Senate Banking Committee hears on future of cryptocurrency regulation

Everyone agrees the current financial system isn't working. Few agree on how to solve it.

The US Senate Banking Committee held another hearing on the broader future of cryptocurrency regulation, following up from the recent Libra-focused congress hearings.

In it, lawmakers heard from three experts in the field, with the general idea of having one cryptocurrency advocate, one opponent and one neutralist.

It was a far cry from some of the cryptocurrency circus acts which graced the senate last year, and was all around much more informative and fact-driven, oriented largely around the question of whether cryptocurrency can help facilitate financial inclusion.

Jeremy Allaire, CEO of Circle, represented the Blockchain Association, as the pro-cryptocurrency voice. The middle ground came from Rebecca M. Nelson, a specialist in international trade and finance with the Congressional Research Service. And the opposing voice was Mehrsa Baradaran, professor of law at University of California Irvine School of Law.

In brief: Jeremy Allaire

Allaire advocated cryptocurrency and started by saying the existing financial industry is a bit rubbish, saying:

• Financial services are generally slow and expensive to deliver and the industry is inhabited by rent-seeking middlemen.
• It "is also riddled with crime and money laundering".
• Only the wealthy and well-connected are able to easily invest in small and growing private businesses, which limits investment opportunities for people everywhere. "A new, more open and accessible system of capital formation must be possible."
• People's personal identities will not be secure without drastic revolutions in the financial industry. "Banks, credit card companies [most recently Capital One], and credit reporting agencies have failed to adequately plug the holes in the dike as cyber criminals and hostile nation states take aim at our financial infrastructure," Allaire said.

"Our existing financial system is in desperate need of transformation. There is absolutely a better future ahead of us, one that is built on a technological transformation ushered in by digital assets and blockchains."

The blockchain vision of the future will include:

• People becoming comfortable with a mix of private and public digital currencies being available for use.
• Payments and transfer of value becoming a completely free service, similar to how sending messages with WhatsApp and similar are free services relative to sending a text message.
• Global, public Internet-based capital markets.
• Economic and commercial relationships being increasingly run by public blockchain smart contracts, for improved security, efficiency, transparency, certainty and enforceability across borders.
• Decentralised blockchain self-sovereign identity

In order to facilitate these advances, some regulatory changes are needed, Allaire said. These may include:

• A new set of laws around digital assets, rather than trying to cram all digital assets into one of the existing "security", "currency" or "commodity" shaped boxes.
• Broad crypto licensing procedures which can span the full gamut of digital asset services, including storage and custody, payments, dealing and trading, and operating exchanges.
• A single supervisory authority rather than the existing patchwork approach.
• An emphasis on light-touch regulations.

The US is a global regulatory leader, Allaire said, but without making some regulatory changes for the digital age it will inevitably cede its crown.

In brief: Rebecca Nelson

Nelson enunciated existing arguments for and against cryptocurrencies, and then outlined the different regulatory approaches being taken by countries around the world.

"In general, observers debate whether cryptocurrencies will in time achieve their purported potential, or whether they are another speculative bubble," she said.

Regulatory-wise, countries tend to fall into one of three categories, she said, not unlike the panel before the banking committee.

Pro-crypto countries

Pro-crypto countries, such as Singapore, Malta and Switzerland, "view cryptocurrency as an important financial innovation that can create jobs and generate economic activity", and have created regulatory frameworks specifically designed to attract crypto companies to their shores, or mountains as the case may be.

The strongly pro-cryptocurrency regulators in Singapore have been characterised by analysts as well-informed and transparent about blockchain technology, Nelson noted.

Anti-crypto countries

There are a lot of anti-crypto countries, Nelson observed, each of which has varying degrees of opposition to the idea of cryptocurrency. These bans take different forms. Some bans prohibit banks from handling cryptocurrency, some are outright trading bans, while ICO bans are particularly common for the sake of consumer protection.

Then you have a middle ground, where governments are "seeking to balance encouraging financial innovation and managing the risks posed by cryptocurrencies, while providing better clarity surrounding the emergence of cryptocurrency".

Middle grounds

These countries aren't banning cryptocurrency, but neither are they actively trying to become cryptocurrency hubs like Gibraltar, Bermuda and others.

"Most major advanced economies, including the United States, Eurozone countries, and the United Kingdom, have adopted this type of approach," Nelson said.

Similar to how different countries are viewing cryptocurrency differently, exchanges, ICOs and other crypto-related activities are also specifically regulated in different ways in different countries. The end result is a very complicated global mix of regulations.

The need for unified global regulations

The centrepiece of Nelson's information was that there's a lack of global regulations, and that typically a lack of regulatory unity across borders can create instabilities through regulatory arbitrage, or countries engaging in a "race to the bottom" to attract increasingly shady businesses.

