Crypto’s Lack of Regulatory Certainty Poses Challenges for Founders

By Andy Kangpan on October 13, 2022

Regulatory scrutiny is increasing amidst a volatile market environment

Amidst the backdrop of the most severe market drawdown in a generation across many asset classes, the crypto market in particular has been reeling. Several high flying crypto-focused companies have imploded, numerous investment firms have gone under, and market sentiment across the board has soured. Consequently, regulators are focused on the crypto markets more than ever before. This scrutiny brings immense uncertainty to an already volatile market environment. The prospect of increased regulatory oversight has existed over the crypto industry for many years, but it has never truly manifested.

Times have changed. Over the past couple of years, there have been a number of striking developments leading to action from regulators.

  • Retail exposure. A recent poll found that one in five Americans have traded crypto. While this is still far away from the 56% of Americans who own stocks, crypto is no longer relegated to the fringes of niche technology circles. A significant number of retail investors have allocated capital to the space putting pressure on agencies to act.
  • Pervasive fraud. The pervasiveness of fraud in the crypto space is shocking. Since January 2021 over 46,000 people have collectively lost over $1B in scams involving crypto. The FTC projects that consumers will lose more than $1B in 2022 from digital asset scams in 2022.
  • Systemic financial risk. The crypto market does not seem to pose a serious risk to the American economy today, but this could become a reality over time. As more retail investors touch crypto and institutional market participants enter the space the scale of the asset class will grow, which could put stress on the financial system in times of volatility.

As a result of these developments, a number of high profile enforcement actions have emerged in recent months including a very high profile insider trading case brought against a former employee at Coinbase, as well as his brother and a friend. Furthermore, in recent weeks there have been a number of major reports released in response to the Biden Administration’s executive order in March that produced the first-ever comprehensive framework for the responsible development of digital assets in the U.S., which demonstrates the amount of attention agencies are directing towards the digital asset market. This framework underscores the value of the digital assets opportunity, purporting, “Digital assets present potential opportunities to reinforce U.S. leadership in the global financial system and remain at the technological frontier.”

Despite the regulatory momentum, these recent reports do not answer key questions facing this market other than to imply the U.S. government is going to spend more resources on the initiative.

Founders need a clear set of rules to abide by to build effectively

Ultimately, we think many of the regulatory goals that various agencies are focused on are desirable. In particular, protecting retail investors from fraud, and ensuring that firms accepting retail deposits abide by common sense guidelines to avoid catastrophic loss are desirable objectives. The recent collapse of Celsius is an outcome that we should all want to avoid moving into the future.

Critically, we believe greater regulatory certainty will allow the United States to take advantage of rampant innovation in this burgeoning market that carries significant potential to transform many aspects of our economy. In the absence of regulatory clarity, many entrepreneurs looking to build crypto businesses in the U.S. face a variety of challenges that do not appear to exist in other countries. As a consequence, we have seen many new crypto-friendly havens emerge (e.g., Bahamas, Dubai, London, etc.) that appear to provide more clarity and flexibility for individuals looking to leverage this new technology. These jurisdictions have begun to attract many founders and industry operators and could challenge the United States’ position at the “technological frontier” in the future.

In establishing this regulatory clarity, we believe the U.S. should seek to preserve the core tenets of the crypto market – privacy, open markets, transparency, and decentralization – as much as practically possible. Entrepreneurs in this market are building in this space because there is an opportunity to build a more open, fair, and efficient global system of value exchange. There will undeniably be individuals looking to subvert this technology for selfish gains at the expense of the greater ambitions of the crypto industry, but these bad actors shouldn’t be the only focus for regulation.

Regulation is coming. If you are an early stage startup, it is important to invest time and resources in understanding this changing landscape. Some practical steps can be taken even in the face of this uncertain landscape. Working with legal and regulatory experts (whether in-house or via a reputable firm) that can help you navigate this change is a critical first step.

If you are a founder in the space looking to better navigate these challenges, please don’t hesitate to reach out. We welcome the chance to talk through this changing landscape with you and what it could mean for startups moving forward.

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