The Friday List: Top 10 Cryptocurrency Regulatory Solutions
Today, I offer the “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues. The Friday Lists are an expanded “Our Take” on a particular subject, offering my unique (and sometimes controversial) perspective on an industry topic.
Nothing is hotter in financial services than cryptocurrency. People are investing in it. People are using it. Congress is worried. Yet, the financial regulators continue to emphasize risk over regulation. Back in March, the SEC’s Division of Examinations issued a Risk Alert warning advisers and broker-dealers about the “unique risks” of crypto. In 2018, then Investment Management Director Dalia Blass asked sponsors to stop initiating registrations for crypto products because of outstanding regulatory questions. I understand that digital assets raise several regulatory issues. However, the SEC should seek to regulate cryptocurrency offerings rather than just offer warnings. The SEC is the best financial regulator in the world. Its entire reason for being is to review financial product innovations, assess them, and then regulate them to make them safe for investors. Crypto is a fact of modern financial life. If the SEC doesn’t step in, the market will continue to operate through unregulated, and perhaps shady, facilities, thereby increasing risk and ultimately harming the markets and investors.
The crypto market should welcome regulation into the mainstream. Only through regulation will the crypto market become more accepted, safe, and liquid. Regulation will open the door to more participants who could feel safe investing in crypto, rather than worrying about fraud or information imbalances. Stringent regulation is what allows investment products to succeed. For example, the mutual fund is the most regulated, and most successful, investment product in world history. People forget that mutual funds in the 1920s and 1930s had the same type of dodgy reputation as cryptocurrencies do today, but the Investment Company Act of 1940 brought mutual funds to Main Street.
In today’s Friday List, I raise some of the oft-cited crypto concerns and offer possible solutions that the regulators could consider to make the cryptocurrency world safe for investing.
Top 10 Cryptocurrency Regulatory Solutions
- Money Laundering. The Treasury Department recently announced plans to require crypto exchanges to report transactions in excess of $10,000, similar to rules for cash transactions. FinCEN could step in and require the same types of Suspicious Activity Reporting currently required for securities transactions.
- Valuation: Several proposed funds have used various indexes, futures prices, or other proxies to value cryptocurrencies. Valuation is certainly more subjective than with exchange-traded equities, but the financial markets have a great deal of experience implementing valuation policies for Level III securities such as private funds or esoteric bonds.
- Liquidity and volatility: Isn’t this really a disclosure issue? Like any market, the cryptocurrency market could experience periods of more volatility and limited liquidity. For funds, perhaps the SEC could limit the percentage a fund could invest in cryptocurrency or only allow certain, more-widely accepted cryptos.
- Custody: The SEC has already greenlighted a pilot program to allow special purpose broker-dealers to maintain custody of digital asset securities. We’ll see whether these custodians experience the access, security, transfer, and operations concerns that naysayers envision.
- ETF Creation: Several funds have already set up facilities with authorized participants for unit creation. We’re just waiting for the SEC to approve the funds.
- Lack of regulation: We can start with U.S. regulation. If past is prologue, we can expect other developed markets to follow suit.
- Market manipulation: The SEC has adopted market manipulation, fraud rules, and disclosure for the securities markets. There is no reason why similar rules couldn’t apply to cryptocurrencies.
- Cybersecurity: The SEC, FINRA, and the banking regulators have all adopted cybersecurity regulations that include governance, incident response, remediation, and reporting. Similar rules could apply to distributed ledger systems.
- Disclosure: Several crypto funds have already shown how to disclose the risks inherent in crypto investing. If the SEC thinks that investors need more disclosure, they could certainly adopt more disclosure rules.
- Suitability: The concepts of suitability, fiduciary duty, and best interest should apply equally to cryptocurrencies as an asset class as they do recommendations to purchase exchange-traded securities.