Is the piecemeal approach to crypto oversight creating regulatory arbitrage?
The raft of bodies weighing in on the opaque and at-times contentious territory of digital-currency oversight could be leading to regulation arbitrage, where companies use loopholes to create favorable regulatory rulings.
Over the past 10 days, two New York bodies — the Attorney General’s office and the Department of Financial Services (DFS) — have separately weighed in with comments and rulings in the digital-currency industry. The Securities and Exchange Commission leads the way at a federal level for most crypto-related regulatory issues. But at least one expert is asking if the piecemeal approach to regulation is detrimental to robust controls. “We have a patchwork of regulatory agencies at the federal level, with somewhat overlapping jurisdictions. Moreover, we have a parallel system of state and federal regulation, again with overlapping jurisdictions,” said David Yermack, professor at New York University.
“There are a lot of weaknesses in the U.S. system, including high cost, regulatory arbitrage and competition among agencies for control of turf. Crypto seems to be a good manifestation of these problems, but it is neither the first nor the last,” he said.
The jurisdiction debate came to the fore Wednesday when the Kraken Exchange and its CEO and co-founder, Jesse Powell, accused New York Attorney General Barbara Underwood and her office of operating outside its turf after the release of its Virtual Markets Integrity Initiative. In the report, the attorney general’s office said it had referred Kraken and two other exchanges to the New York DFS for potential violation of New York’s virtual-currency regulations because they believe the exchanges had accepted trades from within the state of New York, a claim rebuffed by Kraken.
“We told you we don’t operate in NY. AG trying cases in court of public opinion now?” the Kraken exchange tweeted on Wednesday.
MarketWatch asked the New York Attorney General’s Office if it collaborated with the SEC during its fact-finding inquiry and has yet to receive a response.
Felix Shipkevich, principal of Shipkevich PLLC, noted that gaps in regulation already exist, but if things remain at a state level the ability to skip around jurisdictions is only going to become easier. “New York is different, many of the other states may not have the resources to oversee it, which naturally creates further regulatory arbitrage,” said Shipkevich.
Nine days prior to the attorney general’s report, the uncertainty around which body should regulate what was again evident when the New York DFS said it had approved the application of two stablecoins — a cryptocurrency that is pegged 1 for 1 with the U.S. dollar — by Gemini Trust Co. and Paxos Trust Co. Asked whether or not Paxos had any dialogue with the SEC before seeking approval from the DFS, Paxos CEO and co-founder Chad Cascarilla said: “our attorneys got an opinion, which was there was no need for dialogue.” Cascarilla added that Paxos is regulated as a trust company, meaning they are charted by the DFS.
When MarketWatch asked the New York DFS whether or not it consulted with the Securities and Exchange Commission or the Commodity Futures Trading Commission before making the ruling on the two stablecoins, the department said in an emailed response that it “does not comment on its application review process.”
Regulation continues to be topic of debate among bitcoin BTCUSD, +1.60% enthusiasts, with some citing the lack of clarity for the decline in the price of the world’s largest digital currency, which has fallen more than 50% year to date.
Meanwhile, the SEC has been juggling a number of applications for a bitcoin-backed exchange-traded fund, one of which was tabled by Gemini Trust. That application was rejected July 26.
Attempts to improve regulatory clarity from within took a step forward in early September with the announcement of the Blockchain Association, a consortium of some of the most well-known names in the crypto ecosystem, which will focus on a common narrative to further advance the industry.
“It would be good for the government to take a unified approach to regulating crypto assets, but given the byzantine structure of our financial regulation, I would not expect miracles,” said Yermack.
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