Crypto 'Floor is Lava': SEC's Peirce Demands Clearer US Rules

Our view is that the U.S. crypto market is at a decisive inflection point. Regulatory uncertainty is the biggest risk of all, putting a damper on potential innovation and investment. As SEC commissioner Hester Peirce has so accurately put it, we are “in a period of no rules.” She compares it to an adult version of “the floor is lava.” For starters, crypto firms should take all reasonable steps to avoid any direct exposure to crypto assets. Without a better understanding of what regulatory protections are actually required, they risk being the subject of future enforcement actions. This toxic environment both kills growth and drives businesses to more hospitable jurisdictions. DeliciousNFT.com’s goal is to demystify this emerging and often confusing space and provide useful guidance for making the most of today’s landscape.

The Need for Clear Regulations in Crypto

The fundamental issue here is the lack of clarity about how digital assets are classified and held. Are they securities? Commodities? Something else entirely? Without clear, uniform definitions, businesses find it nearly impossible to comply with current and future regulations that the SEC has to enforce in a consistent and fair manner. The lack of any bright line rules casts a chilling impact. Yet at the same time, it saps innovation and investment in the U.S., as other countries advance with strong, supportive frameworks. This lack of clarity only adds to the confusing obstacles. Moreover, it greatly stifles the innovation and development of the U.S. crypto market.

The SEC’s enforcement-first approach – widely seen as creating a chilling effect on innovation and idea-sharing – makes it even worse. The SEC instead regularly decides to pursue enforcement actions against entities that it believes have violated the securities laws. Rather than providing unambiguous direction and working with the industry, they choose to punish. Enforcement remains an extremely important mechanism to protect investors and ensure the integrity of our markets. It must not be the primary approach for designing the regulatory landscape. In order to finally achieve a healthy and thriving crypto ecosystem here in the U.S., we urge you to take a more balanced approach. This approach must balance enforcement with clear guidance while fostering open dialogue.

The consequences of inaction are significant. Businesses are avoiding states or localities with muddier regulatory environments. In doing so, the U.S. is likely to fall behind its competitive interests in the rapidly evolving space of crypto technologies. Innovation will be the big loser if we remain inactive. Without investment the U.S. will fall further behind other countries in leading the development and deployment of blockchain technology. This is more than just a crypto industry issue—this is the future of finance and technology in the U.S.

Paul Atkins, Chairman, on the Importance of Clarity

Paul Atkins, a former SEC commissioner currently serving as the Chairman and CEO of Patomak Global Partners. He has repeatedly touted the need for regulatory clarity on the crypto frontier. He contends that consistent standards are necessary to encourage innovation, safeguard investors, and maintain market integrity. Without clear guidelines, companies have to speculate on what is allowed, which breeds uncertainty and stifles investment. Atkins thinks the SEC should be listening and working with the industry. Only together can they create a regulatory framework that is tailored to the unique nature of digital assets.

In addition to this, Atkins has cautioned that a uniform approach to crypto regulation would be misguided. He makes the case that not all digital assets are created equal and should thus be treated with different risk profiles and regulations. First, what is a stablecoin? Stablecoins are digital currencies that try to maintain a stable value. They should be subject to lighter regulation than risky crypto assets like Bitcoin. Atkins believes that a flexible and adaptable regulatory framework is essential for accommodating the rapid pace of innovation in the crypto space.

Additionally, Atkins is of the opinion that international cooperation is key for effective crypto regulation. Because crypto assets transfer so easily across borders, they can be used to evade sanctions. This is why it is essential for countries to come together to develop unified regulatory requirements. This will avoid regulatory arbitrage by preventing companies from relocating to jurisdictions with the lowest common denominators in regulation. Equally important, it will reaffirm that all investors—whether across America or around the globe—are entitled to strong protections.

Hester Peirce (“Cryptomom”) Advocates for a Brighter Future

Hester Peirce, affectionately known as "Cryptomom" within the crypto community, has been a vocal advocate for a more balanced and pragmatic approach to crypto regulation. She has repeatedly called on the SEC to provide more clear guidance. She would like to see the agency work alongside the industry to create a regulatory framework that promotes innovation and protects investors. Her “floor is lava” analogy dramatically explains why it’s so uncertain in the present day. Businesses need to be able to nimbly cut through a complicated and ever-changing regulatory terrain.

It is that clear guidance that Peirce strongly encourages the SEC to provide. She focuses on the need to clarify fundamental questions such as how to classify and hold digital assets as well as how to regulate crypto exchanges. She further condemned the SEC’s enforcement-first approach. She contended that this approach suppresses innovation and drives companies away from the U.S. market. Peirce, a hope-filled pragmatist, is an evangelist for the power of collaboration. She emphasizes that transparency and good-faith interaction between regulators and the industry are key for developing a long-term, responsible crypto-market in the U.S.

Peirce's advocacy extends beyond simply criticizing the SEC's current approach. She has shared specific ideas on how the SEC could ensure better regulation of the crypto market. She has proposed that the SEC develop a “safe harbor” for certain categories of crypto projects. This would give them the breathing space to operate without the looming fear of enforcement action as they take tangible steps towards compliance with existing regulations. To her credit, she has called for more guidance from the SEC. She is interested in learning how current securities laws should be applied—or not applied—to digital assets.

Understanding Crypto Custody Challenges

One of the other significant obstacles in the annoying and dangerous regulatory landscape of crypto lies in the realm of custody. Custody is the term used to describe the safekeeping of investors' digital assets, and it is central to protecting investors. The traditional models of custody for securities and financial assets do not work with crypto assets. Their unique characteristics mean they need a special touch. Companies that want to get into the custody business for digital assets don’t know where they stand. Similarly, states and investors want to be confident that their assets will be safe and secure.

