Shaq, <em>Ripple</em>, and the Future of Crypto Regulation

Crypto is at a regulatory crossroads. The Securities and Exchange Commission (SEC) and other regulators have taken a hard line on enforcing traditional regulatory requirements that would severely limit crypto offering activities. At the same time, crypto advocates seek preferential treatment, under the guise of “regulatory clarity,” that would allow them to bypass much of the applicable regulatory regimes. After a halt to legislative activities, brought on by the FTX implosion and ensuing crypto winter, the battle for crypto’s future is currently in the courts. Two pending, bellwether cases—the class action against Shaquille O’Neal and other celebrity spokesmen for FTX, and the SEC’s protracted Ripple Labs litigation—illustrate the following claims about crypto and financial regulation: (1) Crypto’s attempts to access broad public markets are incompatible with the existing financial regulatory framework, which either prohibits access to public markets (as for securities) or requires alternative regulatory oversight (such as substantive prudential banking regulation). (2) Calls for “clarity” regarding crypto regulation are disingenuous in that crypto investments, with quite limited exceptions, are clearly prohibited from public trading under existing regulatory frameworks. Rather, calls for clarity are actually seeking more lenient treatment than exists for comparable assets. (3) Because crypto innovations are minimal and largely reinvent the wheel of traditional back-office financial plumbing, any privileges granted to crypto may lead to massive regulatory arbitrage. Virtually any traditional financial function—fundraising, brokerage, banking—can be recast as blockchain-based with minimal functional changes for the end-user. (4) Whether the current regime—which prohibits public access for most unlicensed investment products—is desirable from the standpoint of economic efficiency is debatable. However, to date, there is little reason to treat crypto offerings differently than other passive investments, as crypto assets suffer from significant informational asymmetry and are subject to manipulation and related-party transactions. Decentralization and deconstruction of crypto financial functions is largely endogenous (and provides limited, if any, efficiency gains), such that crypto’s purported inability to comply with existing regulation is a choice that can be exploited for regulatory arbitrage.