The USA’s regulatory chaos in cryptocurrency is killing innovation
For exchanges, blockchain firms and crypto startups, the US is a headache that's not worth having.
Cryptocurrency regulation in the US is easy.
All you need to remember is that cryptocurrency marketplaces qualify as securities exchanges according to the SEC because they call themselves exchanges or maybe because ICO tokens and other coins are technically securities depending on who you ask, as long as you're not in Wyoming, but capital gains taxes need to be paid on cryptocurrency appreciation because they're an asset like property even though they're also a security, utility token or currency that's not legal tender, except according to the CFTC which treats them as commodities, all subject to change on a state-by-state, territory or federal basis.
Okay. Maybe it's not that easy.
Unfortunately, the penalties for not following these ambiguous and occasionally self-contradictory regulations can be severe enough to permanently cripple any cash-strapped startup. And the cost of even attempting to detangle the spaghetti bowl of US regulations, get appropriately licensed and operate compliantly is increasingly just not worth it.
The US is an attractive market, but only for the largest operators with enough resources to negotiate the increasingly cryptic crypto regulations and handle the enormous expenses that come with doing so. There aren't many of them.
To make matters worse, the disconnected state-by-state regulatory framework that's used for much of crypto sharply reduces the available customer base, while multiplying the costs of compliance.
- Coinbase operates under a series of state-by-state money transmission licenses, which had to be individually applied for in different locations and in line with different criteria, and it still came out with a series of caveats and conditions in about 10 states.
- Circle just rolled out a cryptocurrency trading app for US customers except those in Minnesota, Hawaii, New York or Wyoming.
- Robinhood introduced crypto for California, Massachusetts, Missouri, Montana and New Hampshire only and plans to gradually add more states as it navigates the regulatory needs.
All of these are only able to serve the US because they managed to grow up big and financially strong before the regulatory mess rolled in. The same thing probably couldn't happen today.
Yankee go home?
Companies that aren't dependent on US customers decided to just cut them off instead. Hong Kong-based Bitfinex is one of the world's largest cryptocurrency exchanges, but it simply kicked off all US customers rather than deal with the regulatory problems of servicing them.
"A surprisingly small percentage of our revenues come from verified U.S. individual accounts while a dramatically outsized portion of our resources goes into servicing the needs of U.S. individuals, including support, legal and regulatory," its announcement reads. "We are thankful to all of our loyal U.S. customers that have consistently traded with us but, unfortunately, we have an obligation to our whole customer base and to our shareholders to make rational resource allocation decisions."
Presciently, it also said "we anticipate the regulatory landscape to become even more challenging in the future."
A similar situation also swept the US on a state-by-state basis. Back in 2015, for example, New York state introduced a new BitLicense system to regulate crypto exchanges that serve New York customers. This led to exchanges banning New York-based customers, although a few of them gamely poured thousands of hours and hundreds of thousands of dollars into attempted licensing before giving up. The only exchange to successfully get the license at the time was Coinbase, inadvertently giving it a very effective monopoly in the state.
The nature of cryptocurrency doesn't help either. It's an entirely borderless product with an extremely scattered global userbase. When limited by geography, there will be few customers around relative to other types of product.
It's estimated that about 7% of Americans own cryptocurrency, about 95% of whom own only a small amount and don't do much in the way of trading, flipping or anything else. And they're already well locked up by the handful of big names in operation. And thanks to the mishmash of state and territory regulations, it's not even possible for a startup to serve more than a fraction of them at once.
At the moment, the money just isn't there.
Will it get better?
Unlikely. Barring some kind of miracle, the US will be ceding its "world's most innovative country" badge soon – perhaps to Singapore or Israel.
The US is already effectively off-limits for any new exchange without enormous venture capital backing, overseas exchanges are steering clear of its regulatory chaos and even the established giants are running to diversify their customer-bases outside the unpredictable confines of the US.
Individual states like Wyoming are proudly announcing their own regulatory developments, but these announcements are just small, squeaky voices with little tangible effect. The only thing that might come out of them is a form of precedent, or functional regulatory framework, that can save effort on wider adoption later.
Comprehensive and well-rounded federal cryptocurrency clarity is probably what's needed in the long run, but a good first step, argues Coinbase's chief legal officer Mike Lempres, would simply be for the SEC ("cryptos are securities") and CFTC ("cryptos are commodities") to get it together.
"Congress should insist that the SEC and CFTC coordinate, as they have in the past, to clarify how companies, markets and investors can determine whether an individual token is a security or a commodity," Lempres said in remarks to a House of Representatives hearing on cryptocurrencies. "The current regulatory environment – in particular regulation by enforcement without enough clear guidance on what is permissible – is harming healthy innovation."
Speculators and startups probably shouldn't hold their breath. Regulatory bodies have already said the current laws are clear enough, and there's no reason to expect a sudden change of tune. It's worth noting that this kind of disorganised ambiguity isn't unique to the US. Operators elsewhere have experienced similarly messy responses from their country's regulators.
But this disorganisation is magnified and compounded across all the US's states and territories, while meaningful legislative change on the federal level is also much harder to achieve in the US than in smaller and nimbler countries.
The hearing at which Lempres spoke might show the current state of the regulatory debate. There were a lot of voices in favour of development, but one of the strongest opponents was California representative Brad Sherman (D), who described cryptocurrencies as "a crock."
"They help criminals and terrorists... they help startups perpetrate fraud... undermine the dollar, encourage gambling for no social benefit... and are popular with guys who want to sit on their couch and tell their wives they are going to be millionaires," he said.
According to OpenSecrets, Brad Sherman's biggest financial supporter, by a large margin, is the securities and investment industry.
US policymakers have a poor track record for passing legislation against the interests of their campaign donors. Sorry, America. It's not looking good for you.
Disclosure: At the time of writing the author holds ETH, IOTA, ICX, VEN, XLM, SALT, BTC and XRB.
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