Unclear custodial guidelines for crypto have only exacerbated an already fragmented and inconsistent regulatory landscape. While some states, like Texas and Wyoming, have implemented their own laws and regulations to govern crypto custody, not all states have followed suit. This results in a confusing patchwork of regulations that are cumbersome and expensive for businesses to navigate. In fact, the SEC has recently been quite vocal about crypto custody. Its advice is still scant and sometimes contradictory.

The challenges of crypto custody are multifaceted. One of the biggest challenges facing the new space is the security of digital assets. Crypto assets reside on blockchains, which are essentially decentralized and immutable (permanent) digital ledgers. They are the most resistant to hacking and fraud. The major drawback of this technology is that if an individual loses their private keys, they lose access to all of their assets permanently. Thus, it is extremely important that custodians develop strong security practices to fend off security threats from both insiders and malicious external actors.

Caroline Crenshaw's Perspective on Trust in Crypto Custody

SEC Commissioner Caroline Crenshaw has written a great deal about how trust and regulatory compliance must underpin any crypto custody offerings. She focuses on the need to protect digital assets when custodians are holding them. This protection is vital for sustaining investor confidence and upholding market integrity. Crenshaw continues to stress the dire and increasing need for robust regulatory guard rails. These frameworks need to address the crypto-specific risks of custody like cybersecurity threats, operational vulnerabilities, and conflicts of interest.

It’s an example of Crenshaw’s longstanding advocacy for clear regulatory standards. He argues that custodians need to have stringent internal controls in place, asset segregation and total risk management strategy. She says these steps are necessary to ensure investors don’t get stuck with the bill for big losses. By extension, they help keep the rest of the crypto market stable. Crenshaw addresses the importance of transparency and the need for disclosure. Custodians should be required to provide investors with meaningful and relevant disclosures about their custody practices and related risks.

His argument underlines the need for a greater degree of ongoing oversight and enforcement. We do this by requiring custodians set regulatory requirements and maintain the highest standards of security and integrity. She thinks a forward-looking, watchful regulatory stance is needed. By doing so, it fosters greater trust and confidence in the broader crypto market, facilitating its long-term growth and development.

Key Questions Raised During the Roundtable Discussion

Those questions include:

What constitutes adequate custody of digital assets?
How should custodians be regulated to ensure the safety and security of digital assets?
What are the appropriate capital requirements for crypto custodians?
How should custodians address the risks of cybersecurity and fraud?
What role should insurance play in protecting investors from losses due to custody failures?

Addressing these questions is essential for creating a regulatory framework that provides clarity and certainty for businesses, protects investors, and fosters innovation in the crypto space. The SEC must work in partnership with the industry to address these questions as fundamental challenges to face. By collaborating, they can produce useful regulations that acknowledge the special nature of digital assets.

The Importance of Regulation for the Crypto Community

Many crypto advocates view regulation as an affront to the decentralized, permissionless core of blockchain tech. At the same time, we need to recognize that reasonable and well-thought out regulation is key to fostering the long-term innovative growth and adoption of crypto assets. Predictable and flexible regulations provide them the confidence to invest, innovate, and plan for the future. In addition, they deter fraud and manipulation and protect investors — large and small — thus promoting a fair playing field for all market participants.

Regulation doesn't have to stifle innovation. In truth, it can serve as a force for fostering stability. When governments provide a better-defined and more predictable environment, businesses are better able to operate efficiently. When businesses know what the rules are, they can focus on developing new products and services without having to worry about running afoul of regulators. This, in turn, will spur more investment, faster innovation and broader adoption of these crypto assets.

Additionally, regulation can prove to skeptical public audiences and institutional investors that the crypto industry is legitimate and should be trusted. This may cause many potential investors to hold off on joining the market in crypto. They fear the absence of regulation and the potential for fraud and manipulation. The SEC is well-positioned to address these concerns through strong, straightforward rules. This move will bring a new wave of institutional crypto investors to the market.

Why Clear Rules Matter

Rules that are clear and stable by definition provide certainty, enhance investor protection and long-term sustainable innovation. Without established guidelines, private enterprises are forced to speculate what might be allowed, fostering ambiguity and deterring investment. As a result, the risk for investors to become victims of fraud and manipulation is greater. Consequently, the crypto market can’t realize its promise.

Well-defined rules bring order to the process and instill some faith that everyone is playing by the same rules of the game. When entities understand the rules of the game, they can then compete in a competitive and transparent manner. First, this promotes competition, drives innovation, and ultimately benefits consumers.

The murky regulatory picture in the U.S. is exacerbating market conditions and hampering innovation and growth within the crypto market. Consequently, firms are looking for jurisdictions that are more business-friendly to operate and prosper. The SEC needs to act quickly to provide clear guidance and work collaboratively with the industry to develop a regulatory framework that fosters innovation while protecting investors.

Anticipating Upcoming Crypto Regulations

The future of crypto regulation in the U.S. remains uncertain. A few possible events have the potential to make big waves and greatly influence that regulatory picture in the months and years to come. These include:

Congressional action: Congress could pass legislation that provides a clear definition of digital assets and establishes a regulatory framework for the crypto market.
SEC rulemaking: The SEC could issue new rules and guidance on key issues such as the classification of digital assets, the custody of digital assets, and the regulation of crypto exchanges.
Enforcement actions: The SEC could continue to bring enforcement actions against companies it believes are violating securities laws, which could provide further clarity on the SEC's interpretation of existing regulations.
International developments: The regulatory landscape in other countries could influence the SEC's approach to crypto regulation.

It is absolutely critical that those businesses and investors interested and engaged in this opportunity remain aware of what is likely to develop. They should be prepared to adjust if the regulatory landscape changes. DeliciousNFT.com will be tracking these developments and providing analysis on these issues as they play out.

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