Crypto Self-Regulatory Body Proves to Be No Easy Feat

By Lydia Beyoud

Factions among cryptocurrency exchanges may be hindering forward movement toward forming a self-regulatory organization two months after a federal regulator first proposed the idea.

Such a group could help further legitimize business models and practices that don’t fit neatly into regulatory boxes, such as trading practices and asset classifications. It could also allow them to deal more cohesively with federal and state regulators and law enforcement offices scrutinizing their businesses and exploring the parameters of their regulatory authority over the exchanges.

So far, though, cryptocurrency exchanges seem more interested in forming small cliques than coming together as a cohesive group.

“Everyone’s got their own ideas of who should be in charge and so from that perspective, you get less standardization that way when you have competing bodies,” Jenny Cieplak, counsel with Crowell & Moring in Washington, told Bloomberg Law. “I think the formation of the ecosystem is going to be fractured at first,” Cieplak said.

Gemini, the first exchange to launch bitcoin futures trading in partnership with the Cboe Futures Exchange, proposed parameters for a self-regulatory organization (SRO) in March. That plan has attracted little public support from other exchanges.

Regulators remain hopeful the industry will be able to come together through an SRO. “I’ve heard some general interest that firms and participants are interested in that type of concept, but I have not heard of anyone trying to take a leadership role, other than what I saw Gemini put out,” Commodity Futures Trading Commission member Brian Quintenz told Bloomberg Law earlier this month. Quintenz suggested the industry form an SRO in March 7 during a keynote speech at the Chamber of Digital Commerce’s annual DC Blockchain Summit.

“Whoever can develop that type of structure will be doing everybody, especially the market participants, I think, a service,” he said. “Anything’s better than nothing and right now we have nothing,” he added.

Voluntary or Not?

One of the foundational issues that could determine an SRO’s success or failure is whether it would be voluntary or legally mandated.

Legally-mandated SROs like the National Futures Association (NFA) or Financial Industry Regulatory Authority (FINRA) have real authority to enforce their regulations on bad actors and fine entities that don’t join when required.

The strengths of voluntary SROs are more abstract. “The voluntary SRO is something that does have value because it gives people a stamp of approval,” Cieplak said.

Voluntary SROs also have less teeth. They are typically governed by contracts and guidelines and wouldn’t necessarily be subject to regulatory review or enforcement, Cieplak said. Enforcement issues would have to be worked out in court rather than through regulatory fines.

Voluntary SROs can also fail to capture the operators of most concern to the market and industry, she said. “It’s almost like the people that want to comply are going to comply,” while others won’t want to be involved, Cieplak said. “Those are the people you really need to worry about.”

Ultimately, if a new crypto asset SRO does come together, it would need to work closely with the CFTC, the SEC or more regulators to ensure that participation is mandated, Cieplak said.

Democratic CFTC Commission Rostin Behnam called on industry groups exploring an SRO to continue to engage with regulators.

Speaking at a May 3 futures industry conference, Behnam said: “Industry buy-in will be critical in achieving the engagement with policymakers needed to ensure that any recommendations and decisions reflect an understanding of FinTech and address the concerns and needs of all stakeholders.”

Looking to Japan

Japan, one of the largest markets for virtual currency trading, has proven successful in its efforts to form an industry body and shift from a voluntary model to a regulated one.

Today, the formal Japan Virtual Currency Exchange Association (JVCEA) includes 16 members. The voluntary SRO that became the JVCEA was established in 2014 in response to the hack of Mt. Gox, the largest virtual currency exchange at the time, based in Japan.

The group developed regulations and a registration process for exchanges in Japan. "The objective was to help regain public trust and to try to bring regulators back into the broader conversation," Hailey Lennon, director of compliance at bitFlyer USA, whose parent company was of one of the founding members of the JVCEA, told Bloomberg Law by email.

Having something similar to the JVCEA in the U.S. would be a positive move, Lennon said. “The big question is determining who an SRO would look to for regulatory guidance,” she said.

“An SRO in the U.S. would serve as an opportunity for players in this space to speak to the legitimacy of the industry. We plan to be part of the conversation and to potentially partner with other key players in the industry and/or regulators in figuring out the best way to do that,” Lennon said.

To contact the reporter on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com

To contact the editor responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com

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