With cryptocurrency comes MORE regulation NOT less

Speaking at last week’s DC Blockchain Summit, Brian Quintenz, Commissioner of the Commodity Futures Trading Commission (CFTC), advised against too quickly assuming that self-regulation of the brave new world of cryptocurrency by its members is the best road to compliance. Rather than each member overseeing their own organizations, he encourages the development of an independent, private regulatory body.

Forming a crypto-advisory committee

In an effort to oversee a technological revolution that he says promises to transform the building blocks not just of financial markets, but of commerce in general, Quintenz is sponsoring the CFTC’s Technology Advisory Committee (TAC). Following its first meeting in February, the TAC recommended that the Commission create four subcommittees to provide actionable advice regarding cryptocurrencies, DLT, cybersecurity, and the modern trading environment. That last subcommittee will explore the real risks of the modern trading environment so that a properly calibrated replacement to Regulation Automatized Trading (Reg AT) can be considered by the Commission.

Who should regulate cryptocurrency?

Quintenz is open to exploring how a new, private independent organization take on oversight of U.S. cryptocurrency platforms. Already, he says, this private independent model option is working through the National Futures Association (NFA) and the Financial Industry Regulatory Authority (FINRA). Currently, a patchwork of state and federal regulators also have regulatory jurisdiction.

The greatest need for enhanced regulatory certainty, he believes, is the spot market. At present, state regulators and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) regulate cryptocurrency platforms as money service businesses. However, he notes, while cryptocurrency exchanges can resemble traditional money transmission services, there are enough differences to warrant different regulatory treatment. He expects that as Congress works with federal and state regulators to determine the appropriate regulatory framework for cryptocurrencies, an SRO-like entity could develop industry standards that could inform, or even serve as a blueprint for, future action.

Indeed, he continues, the market is already seeing a movement toward self-regulation in the cryptocurrency sector. A cryptocurrency trade association called “CryptoUK” was recently established in the United Kingdom. The organization has established a code of conduct for its members which includes guidelines around due diligence checks, customer protections, and pricing transparency. Similarly, the heads of two cryptocurrency trade groups in Japan, together with the country’s spot exchanges, have committed to establishing a new self-regulating body.

In the United States, he adds, efforts toward standardization are also underway at the state level. Seven states have agreed to recognize each other’s money service business licenses and a model state virtual currency law has been published.

“I think an independent, self-regulating body for spot platforms in the United States could significantly contribute to these ongoing efforts to rationalize and formalize cryptocurrency regulation. Initially, this entity could establish best practices for spot platforms, including setting minimum standards of fitness for their employees. Eventually, it could enforce rules on its own membership, supervise them for compliance, and provide a forum for customers to seek redress against member platforms, just like FINRA and NFA do for the securities and derivatives markets today. An SRO-like, independent regulatory body could create uniform standards for these trading platforms, reduce the possibility of regulatory arbitrage, and avoid duplicative regulation.”

What are the advantages of private, independent regulators?

According to Quintenz, the advantage of a private cryptocurrency oversight body includes:

1. As a private membership organization, these regulators could provide oversight over spot platforms far more quickly than any federal regulatory regime, which could only be established following the promulgation of a new law, given the current lack of oversight jurisdiction. A case in point is the regulation of the off-exchange retail foreign exchange (“retail forex”) industry. The NFA began regulating this sector seven years before the CFTC.

2. Quintenz believes SRO-like entities provide numerous efficiencies. They are funded by their members, not by the federal government. They can adopt and amend rules more quickly than a federal agency. The rules and best practices published by an SRO are informed by practical experience because the organization has input from industry participants. This is especially beneficial in the case of a rapidly evolving industry, like cryptocurrency, where products and trading conventions are constantly changing.

3. Past SROs have not limited their functions to enforcing fair trading practices. In the 1890s, the Butter and Cheese Exchange of New York (the predecessor to the New York Mercantile Exchange (NYMEX)) implemented groundbreaking methods of standardizing butter, cheese, and eggs before the U.S. Department of Agriculture.

What kinds of rules should regulate the SRO implement policies and procedures?

According to Quintenz, SRO-like bodies require policies and procedures to address potential conflicts of interest between itself and the industry it regulates. It should strive to have a fair representation of diverse views among its members and leadership. But, such entities need not develop standards for independence and fairness from scratch. The International Organization of Securities Commissioners (IOSCO) has developed internationally recognized Principles for Self-Regulation. According to this benchmark, an SRO should establish standards of corporate governance to effectively manage any conflicts of interest. IOSCO calls upon SROs to observe standards of fairness and confidentiality when exercising powers and responsibilities, and to avoid rules that may create anti-competitive situations or allow any market participant to unfairly gain an advantage in the market. The SRO should also have the ability to enforce compliance by its members with its standards and should develop rules that promote investor protection and market integrity. Compliance with IOSCO’s robust set of protocols would lend credibility to any SRO-like body for cryptocurrency spot platforms.

Ultimately IOSCO’s framework calls for the SRO to be subject to the oversight of a government regulator, who can assume responsibility should the SRO exhibit conflicts of interest or prove unable to discharge its responsibilities. To-date, Quintenz says, “Congress has not authorized the creation of an SRO to serve in this capacity in the cryptocurrency markets. Notwithstanding this fact, I believe that while Congress considers what, if any, further federal action in this area is appropriate, an SRO-like entity could begin to develop ideas and standards that would strengthen the integrity of the spot markets. We regularly hear from cryptocurrency market participants that they desire a more credible, regulated marketplace. I believe that a private, cryptocurrency oversight body could help bridge the gap between the status quo and future government regulation.”

What does a new regulating body mean for you?

More regulation? Maybe. Maybe not. Regardless, it does mean that compliance still matters – to you and your organization. That’s also where Patrina can help. We’ve built a business on helping organizations stay on the “straight and narrow” efficiently and cost-effectively. So, let’s talk. Call 212-233-1155 to ask about Patrina’s cost-effective and comprehensive, 8-module compliance solution, and compliant data capture, file storage, and records archiving specifically designed for the financial services community. Be smart. Be covered.