he new head of the Security and Exchange Commission (SEC), Gary Gensler, recently went before Congress to demonstrate his plan to regulate the burgeoning blockchain and crypto industries. Congress grilled him over how he sees cryptocurrencies fitting within current SEC definitions of securities and how the SEC should handle them.
While Gensler has a background teaching blockchain education at MIT, it seemed even he had trouble with definitive answers. This isn’t surprising considering the novelty of cryptocurrencies, and such is the case with most emerging technologies.
One thing that Gensler seemed confident about, however, is that blockchain and crypto spaces are a “Wild West,” and the vast majority of cryptocurrencies won’t be around much longer after proper regulation is in place.
Gensler’s recent visit to Congress shows that there’s an urgent need for fresh legal minds to enter into the discussion. There is a regulatory vacuum within the blockchain industry, and we need lawyers to fill it in.
Governments, blockchain companies and investors will all need lawyers that can navigate these new legal precedents. Those looking for jobs in a disruptive new industry will have opportunities in abundance.
What to regulate: Decentralized Finance
A good place to start with regulations is decentralized finance (DeFi). Blockchain professionals use the term “DeFi” to describe the array of financial tools that blockchain technology enables—such as trading, lending, borrowing and earning yield on “staked” assets.
What differentiates DeFi from traditional banking is that all of these tools are built using “smart contracts,” which are self-executing lines of code that facilitate transactions when specific conditions are met. With smart contracts, there is little need for human intervention to run entire business processes.
Examples of smart contract use cases are decentralized exchanges (DEXs) and decentralized applications (DApps), such as Uniswap and Brave Browser, respectively. Companies behind DEX and DApp projects are coming under deeper scrutiny by regulators.
DEXs, for example, are like stockbrokers, except that instead of the broker holding a reserve of money in custody to handle market liquidity, coin holders on DEXs lock their crypto into smart contracts known as “liquidity pools” and earn interest yields as incentive.
Where the trouble starts is that any crypto project can list a coin on a DEX and create a liquidity pool for traders to lock their funds. A nefarious blockchain developer can leave backdoors open and perform what’s called a “rug pull,” where they wait for enough people to lock funds into a liquidity pool before doing a classic exit scam.
Billionaire investor Mark Cuban famously fell victim to a rug pull as he experimented with a DeFi protocol in 2020. His frustration toward the situation led him to call for regulations within the space to protect other investors from suffering the same fate as him. And indeed, rug pulls are not uncommon within the DeFi space, and countless traders have fallen victim.
Not only that, but the DeFi space is rife with hacks leading investors to lose millions of dollars collectively. Hackers in these situations rarely suffer consequences due to the absence of regulatory structures, and the decentralized, semi-anonymous nature of blockchain makes it hard to locate them.
So, when people refer to the crypto space as the Wild West, these are just a couple of the scenarios they are referencing.
What to regulate: Stablecoins
Another gray area within the crypto space involves stablecoins—which are digital assets pegged to other, more stable assets such as the U.S. dollar, and therefore usually sit at a $1 price tag. Crypto traders often leave their idle capital in stablecoins so that they can wait for buy-ins without risking a loss of funds from price movement.
Gary Gensler has compared stablecoins to “poker chips”, alluding to the casino-like nature of the crypto space. The SEC has already shot down Coinbase’s attempts at offering its users the ability to earn interest on stablecoins listed on its platform. Coinbase is one of the most popular crypto exchanges and had a watershed moment when it completed its IPO earlier this year.
Multiple regulatory entities, including the SEC, Office of the Comptroller of the Currency and Commodity Futures Trading Commission, have their eyes on stablecoins and are currently working out ways in which these digital assets fit within their existing frameworks.
Recently, the Biden Administration has called for a new regulatory framework surrounding stablecoins, suggesting that the government treat them as banks.
Calling all legal professionals
The bottom line is that we’re dealing with an emerging financial technology right now that has a big impact and very little regulatory oversight. As Congress weighs how much of a risk cryptocurrencies are to investors, crypto enthusiasts worry that the U.S. will come down too hard on them, stifling the beneficial innovations that blockchain technology and cryptocurrencies hold for society.
At the moment, there is ample opportunity for legal professionals to offer insight into the discussion and steer regulations toward a satisfying goal. Lawyers entering the crypto space now would be pioneering new precedents as new cases open up within the blockchain industry. In addition, blockchain companies and investors alike will need legal experts to help them navigate new regulatory structures.