Thread by @ProfHilaryAllen

Rs on House FS and Ag Cttees have dropped text of their digital asset market structure bill, which they’re rushing into markup next week. There are many reasons to pump the brakes on this bill, and I’ll discuss some in this thread. But first - what’s really driving the rush?

First of all, does anyone really think that regulating the crypto markets is the most pressing financial or agricultural issue facing the American public? No. Instead, pressure for this legislation is coming from some venture capitalists, the crypto industry, and their lobbyists.

As I explore in a new paper, VC has been driving the crypto industry, including by actively seeking to get the law changed to accommodate and legitimize it (a strategy known as “regulatory entrepreneurship”). papers.ssrn.com/sol3/papers.cf…

(Here’s the link to the OG paper on VC’s regulatory entrepreneurship strategy, and while we’re at it, also a link to a great new paper on “venture predation”).

https://t.co/luKrpjPahXpapers.ssrn.com/sol3/papers.cf…
papers.ssrn.com/sol3/papers.cf…

As I’ve testified, it’s perfectly possible for blockchain-based businesses to comply with the securities laws, but the problem is that blockchain is not actually very good tech. So these businesses prob won't succeed on technological superiority. docs.house.gov/meetings/BA/BA…

Blockchain tech can’t guarantee economic decentralization either – and even if it could, there would be no profit and so VCs wouldn’t be funding it. So blockchain won’t be delivering on that front either. papers.ssrn.com/sol3/papers.cf…

So how does this industry profit? 1, assets can be made up out of thin air (often wash traded to pump up valuation) & then sold for profit. 2, exchanges engage in combinations of brokerage, exchange, clearing and proptrading activities (sometimes with commingled customer funds)

The SEC simply wouldn’t allow this in the securities world (with good reason - these kinds of conflicts have led to harm time and time again) . So while the tech is not incompatible with the securities laws, many crypto BUSINESS MODELS are.

Crypto is now facing an existential crisis. The SEC is cracking down on securities laws violations, and most Americans have wised up to crypto’s problems, with 75% of Americans who have heard of crypto saying they don’t trust it. .pewresearch.org/short-reads/20…

Even some in the VC world seem to be losing interest – AI is the shiny new thing. The crypto industry desperately needs (i) new investors, and (ii) the ability to continue its conflicted business models. That’s where this legislation comes in.

The industry would like to see crypto legitimized as an investment for retail AND large institutional players like 401k plans and pension funds. They also would like the blessing to keep running conflicted exchanges. And they would like it ASAP. Hence the rush on this bill.

Now to the specifics of the bill: if you want more detailed discussion of what was wrong with the earlier, draft version of this legislation, here’s the comment I authored with @Miercoles_Hays and @leereiners . sites.duke.edu/thefinregblog/…

Oh - and here's the link to the current bill text agriculture.house.gov/uploadedfiles/…

Most of our critique still applies to this revised version. It is still unnecessarily complex, riddled with loopholes, will become outdated as soon as tech and business models evolve, and is predicated on the fantasy notion that governance can ever be decentralized at scale.

The bill still doesn’t address the fact that blockchains are riddled with operational fragilities, and are not something you'd want to run a financial system on papers.ssrn.com/sol3/papers.cf…

The SEC is still faced with unreasonable hurdles in rebutting people’s assertions that their digital assets live on decentralized blockchains and are therefore beyond the SEC’s jurisdiction.

(And this comes at a time when even lots of people in the crypto industry admit that decentralization is aspirational rather than reality – so again, why are we rushing so fast to create a regulatory framework for it?)

One problem we IDed with the draft bill is that it wouldn’t just give the crypto industry an accommodative regulatory regime , it would create opportunities for other kinds of securities to migrate into the same light touch regime, eviscerating the securities laws as we know them

(The new regime will be administered by the smaller and underfunded CFTC, rather than the SEC)

This problem arises because most financial assets are already in digital form, and the draft legislation said it would apply to any fungible digital asset whose ownership is recorded on a blockchain. But there’s nothing particularly special about a blockchain

Despite blockchain’s limitations, I’m sure that many issuers of existing securities would be willing to put their assets on a blockchain if it meant they could avoid SEC regulation but still have their securities traded on a public exchange.

This revised piece of legislation tries to address this concern by providing that traditional kinds of securities like “notes” and “stock” aren’t digital assets. It’s not hard to see where this will go.

Instead of fighting over the Howey test for investment contracts, the SEC will be forced to fight over Reves v EY for “notes”, or Landreth Timber for “stock” as traditional securities issuers try to litigate their way out of these categories & into the new light touch regime.

Kind of ironic that a bill supposed to provide certainty about investment contracts will open up a big can of uncertainty about other kinds of securities. If certainty were really the goal, the bill could specify that all digital assets on a blockchain count as securities.

Certainty provided, arbitrage opportunities eliminated – but the crypto industry doesn’t want THAT kind of certainty.

Instead they want light touch regulation by the CFTC. And so Section 406 prevents the commingling of consumer funds by digital asset broker/dealers, but provides a procedure where consumers can waive this protection in writing.

Cue the contracts of adhesion with waivers built in: Want to use the exchange? Then you’ll need to let us use your funds…

Section 406 also doesn’t require structural separation of broker/dealer, exchanges, and clearing to prevent conflicts of interest (like the securities laws do) – instead, digital asset broker/dealers get to come up with their own “conflict of interest systems and procedures”

And then, going back to my point about eviscerating existing securities laws, there’s Section 504 that would give the SEC a new innovation mandate, and regulated industry a new cudgel to undermine the SEC. Here’s my op-ed on this issue. thehill.com/opinion/financ…

There’s much more not to like about this bill, but I’ll stop here. The status quo isn’t perfect, but it does a decent job of protecting US citizens, and the public would benefit if Congress supported – instead of undermining – the SEC’s investor protection efforts.

@ErikVoorhees "Because money and finance are the lifeblood of our economy, finance has always been highly regulated in a way that Kodak’s provision of photographs and FedEx’s delivery of couriered letters never have been."

@ErikVoorhees papers.ssrn.com/sol3/papers.cf…