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Peer-to-Peer Governance: Why Cryptocurrency SROs Can Work

Feb. 11, 2021, 9:01 AM

It is time to consider how to better oversee the burgeoning cryptocurrency industry.

In his final address on Jan. 19, then-Assistant Attorney General Makan Delrahim of the Department of Justice proposed the establishment of the Digital Markets Rulemaking Board (DMRB), a regulatory board of industry and government officials with substantive rulemaking authority over issues of market integrity and investor protection within the digital marketplace, subject to ultimate supervision and enforcement by federal regulators.

This public-private approach to governance, Delrahim contended, could serve as a complement to the “rigid” and “static” rules imposed by traditional regulatory agencies, which often lack the nimbleness to effectively regulate the swiftly evolving digital economy.

While Delrahim’s remarks were concerned with antitrust in the broader digital marketplace, the necessity of self-regulation is perhaps most pronounced in the context of cryptocurrency.

Cryptocurrency Is Ready for Self-Regulation

In the span of little more than a decade, cryptocurrency has evolved from a white paper into a mainstream retail and investment-grade asset class with a market capitalization of over $1 trillion.

Estimates suggest that approximately 7% of Americans and one-third of large U.S. financial institutions now hold some form of cryptocurrency. However, the rapid adoption of cryptocurrency, combined with the unique attributes of its underlying technologies, challenges long-standing paradigms of regulatory jurisdiction and the role of federal agencies.

Unlike traditional financial instruments such as equities and commodities, it remains unsettled which, if any, federal agency should have primary jurisdiction over cryptocurrency. As a result, a patchwork of intersecting, and often conflicting, regulatory approaches has emerged, spanning the Securities and Exchange Commission, the Commodity Futures Trading Commission, federal bank regulatory authorities and the DOJ, among other federal, state and international bodies.

While such overlap is not uncommon within heavily regulated sectors, the lack of cryptocurrency-specific federal law and a designated primary regulator have stymied the development of a single comprehensive regulatory scheme for the cryptocurrency marketplace.

In keeping with the framework of self-governance that is foundational to the modern U.S. financial regulatory schema, lawmakers should give serious consideration to the recognition and approval of one or more cryptocurrency self-regulatory organizations (SROs) such as the DMRB to support the mission of regulators.

What Is an SRO?

In the most basic terms, an SRO is a private or quasi-governmental organization that has the power to set rules and standards over its members. SROs typically, but not always, derive their authority from a statutory basis and remain subject to the ultimate oversight of a principal regulatory agency.

Participation in an SRO may be voluntary, though it is often effectively mandated by statutory or regulatory requirements, as is the case for the Financial Industry Regulatory Authority (FINRA), which oversees securities brokers and broker-dealer firms.

There is already broad support and momentum for formal self-regulation within the cryptocurrency industry, including among current and former federal policymakers and industry leaders. Further evidence of the growing appetite for self-governance is demonstrated by the number of voluntary cryptocurrency SROs that have been formed or proposed in recent years, both in the U.S. and abroad.

Advantages of a Cryptocurrency SRO

Interest in self-governance is perhaps unsurprising given the advantages that an SRO-based regulatory framework yields over exclusive government oversight. Most notably, SROs place greater authority in the hands of industry experts who are most familiar with market practices and emerging issues.

SROs also promote the specialization of knowledge, as a cryptocurrency SRO could focus solely on cryptocurrency-related issues, whereas government agencies are required to monitor all aspects of their significantly broader jurisdictions. Given the infancy of cryptocurrency and the complexity of its underlying technologies, substantial technical input from stakeholders, beyond the limited opportunities afforded by agency rulemaking processes, is crucial for the development of sound regulatory policies.

Further, as regulators find the need to draw on the expertise of specialists, an SRO would serve as a repository of institutional knowledge and talent.

Authorizing an SRO would also support regulatory efficiency, allowing agencies to conserve limited resources for highest priority concerns. Member funding would ensure that taxpayers bear no cost for SRO market activities.

To the contrary, the burden of market oversight and enforcement would be shared between regulators and the SRO, enabling more efficient allocation of public funds. Moreover, the work of a cryptocurrency SRO could yield additional fiscal savings by reducing redundancies of overlapping state and federal regulatory initiatives.

Finally, a cryptocurrency SRO would serve as a hub of resources for members and the public not provided under the current regulatory regime. SROs such as FINRA not only promulgate and enforce industry standards, they also host trainings, prepare market reports, educational materials and compliance guides and provide specialized tools like FINRA’s BrokerCheck that allow investors to conduct diligence on member firms.

In addition, SROs importantly serve as a forum for arbitration and mediation, allowing conflicts involving members to be resolved without the need for litigation. A cryptocurrency SRO would provide a centralized and specialized source for such services and information.

It is apparent that a clearly defined regulatory framework and additional oversight for cryptocurrency are necessary to preserve the integrity and stability of the marketplace. Greater leadership and increased involvement by federal agencies and lawmakers will almost certainly be necessary to achieve these goals, but government-recognized self-regulation within the cryptocurrency industry presents a promising and complementary path forward. It is time we took a closer look.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Author Information

J. Christopher Giancarlo is senior counsel to Willkie Farr & Gallagher LLP in New York. He previously served as chairman of the Commodity Futures Trading Commission.

Conrad G. Bahlke is counsel at Willkie Farr & Gallagher LLP, practicing in the areas of commodities, derivatives, and banking transactions and regulation. He has held previous positions at the Federal Reserve Board and Chicago Board of Trade.

Graham E. Pittman is an asset management associate in the New York office of Willkie Farr & Gallagher LLP whose practice includes private equity, hedge fund, and bank regulatory matters.