The Catch-22 of U.S. Crypto Regulation

The
current
state
of
crypto
regulation
is
a

“Catch-22,”
a
series
of
absurd
and
contradictory
rules
and
requirements
that
are
impossible
to
follow.

Marcelo
M.
Prates
is
a
central
bank
lawyer
and
researcher.

In
Joseph
Heller’s
famous
novel,
a
Catch-22
refers
to
a
stipulation
that
pilots
seeking
to
be
excused
from
their
combat
duties
could
file
a
request
stating
they
are
insane.
With
one
catch:
filing
the
request
implies
that
the
petitioner
is
sane
and,
thus,
ineligible
to
be
excused.

In
2024
America,
the
SEC’s
“come
in
and
register”
approach
is
a
Catch-22
for
crypto.

SEC
Chair
Gary
Gensler
often
says
that
registering
with
the
SEC
to
comply
with
securities
regulation
is
straightforward,
“it’s
just
a
form
on
our
website.”
And
crypto
issuers
and
exchanges
“are
just
choosing
not
to
do
it”
despite
knowing
how
to
do
it.
The
SEC
chair
makes
it
sound
like
crypto
firms
have
been
unreasonably
(if
not
unlawfully)
stubborn
in
not
filing
the
required
registrations
in
the
face
of
a
welcoming
SEC.
This
characterization
hides
a
catch.

Even
if
we
assume,
as
Gensler
does,
that
all
crypto
tokens
are
securities
and
should
be
registered
with
the
SEC
—

which
is
debatable
—
and
that
the
registration
process
is
simple
—

which
is
not
—
successful
registration
would
lead
to
a
dead
end.
Registered
crypto
tokens,
like
any
registered
securities,
could
only
be
traded
on
registered
exchanges
through
registered
broker-dealers.
But
that’s
impossible
today.

The
Financial
Industry
Regulatory
Authority
(FINRA),
a
self-regulatory
organization
that
oversees
broker-dealers,
has

approved
just
a
few
institutions
to
deal
with
crypto
tokens.
Among
these
institutions,
only
one
is
a
Special
Purpose
Broker-Dealer,
Prometheum,
which

remains
inactive
and
hasn’t
yet
listed
a
token
to
trade
almost
one
year
after
the
approval.

See
also:



Aspiring
Crypto
Bank’s
Plight
Shows
Binance’s
Issues

The
SEC,
moreover,
hasn’t
allowed
any
currently
registered
exchange
or
broker-dealer
to
list,
custody
or
trade
crypto
tokens.
The

SEC’s
view
is
that
any
registered
institution
willing
to
work
with
crypto
tokens
“could
not
deal
in,
effect
transactions
in,
maintain
custody
of,
or
operate
an
alternative
trading
system
for
traditional
securities.”

Further,

virtually
no
crypto
tokens
have
been
registered
with
the
SEC
so
far.
And
that’s
the
Catch-22:
issuers
won’t
register
their
crypto
tokens
before
they
can
find
registered
exchanges
and
broker-dealers
that
can
work
with
them,
and
registered
exchanges
and
broker-dealers
won’t
start
working
with
crypto
tokens
until
they
see
enough
tokens
registered
to
make
the
business
model
economically
viable.

The
reality
for
fintech
isn’t
much
brighter.
Because
of
the
lack
of
a
specific
federal
licensing
framework,
fintech
firms
using
technology
to
offer
more
efficient
and
cost-effective
financial
products
and
services
—
from
debit
cards
and
loans
to
mobile
payments
and
remittances
—
must
partner
with
banks.
This
fintech-banking
partnership
is
known
as
banking-as-a-service
or

BaaS.

Even
when
the
fintech
startup
is
a
licensed
money
transmitter
at
the
state
level,
it
must
partner
with
a
bank
to
make
and
receive
payments
in
dollars
since
only
banks
can
directly
access
the
payments
system.
As
a
result,
licensed
banks
in
the
U.S.
end
up
serving
as
gatekeepers
to
financial
innovation,
as
new
ideas
in
the
financial
system
have
to
be
implemented
through
them.

The

Office
of
the
Comptroller
of
the
Currency,
the
national
banking
regulator,
has
been
increasingly
wary
of
BaaS
arrangements,
making
it
more
difficult
and
costly
for
banks
to
keep
“third-party
relationships”
with
fintech
firms.

Regulators
say
they’re
concerned
with
how
fintech
partners
onboard
customers,
monitor
transactions
and
handle
sensitive
information,
as
well
as
how
banks
manage
these
risks
to
ensure
compliance
with
the
applicable
rules
and
regulations.

Because
of
this
hardened
regulatory
stance
and
the
enforcement
actions
and
fines
that
may
follow,
many
banks
are
“derisking”
by

reducing
or
outright
ending
fintech
partnerships.
At
the
same
time,
federal
regulators
aren’t
open
to
crafting
a

licensing
regime
for
fintech
or
allowing
non-banks
to
directly
access
the
payments
system
by
having
a

Fed
master
account.

There
we
have
another
Catch-22:
in
the
present
regulatory
environment,
fintech
can
only
survive
in
the
U.S.
with
the
active
collaboration
of
banks,
but
federal
regulators
don’t
want
banks
to
partner
with
fintech
companies.
What
can
be
done?

See
also:



In
Lejilex
vs.
SEC,
Crypto
Goes
on
Offense
in
the
Courts


|
Opinion

Only
Congress
can
solve
these
puzzles.
State
legislators
have
been
active
on
both
fronts,
designing
bespoke
regulatory
frameworks
for
crypto,
like
the

BitLicense
in
New
York
or
the

Digital
Financial
Assets
Law
in
California,
and
fintech,
like
the

special
purpose
depository
institution
(SPDI)
charter
in
Wyoming

But
none
of
these
state
laws
and
regimes
relieve
state-compliant
institutions
from
facing
troubles
at
the
federal
level.
Just
ask

Coinbase,
which
holds
a

BitLicense
but
is
being

sued
by
the
SEC
“for
operating
as
an
unregistered
securities
exchange,
broker,
and
clearing
agency,”
or

Custodia,
a
chartered
SPDI
that
wasn’t
allowed
to
hold
a

Fed
master
account
and
thus
cannot
directly
offer
basic
payment
services.

Congress
must
act
to
keep
financial
innovation
alive.
Enacting
tailored
licensing
and
regulatory
federal
frameworks
for
crypto
and
fintech
is
crucial
for
holding
the
U.S.
capital
and
financial
markets
sound,
competitive,
and
inclusive.
To
paraphrase
Heller,
crypto
and
fintech
companies
should
embrace
the
idea
that
they’re
“going
to
live
forever
or
die
in
the
attempt.”