#224—When no one’s writing the rules

Matt Levine doesn't think Gary Gensler's approach will work

Sep 19, 2022

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Gary Gensler doesn’t want to write the rules
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1. Gary Gensler doesn’t want to write the rules

We’re in an interesting place in time. New technologies are enabling smarter, better ways of doing things. But the rules are written for a bygone era and outmoded frameworks.

Take for instance, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) Customer Identification Program (CIP) Rule, which hasn’t really been updated since 2003. That’s 4 years before the release of the first iPhone.

Ambiguity around rules can stifle innovation as much as it enables it, particularly for risk averse and highly regulated financial institutions. And outmoded systems hurt society. Consider that at the peak of the pandemic, one of Houston’s primary bottlenecks was their fax machine.

The other thing about ambiguity around rules is that it empowers regulation by enforcement. When the rules aren’t clear, regulators can cherry pick fights and interpret the rules to their own benefit. In that sense, regulatory agencies like the SEC are incentivized to keep it vague. At a time of immense technological transition, the benefits are equally large. For regulators, the Wild West amounts to a potentially mammoth land grab.

Self-sovereign identity and stablecoins represent a radical technological shift in the way society is able to interact and transact. Suddenly, we have trust and value that individuals can own and control that also can connect freely with the open, permissionless internet while serving as bridges to practical society. It’s the best of all worlds.

For trust and value, it’s a printing press moment in terms of access and individual empowerment.

SEC Chief Gary Gensler wants to reign over the latter, which he talked about in a speech the other week.

And he wants to do it by explicitly not writing the rules.

Here’s what Matt Levine thinks:

On the other hand, if you are an ambitious financial regulator who wants to regulate crypto, you have to regulate crypto! You have to put in the work! You have to sit down to try to understand how the crypto market operates, what investors need to know, and what is required to encourage useful capital formation. You have to write rules that anyone can read and that create some plausible path for how crypto developers can register their tokens and how exchanges can trade them. And then you have to focus your enforcement efforts on actual consumer protection, going after the crooks instead of just the people who are naive enough to walk into your office.
If you don’t do that, then, what? Then the US will not be a leader in crypto innovation, is the traditional answer, and US investors will not have access to all the great crypto projects. As a consumer protection matter, I can see why Gensler might find this answer dumb. Crypto prices have crashed, and I suspect Gensler thinks that a lot of these projects are scams anyway, and so missing out on them might be broadly good for US investors.
Still I do not understand the game here. Gensler’s posture seems like a massive bet against crypto ever being important. His message is basically “I should be the main regulator of crypto, and as the main regulator my plan is mostly to ban it.” That’s not, abstractly, an insane posture: That’s more or less the view that the US Drug Enforcement Agency takes toward cocaine, for instance. (Or the view that China takes toward crypto, for that matter.) But most of the people who are jockeying to be the main regulator of crypto want to regulate a thriving ecosystem; they want it to be big, and they want to be in charge of it. Gensler wants to be in charge of it and have it be irrelevant and cumbersome and slow-moving.
That might be a good pitch, now, in the crypto winter, when so many crypto stories are about people losing their life savings to unregulated scams. But it is not going to appeal to anyone in the crypto industry, and I don’t think it’s going to appeal to the politicians who are interested in crypto and who are writing their own legislation to decide who should regulate it. Gensler’s posture is that he should be in charge of writing the rules for crypto, but not write them. I don’t see how that can work.

The original Howey Test dates back to a 1946 Supreme Court ruling over orange groves. (That’s 76 years before the release of the first iPhone for anyone keeping count.)

But the spirit of the rule remains in tact and relevant:

“The test,” the famous Supreme Court case says, “is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”

Still, there’s suddenly an incredible amount of nuance required to navigate the rules because, you know, smart contracts and all that other stuff.

Here’s Matt Levine, again, a few days later:

Crypto people want rules! I don’t mean that they want to be regulated; I mean, specifically, that they want rules. They want published, objectively specified, open and transparent rules, so that everyone is on a level playing field to do crypto stuff that complies with whatever the rules are. I don’t mean that everyone in crypto wants that: Informal regulation favors the well-capitalized and the incumbent, and if you’re a big crypto firm on good terms with the SEC (which might be an empty set) you might prefer informality and opacity. I just mean that, philosophically, crypto people should want open transparent rules for permissionless innovation. That is how the crypto system is designed to work, and they should want the securities laws to work the same way. And in fact Coinbase Global Inc., which is maybe the closest thing the US crypto industry has to a big regulated incumbent, has sent the SEC a petition asking it to make rules for crypto securities.
…
Philosophically I sympathize with the crypto industry here: There should be clear rules that are open and available to everyone. Practically I am pretty sympathetic to the SEC. But mostly I just want to point out that there is a disconnect. And if your vision of crypto is about disrupting the traditional financial system, then this might look like the SEC protecting the traditional system from disruption. “Just come in and talk to us,” the SEC says, but you might hear that as “you can’t do anything in crypto without talking to us first.”

Gensler spoke on the topic again at a Senate Banking Committee hearing last Thursday.

Here’s Bloomberg:

Crypto investors who have been celebrating this week’s overhaul of Ethereum’s blockchain may have to deal with an unwelcome guest at their party: US Securities and Exchange Commission Chair Gary Gensler.
Gensler on Thursday signaled that a feature of the network’s software could lead to tokens being considered securities by the SEC. While Gensler was careful to say he wasn’t speaking about any digital coin specifically, his comments add to questions about the Wall Street regulator’s views on Ether, which is the second-biggest virtual currency.

Relevant:

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Discussion about this post

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#224—When no one’s writing the rules

Matt Levine doesn't think Gary Gensler's approach will work

1. Gary Gensler doesn’t want to write the rules

2. This week in new money

3. This week in digital identity

4. Stuff happens

Discussion about this post