You Can’t Regulate What You Don’t Understand (2.0)

Earlier this year, Paradigm Policy wrote about how government ethics rules are negatively impacting sound crypto policymaking.

Last week, the SEC Inspector General released a report noting that, despite the rapid growth of crypto markets, the SEC was encountering “challenges in recruiting specialists in crypto assets, which Enforcement considers critical to strengthening its capabilities to investigate new and emerging issues in crypto-asset markets.” Besides general competitiveness for crypto talent, the SEC was running into issues in attracting crypto specialists because “many qualified candidates hold crypto assets, which the Office of the Ethics Counsel has determined would prohibit them from working on particular matters affecting or involving crypto assets…Candidates are often unwilling to divest their crypto assets to work for the SEC.” (Editor note: shocker.)

Regrettably, this problem will metastasize for the SEC as crypto becomes further integrated into the traditional financial system. Earlier this year, payments giant PayPal announced the release of their own stablecoin, PYUSD, and their intention to integrate it into their payments services, including Venmo. This promptly earned them a subpoena from the SEC, despite findings from the Presidential Working Group on Stablecoins, and Congressional intent in numerous bills that stablecoins should be regulated under a prudential oversight framework.

Given the SEC’s desire to assert jurisdiction over stablecoins, consider this not-unlikely scenario: SEC staff will be prohibited from use of Venmo, a payment app used by 78 million Americans in 2022 to pay family, friends, or service providers.

It will get worse from there. We are already seeing the rapid advancement of video games built on blockchain rails, where in-game assets (items, avatar skins, etc.) are tokenized to support gamer monetization and interoperability between games. If most video games in the future involve NFT assets the SEC is also trying to assert are securities – can SEC staff and other government employees no longer play video games?

The life of a regulator in the future seems increasingly disconnected, walled off from 1) consumer payment apps, 2) video games, 3) airline or credit card rewards points, 4) Starbucks customer loyalty programs, 5) Nike sneakers, and so on.

As the problems created by the government’s harsh ethics rules become even clearer, Paradigm Policy reviewed and re-evaluated our suggested principles around government crypto ownership and use from earlier this year, and stand behind our findings – though we have amended our suggestions in a few key instances. These principles are intended as a starting point, and Paradigm welcomes conversation and collaboration with policymakers who might be open to implementing a more tech-forward approach:

• Threshold. For restricted policymakers, we proposed an exemption to ethics rules that permits ownership of cryptocurrency under a threshold amount, indexed to metrics such as inflation or blockchain gas fees. We previously suggested $1,000 as a benchmark; we now propose $5,000 for greater flexibility, and increased ability to pay gas fees enabling complex onchain transactions. Any holdings above this threshold must be divested or placed into a blind trust. (NB: assuming crypto fulfills its full potential and forms the underlying infrastructure for the financial system writ large, even this dynamic thresholding — indexed to inflation or gas fees — will likely become eventually unsustainable.)
• Stablecoins. Stablecoins were not included in our initial recommendations, but growing adoption merits an immediate change in government ethics approach. Specifically, ownership of stablecoins should be carved out entirely from ethics rules (and thus would not factor into the above proposed threshold). Put simply, using stablecoins is no different than handling dollars, and cutting off access to this critical technology would especially stymie good regulation.

In response to the SEC’s report this week, crypto commentators made clear what the problem is with every analogy in the book. Imagine FAA safety managers never touching a plane. Building inspectors never visiting a construction site. Food safety engineers never seeing a packing plant. All would be incompetent at their jobs.

As we have previously emphasized, government ethics policies are helping America fall further behind on crypto. It is time for our leaders to lean into progress.