Rayne Steinberg is Chief Executive Officer at Arca, an asset management firm investing and innovating in digital assets.
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Regulation is a necessary evil. If you could count on people to always do the right thing, then it would be superfluous. Often when enforcing seemingly obvious rules, innovation is stifled because rules are not one-size-fits-all. But without rules, there would be anarchy. Because of this, over the years, countless governing bodies have been created that are responsible for supervising specific areas. There are myriad regulating bodies; communication among them is often disjointed and rulings take an eternity. It’s no wonder many fear and resent regulators. Regulators have their own obvious obstacles to overcome yet have the final say that can make or break companies, of which they might not know that much about. Legislation is inevitable, but ultimately the world is better for it.
Laws are rules set up by social institutions to govern behavior, and regulation is the process of monitoring and enforcing these set legislations. Speed limits, cigarette bans and votership equality — what would the world look like without these laws? There was a time when each of these rulings may have seemed unnecessary and an impediment, similar to how some view regulators’ initial forays into regulating blockchain and digital assets. In the moment, some may feel they don’t need Uncle Sam peeking over their shoulder, but the reality is rules encourage responsible innovation. Fundamentally, the crypto industry and regulators are striving for the same result, promoting innovation and growth while keeping order, akin to the Red Queen Effect.
Technology has vitalized the “work smarter, not harder” mentality, promoting efficiency and providing solutions. It also provided a rapid rate of advancement that neither digital asset participants nor regulators want to see stifled. Yet it is this rapid progress that makes it challenging for regulators. In general, regulators are tasked with protecting market participants and creating a level playing field. This is hard to do even in well understood, mature environments and extremely difficult in an area evolving as fast as the digital asset ecosystem.
Good Vs. Bad Regulation: The Chess Game
Most people can agree there is a necessity for baseline regulation. Using the financial services space and areas that touch money and people’s accumulated wealth as an example, when investors are exposed to dangerous products, the results can be catastrophic to individuals and whole sectors of the economy, such as the mortgage-backed securities that triggered the financial crisis of 2008. In addition to being protective, regulation can actually spur innovation. The origin of the exchange-traded fund (ETF) is a prime example of this phenomenon. This innovative, cost-efficient, flexible financial product traces its roots to the response to Black Monday. The stock market crash of 1987 opened the SEC’s eyes to limitations on mutual fund trading that traditionally closed at 4 p.m., and the possibility of an innovative financial instrument that would solve for hedging and diversification with intraday trading. While the first ETF, SPDR S&P 500 ETF, still took over five years to receive SEC approval, it was worth the hard work to achieve an ETF marketplace that is now a $9 trillion industry.
While it is easy to be in favor of the benefits of regulation, resistance arises over bad regulation — which can be overly burdensome and choke innovation. History has unfortunately provided numerous instances of authoritative bodies getting it wrong. It is clear that regulation requires a measured approach to successfully protect participants and promote innovation. Arguably, regulators thus far have been integral to the rise of digital assets by taking the time to understand the technology and not implement mandates that strangle the new industry. It is appropriate to be mindful of overregulation and harmful regulation, but thoughtful regulation should be encouraged.
Product Vs. Issuer: Alice’s Potion
When considering regulation, it is important to remember it is not monolithic and changes from regime to regime. The Biden administration’s new “sweeping campaign” essentially encourages federal agencies to investigate and undo existing policies in order to replace them with ones that remove a degree of corporations’ power and safeguard the consumer. The SEC’s investigation into Deutsche Bank’s environmental, social and governance (ESG) products is just one instance of regulators cracking down on financial institutions. It is noteworthy that because no regulations exist to date that explain what constitutes an ESG product, the regulating body is forced to take aim at the corporation, rather than the product itself.
Regulation differs greatly between industries, and it is remarkably difficult to test investor safety for financial products. Currently there are 12 active spot bitcoin ETF applications under review by the SEC, none of which have been approved. These are not to be confused with the recently approved futures bitcoin ETF, which holds bitcoin futures contracts, rather than direct exposure to bitcoin. Regulators seem to be taking a product safety approach, insinuating that as the spot bitcoin ETF is currently understood, it does not meet the investor safety qualifications to be publicly accessible. Since retail investors have the ability to access bitcoin via any digital asset exchange, regulators are not actually hindering investors’ ability to participate in the market. In the end, action is measured by accountability.
The Adventure Continues: The White Rabbit
Digital assets have a unique origination story, different from any other asset class. The promise of what they might herald — a fairer, more transparent financial system — is a noble and worthy goal. This is a difficult situation for regulators who have to look at the world as it is now, not as it may become. The attention regulators are giving this nascent industry is actually encouraging and an indication that it is being taken seriously as an asset class. Those of us in the industry should view this as an opportunity to collaborate on the creation of constructive rules that allow further adoption of digital assets. The journey is just beginning.
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