But while there's been a lot of talk about global regulations, this hasn't really progressed beyond AML concerns yet, and no one has set up a systematic forum for countries to unify around the full spectrum of cryptocurrency regulation.

The still-small size of the cryptocurrency market today means it's perhaps not the most pressing issue, but that could change quickly, Nelson noted, as entities like Libra dive into cryptocurrency, and as countries further probe central bank digital currencies.

In brief: Mehrsa Baradaran

Baradaran outlined the problem of under banking and financial exclusion, some of its causes, and then explained why cryptocurrency is not the solution.

"The cryptocurrency industry aspires to offer a more efficient, confidential, and accessible payments system than the bank-operated payments system, which they claim is slow, outdated,
inefficient and exclusionary. They claim that the banking sector has created inequalities, that it has perpetuated fraud and harmed people by their reckless risk-taking. They are frustrated by a banking sector that seems not to have their customers best interests at heart," Baradaran said.

"They are absolutely right and I am grateful to them for drawing attention to the problems in the payments and finance sector. I have spent my academic career trying to illuminate and remedy these problems as well."

But cryptocurrency isn't the answer, she continued, and the Federal Reserve was specifically established in 1913 to remedy the problems cryptocurrency purports to solve. If that system is not working as intended, the answer should be to fix it, not to throw it aside.

"The Constitution of the United States has authorized only this institution, Congress, to change the laws and institutions related to currency. The problems of inequality and inefficiency that Bitcoin and the cryptocurrency industry has set out to solve are not problems of technology, they are problems of policy. And it is in this chamber, and not in a tech startup office or anonymous whitepaper, that these problems must be addressed."

The nature of the problem

Under banking is a severe problem in the USA and elsewhere, Baradaran said, perpetrated largely by banks in search of profit, who wield their government-enforced monopoly in one hand, and their profit motivations in the other.

"In the United States, we have decided that only chartered banks and their customers can access the payments systems built, maintained, and overseen by the Federal Reserve. Yet banks are not mandated to offer these services to all people. Banks can choose their customers and the communities in which they will operate physical branches. Banks have abandoned certain low-profit communities and customers... In these banking deserts, it is not uncommon that the only ATM in the entire area is at a gas station with fees up to $7.50 per transaction. But even where banks are physically available, there remain many barriers for low-income Americans. Banks charge excessive and onerous overdraft fees and excess activity fees—fees that are lucrative for banks and disastrous for low-income consumers."

"Small accounts are not profitable for banks so they avoid them—either by leaving low income areas or repelling low income customers through fees. Faced with seemingly random and punitive fees, low-income customers have taken their business to the fringe banking sector."

Solutions other than cryptocurrency

How about letting post offices offer digital banking services, Baradaran suggested. This would give unbanked consumers ready access to public financial services in their local area. Other issues, such as the usual 3 to 5 day cheque clearing time, can be resolved as easily as using the same technology the rest of the world is also using.

For those who don't remember, cheques are special pieces of paper on which Americans write letters to their bank, requesting that the bank make a payment on their behalf.

Problems with cryptocurrency

In the USA, Baradaran says, cryptocurrency is simply not the answer to financial inclusion. It's a problem to be solved by policy. This is self-evidenced by the fact that the actual problem of under banking in the USA was caused by profit-driven companies seeking out the greatest profits, and there's no reason to believe tech companies won't fall into the same trap.

"The Federal Reserve has only offered its payments system to banks—who, as profit seeking institutions, avoid the least profitable consumers. This is a problem that can and must be fixed through policy rather than outsourced to technology or banking corporations to solve."

At the same time, even if everything goes as planned, there's something profoundly undemocratic about relegating the poor to a fringe private finance sector, while the wealthy continue using the public finance system.

Plus, existing financial regulations are a response to specific problems, Baradaran said. Some regulations combat the risk of fraud, others help ensure the soundness of money, and so on. Regardless of how utopian its promises are, cryptocurrency has done nothing to address these underlying problems, and so by rolling back or exempting cryptocurrency from these, you're just asking for trouble.

Cryptocurrencies are either a store of value, tradable currencies, investments, a payments system, or as some have promised, are all of these things. There is nothing about all these things being put on the blockchain that makes it any less likely that it could lead to systemic risk, fraud, insider information, criminal activity, panics, bubbles, etc.

At the same time, the 2008 financial crisis which spawned Bitcoin, and the banking crisis of the 1980s, were both caused by a rollback of regulation, Baradaran pointed out.

"So far, none of these crypto currencies have reached the level of scale where they would present a systemic threat, but if their ambitions are to be believed they will," she said.

Also watch

Disclosure: The author holds BNB, BTC at the time of writing.

Picture: Shutterstock