Risk of Regulatory Overshoot Threatens Crypto

With any disruptive technology there is both promise and peril — the intrigue of innovation and the risk that it all goes wrong, endangering its own users, perhaps even giving fraudsters new avenues to ply their schemes.

Stellar Development Foundation Head of Policy and Government Relations Seth Hertlein told PYMNTS that when it comes to cryptocurrencies, there’s the possibility that regulators overshoot, erring too far on the side of what might be termed caution by introducing draconian guardrails that underestimate the benefits that come with cryptos and exchanges.

As a result, innovation risks not reaching its full potential.

Illicit Versus Legitimate

For an example of over-regulation, or at least what might be termed a mistrust of crypto that is not borne out by the facts, Hertlein pointed to commentary from Treasury Secretary Janet Yellen, who said at her confirmation hearing that cryptos were used “mainly” for illicit activities.

“Now, I interpret ‘mainly’ to mean a majority, or at least greater than 50%,” said Hertlein.

But the facts don’t support that claim, he said, citing research by Chainalysis that found just one-third of 1%of crypto transactions in 2020 involved some elements of criminality. That’s far less than the roughly 5% of global gross domestic product (GDP) that is laundered through the traditional financial system via cash or fiat currencies each year.

“So, the amount of illicit finance occurring in fiat currencies and through the traditional financial system is orders of magnitude higher than it’s happening in crypto,” said Hertlein. “And yet this trope that crypto is mainly used for crime is often repeated.”

On the flip side, there is also a risk of underestimating the benefits of blockchain. U.S. Sen. Elizabeth Warren recently posed a scenario to Securities and Exchange Commission (SEC) Chair Gary Gensler, in which a hypothetical investor buys crypto just before a market downturn and is left unable to sell his or her holdings because an exchange is offline and network fees spike.

“She painted this picture as proof that blockchain had failed to live up to its financial inclusion goals,” said Hertlein.

He countered that the senator’s scenario “cherry picked” a turbulent market that is neither large enough nor an objective enough sample size on which to base such broad claims.

Gensler himself has said that investors may not be equipped to gauge blockchain’s risks — and Hertlein said blockchain-related projects are typically transparent and tend to offer more details and information than banks and private companies. But the SEC does not give blockchain firms credit for the information they do share because the information itself is different from what is typically disclosed in SEC filings. The SEC tends to regulate corporations and intermediaries.

“But decentralized networks are fundamentally different,” said Hertlein. “And in my estimation, the SEC is trying mightily to shove the blockchain square peg into traditional finance round hole.”

More Than Trading

Blockchain, he said, is about more than just trading — it’s about financial inclusion and empowering people to send money across borders (and to their families) in places like Africa in a bid to build financial inclusion. El Salvador’s debut of bitcoin as legal tender earlier this month may pave the way for stablecoins to be added to the mix, without the volatility that has been a bitcoin hallmark. Other countries, such as Ukraine, have taken a more measured approach to blockchain and crypto-related legislation and use cases.

In the U.S., he said, the regulatory impact of stablecoins has yet to become clear — and there’s risk the coins are “forced into silos of existing financial products.”

None of this is to say that blockchain is without risk. As he said, blockchain is still in its nascent stages, and yes, sometimes systems go down. He likened blockchain’s development to the internet, where there had been hiccups along the way, but the system overall was allowed to develop and grow — and lead to economic prosperity.

The securities laws (which date back to the 1930s) and regulators need to catch up to the age of great technological change. The regulations are geared toward mandating what intermediaries can and cannot do, but in this case, there are no intermediaries.

“It really makes trying to sort of fit the old framework to this new technology really awkward,” said Hertlein, who added, “that’s why it warrants a fresh look. Blockchain really is a different model.”

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