Paradigm: The government cannot regulate the cryptocurrency industry it does not understand

Original Title: You Can't Regulate What You Don't Understand (2.0)

Original Author: Alex Grieve, Paradigm

Original Compilation: Kate, Mars Finance

Earlier this year, Paradigm Policy wrote an article about how government ethical rules negatively impact sound cryptocurrency policy-making.

Last week, the U.S. Securities and Exchange Commission's Inspector General released a report stating that despite the rapid growth of the crypto market, the SEC is "facing challenges in recruiting crypto asset experts, which law enforcement considers crucial to enhancing its ability to investigate emerging issues in the crypto asset market." In addition to the overall competitiveness for crypto talent, the SEC has also encountered issues attracting crypto experts because "many qualified candidates hold crypto assets, and the Office of the Ethics Counsel has determined that this would prohibit them from engaging in specific transactions that affect or involve crypto assets… Candidates are often reluctant to give up their crypto assets to work for the SEC."

Unfortunately, as cryptocurrencies further integrate into the traditional financial system, this issue will shift to the SEC. Earlier this year, payment giant PayPal announced the launch of its own stablecoin, PYUSD, and plans to integrate it into payment services including Venmo. Despite the findings of the President's Working Group on Stablecoins and Congress indicating that stablecoins should be regulated under a prudent oversight framework, this quickly earned them a subpoena from the SEC.

Given the SEC's desire to exercise jurisdiction over stablecoins, consider this unlikely scenario: SEC staff would be prohibited from using Venmo, a payment application that 78 million Americans used to pay family, friends, or service providers by 2022.

Since then, the situation has worsened. We have seen the rapid development of blockchain-based games, where in-game assets (items, character skins, etc.) are tokenized to support player profitability and interoperability between games. If most video games in the future involve NFT assets, and the SEC also attempts to assert that they are securities—can SEC employees and other government employees still play video games?

The lives of future regulators seem increasingly disconnected from 1) consumer payment applications, 2) video games, 3) airline or credit card points, 4) Starbucks customer loyalty programs, 5) Nike sneakers, and so on.

As the problems caused by the government's strict ethical rules become clearer, Paradigm Policy reviews and reassesses the proposed principles regarding government ownership and use of cryptocurrencies that we put forward earlier this year, and supports our findings—although we have modified our recommendations in some key areas. These principles are intended to serve as a starting point, and Paradigm welcomes dialogue and collaboration with policymakers who may be willing to implement more advanced technological approaches:

• Thresholds. For restricted policymakers, we propose an ethical rule exemption that allows the ownership of cryptocurrency below a certain threshold amount, linked to indicators such as inflation or blockchain gas fees. We previously suggested a benchmark of $1,000, and we now propose $5,000 for greater flexibility and to enhance the ability to pay gas fees, thus enabling complex on-chain transactions. Any assets exceeding this threshold must be divested or placed in a blind trust. (Note: Assuming cryptocurrencies fully realize their potential and form the infrastructure of the financial system, even this dynamic threshold linked to inflation or gas fees may ultimately become unsustainable.)
• Stablecoins. Stablecoins were not included in our initial recommendations, but their increasing adoption warrants an immediate change in the government's ethical approach. Specifically, the ownership of stablecoins should be completely exempt from ethical rules (thus not considered under the proposed thresholds above). In short, using stablecoins is no different from handling U.S. dollars, and cutting off access to this critical technology would particularly hinder good regulation.

In response to the SEC's report this week, cryptocurrency commentators clarified the issues with each analogy in the book. Imagine if the FAA's safety managers had never touched an airplane. Building inspectors never visited construction sites. Food safety engineers had never seen a packaging plant. They would all be incompetent in their jobs.

As we have emphasized before, the government's ethical policies are helping the U.S. fall further behind in cryptocurrency. It is time for our leaders to strive for progress.