A Comprehensive Approach to Crypto Regulation
The University of Pennsylvania Journal of Business Law, Vol. 25:2, 2023
35 Pages Posted: 19 Oct 2022 Last revised: 9 Aug 2023
Date Written: May 25, 2023
Regulation of cryptocurrency is a key policymaking issue of our time. There are many challenges associated with developing and applying legal frameworks to cryptocurrency, as the technology, business practices, and uses of cryptocurrency vary significantly from traditional financial services. Moreover, the ecosystem exhibits a rapid speed of innovation and very high level of complexity. Nevertheless, regulating cryptocurrency, particularly as it relates to users, is essential to achieve sufficient investor and consumer protection, as well as to provide the clarity that innovators need to build their businesses.
One unique challenge in policymaking related to cryptocurrency is the potential lack of central entity or traditional intermediary that would be the subject of regulatory authority. In the crypto space, activities are often originated by individual developers, decentralized organizations, or even algorithms — a set of instructions left in place by programmers. A key example of this dynamic is stablecoins, where the cryptocurrency is pegged to a reference asset considered to be stable (such as the U.S. dollar). With stablecoins, certain provisions such as reserves, lockups, clawbacks, blacklisting, fees, and wrapping have given rise to considerations about their behavior and user accessibility. Examination of the relevant limited terms of service/use, auditors’ reports, and business models have implications for credit, liquidity, and operations, as well as consumer protection and financial stability.
Because there may not be a central entity or traditional intermediary to regulate for many stablecoins, we propose a first pillar of cryptocurrency regulation: establishing new “Crypto Standards” that could be applied to the smart contracts of not only stablecoins, but across the burgeoning web3 landscape. Crypto Standards offer many benefits, including progress towards public policy goals of consumer protection and financial stability, as well as tools to promote interoperability, security, and responsible technological innovation.
However, numerous other practices give rise to concern about activities in cryptocurrency. The Terra Luna meltdown highlighted serious concerns about potentially unfair, deceptive, and fraudulent business practices in the cryptocurrency space. In addition, within reserve-backed stablecoins, consumer protection questions arise over certain practices by issuers. For example, many stablecoins maintain the ability to prevent redemption of tokens for fiat money, retrieve tokens without consent (“clawbacks”), or even unilaterally block certain digital wallet addresses from transacting (“freezing"). Most or all stablecoins set forth no formal procedure for how these decisions are made, leading to concerns that they are non-transparent or even arbitrary.
In addition, stablecoins frequently change their online disclosures (if any) and limited terms of service, without providing notice to stablecoin users. The use of limited terms of service combined with extreme practices in the stablecoin space raises significant questions regarding stablecoin behavior and user accessibility, as well as the validity and enforcement of contracts of adhesion and consumer protection. Additionally, these activities have implications for credit, liquidity, and operations, as well as financial stability.
While Crypto Standards offer many benefits, including progress towards public policy goals of consumer protection and financial stability, as well as tools to promote interoperability, security, and responsible technological innovation, standards alone are not sufficient to address all of the practices discussed in this paper. We therefore propose a second pillar of cryptocurrency regulation: an additional national overlay of strong investor and/or consumer protections, as absolutely necessary to address activities in this space. This national overlay should encompass five consumer protection themes that we discuss in this paper, and regulatory consistency and cooperation should be achieved through a federal interagency rule-making process.
The third pillar of this comprehensive approach is international standard-setting. International standard-setting is essential to achieving cooperation and collaboration between jurisdictions on the investor and consumer protections mentioned herein. While standard-setting can be a long and arduous process, it is imperative to achieving long-term efficacy in cryptocurrency regulation. All together, these three pillars (Crypto Standards, national consumer protection regulation, and international standard-setting) can provide a comprehensive approach to investor and consumer protection in cryptocurrency.
Keywords: Crypto, cryptocurrency, blockchain, web3, digital assets, CBDC, digital currency, regulation, financial regulation, consumer protection, crypto standards, smart contracts
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