oppose any direct regulation of cryptocurrency as a technology, its software development, or persons who use or build these networks but who do not hold other people’s cryptocurrency. A comprehensive national regime to regulate trusted cryptocurrency intermediaries, however, may be a good idea if it was reasonably constructed. 

For one thing, such trusted intermediaries are already regulated under a state-by-state patchwork of money transmission licensing regimes. As we’ve written before, the lack of uniformity amongst state licensing laws, coupled with confusing language drafted long before cryptocurrency technologies existed, presents a real barrier to innovation. It’s very expensive to start a business that would support cryptocurrency trading or custody services and be compliant. 

Since 2016, we have worked to create greater uniformity across state lawsalongside the Uniform Law Commission, and in early 2018 we outlined the case for limited federal preemption of state licensing laws. As we wrote in that report, a federal regulator could be empowered to offer an alternative license for exchanges, and exchanges with that license could be exempted from state-by-state obligations. The federal license would be alternative and optional, exchanges don’t need both state and federal licenses and can choose whichever regime they prefer. An alternative federal regulator could also address rising concerns about cryptocurrency investor protection and market manipulation:

[E]mergent investor protection issues are similar to those addressed by the SEC and CFTC with respect to securities exchanges and commodities futures exchanges. But, a digital currency is not a security and therefore it makes no sense to regulate digital currency exchanges as National Security Exchanges. Digital currencies are commodities, but the CFTC only regulates commodities futures markets, not commodities spot markets. All told, should investor protection issues in digital currency spot markets need to be addressed, they would be best addressed through a de novo regime crafted in legislation and seated within the CFTC. Much of that regime would be focused on investor disclosures, market transparency, and guardrails to prevent and police fraud, market manipulation, and insider trading (issues beyond the scope of this report), but the legislation should also deal with the more straightforward issue of licensing for exchanges that play a role as custodians and payment providers. The public policy goals of state money transmission regulators could thus be subsumed within a larger CFTC-administered investor protection regime. State money transmission laws would then be fully preempted for newly CFTC-regulated digital currency exchanges.

In light of increased inquiries about what a sensible national regime for intermediary regulation might look like in legislation, we thought we would share some initial thoughts. 

Comprehensive legislation should clearly delineate the jurisdiction of the relevant regulators: designating the CFTC as the single federal regulator for investor protection and prudential regulation of cryptocurrency intermediaries; clarifying the separate jurisdictions of the SEC and the CFTC; and preempting state authority over any federally regulated entities.

• CFTC: Legislation should create an optional federal license that would be issued by the CFTC to custodians and exchanges interested in applying. This federal license should subject licensed entities to sensible spot market oversight for anti-manipulation, anti-fraud, consumer disclosure, and prudential (licensing, minimum-capitalization, etc.) regulations.
   
• SEC: Legislation should clearly limit securities regulation to investment contracts wherein new cryptocurrencies are promised to investors (ICOs). Legislation should also allow for a sensible handoff from SEC to CFTC jurisdiction for cryptocurrencies that began as ICOs but later resemble Bitcoin or other commodity cryptocurrencies.
   
• States: Legislation should preempt state money transmission licensing for CFTC licensed exchanges and custodians.

Additionally, comprehensive legislation should also create a clear safe harbor from investor protection, prudential, and AML regulations for non-custodial actors. Persons who do not, in the regular course of business, have control over other persons’ crypto are not subject to this or any other licensing regime. 

Building consensus around these goals is one thing, but the hard part will be drafting actual legislation that avoids unintended consequences while laying down clear and justiciable rules. As members of Congress take up this challenge, we are ready to help.