Federal Preemption or States’ Rights? Crypto Advocates Clash Over Regulatory Approaches

It is easy to think of the most prominent blockchain advocates as a united front, whose ranks are tightly closed in the face of the common enemy — a horde of fierce crypto critics, unwieldy regulators, anti-money laundering zealots, “bitcoin is a scam”-ers, and the stakeholders of the old, centralized financial system. On this battlefield, the crypto camp’s fundamental positions are aligned, and its strategic goals are clear. However, in the times of armistice, blockchain champions get together by the campfire to ponder the important details of their common cause, and — astonishingly — at times, they disagree.

This time around, the metaphorical campfire was lit at the MIT Technology Review's Business of Blockchain 2019 conference, which took place on May 2 on the premises of the Massachusetts Institute of Technology’s Media Lab. One of the panels saw Caitlin Long — the woman who is spearheading Wyoming’s transformation into what she herself called the “Delaware of crypto law” — have a deferential yet rather intense exchange with Coin Center’s director of research, Peter Van Valkenburgh, one of the industry’s most eloquent speakers who is known for many notable deeds — for example, standing up for crypto to a bully last October.

The panel, which also featured MIT professor and former Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler, was on crypto regulation, and the main point of contention was whether it is better done on the federal or state level. While they were ultimately concerned about the same thing — i.e., the backwardness of the United States’ regulatory environment that can chase promising startups away to more friendly jurisdictions — Long and Van Valkenburgh offered two drastically different visions of the best way to go about the issue.

Hurdles on all levels

The tension over the boundaries of federal vs. state authority has informed American politics since the foundation of the republic. In the realms of commerce and finance, a relative balance was achieved when the states assumed jurisdiction over the “consumer-facing” commercial law while the agencies of federal government came to oversee operations with more specialized, “institutional” financial instruments — such as securities (Securities and Exchange Commission, SEC), futures and options (Commodity Futures Trading Commission, CFTC), and broad financial crimes (Financial Crimes Enforcement Network, FinCEN).

It has become a truism that, for crypto enterprises in the U.S., navigating the regulatory landscape is about as easy as making it blindfolded through a minefield. All the agencies mentioned above are interested in some subset of digital assets: The CFTC is eyeing smart contract-powered futures options; the SEC is struggling to decide whether all initial token offerings are under its purview, or just some of them; and FinCEN, facing the need to investigate money laundering schemes and shady transactions, understands crypto assets as something it is used to dealing with (i.e., money). In addition, the Internal Revenue Service (IRS) is treating crypto as property for the taxing purposes, which means that capital gains and losses come into play.

To top it all off, individual states have begun to institute guidelines and regulations of their own, with Wyoming blazing the trail by establishing its own classification of tokens. This is not a small deal, either, since companies operating online automatically fall under jurisdiction of every state whose residents they serve — meaning that now they have to comply with state regulations, too.

This chaos is due to the fact that there is no universally agreed-upon, federally enforced definition of a digital asset. While it would come in handy if one existed — for the purposes of delineating the boundaries of different national regulatory bodies’ jurisdiction over different types of tokens — it is also an arduous task to formulate such a definition, let alone to steamroll such a bill through Congress. The last few months saw continuous attempts on behalf of a group of blockchain-conscious members of Congress to introduce more clarity with a bill known as the Token Taxonomy Act.

The crypto community, though, seems to be divided over not just the bill itself but the very idea of a Congress-enacted, binding definition of a digital token with a claim of federal preemption. Some critics point out that, absent a clear understanding of terms and a sufficient corpus of case law on the matter, it is nearly impossible for a bill to define central concepts around crypto assets in a way that would eliminate dreadful ambiguity when enforced. Others, including Caitlin Long, argue that it is not the federal government’s business altogether, and an attempt by Congress to introduce such a taxonomy would amount to an infringement on states’ rights. Long’s talk at the MIT Technology Review event, her polemic with Van Valkenburgh at the panel, and a subsequent interview to Cointelegraph provide a closer look at the “states’ rights” argument that she stands by.

Financializing crypto assets

Put very simply, there are two major elements in regulations that bind financial firms: those related to consumer protection and prudential regulations, which are rules that dictate the need for such firms to be able to handle risks and hold sufficient assets. One of the central theses that Long advanced throughout the conference is that the inadequacy of current U.S. crypto regulation stems from overemphasizing the consumer protection side while ignoring the solvency issues.

In her talk, entitled “The Financialization of Cryptoassets,” Long explained that many digital assets do not qualify as securities, hence they should be treated as property. Commercial law related to property was mainly formulated in the age when all possessions were tangible, which warrants the need for updating this legal area so as to define digital assets — or to “financialize” them.

The key difference between the traditional financial system and blockchain-based systems is the way custody and settlement work. Normally, people do not own the shares in their brokerage accounts. Instead, they own IOUs (“I owe you”) from their brokers, who own IOUs from custodians, etc. With this murky chain of ownership, it is not uncommon that several entities have claims on one asset; it is often impossible to tell where exactly the asset is at the moment; and finally, settlement can take days.

None of these are an issue with digital assets: You can own them directly, they are easily traceable and settlement takes minutes. All that this novel type of property needs is to be treated as such, and to have sound regulation of custody. In Long’s opinion, not only are states in a better position than the federal government to ensure both, but they have the priority to do so.

The panel: state vs. federal

The regulatory panel ensued, now featuring Peter Van Valkenburgh and Gary Gensler alongside Caitlin Long. The Wyoming native kicked off the discussion with the same sentiment that permeated her talk:

“States control commercial law.”