Our internal and external debates regarding regulation would improve if we thought of crypto as two ecosystems rather than one. There is a basic dichotomy that has a big effect on the policy debate, explains where we are with regulation today and will define how we move forward. But we never talk about it. That should change.
One side of crypto is predominantly about investment. Call it “money crypto.” In essence, it is about buying, holding, lending and trading tokens as investable assets. Money crypto wants big institutions and retirement funds to invest and a spot exchange-traded product that every retail investor buys. When money crypto says “it’s still early,” this means that most people haven’t bought yet. This side has the attention of regulators.
Bill Hughes is the senior counsel and director of global regulatory matters at ConsenSys Software.
The other side is about building peer-to-peer computer networks where participants transact by interacting with globally accessible software. Call it “tech crypto.” Tech crypto wants these new computer ecosystems to actually work and provide utility for their users. When tech crypto says “it’s still early,” it means that a lot of the key tech that will define the long term has yet to be built out. The required innovation has not much directly to do with prices going up (but prices going up isn’t irrelevant, in part because it impacts upon the security of these protocols). Generally, this side is poorly understood by regulators but some are learning fast.
Centralized finance (CeFi) is the beating heart of money crypto. Intermediaries define the investment landscape and are the driving force. In tech crypto, by contrast, the defining feature is software serving as a transactional counterparty or intermediary. Tech crypto is much more DeFi (decentralized finance) than CeFi.
Money crypto and tech crypto present different risks that public policy might address. In money crypto, the risks look more or less as they do in traditional finance: third-party custody, third-party-facilitated payments, retail investor protection, illicit finance and market manipulation, among other things. CeFi looks a lot like traditional finance (TradFi), after all. Tech crypto risk encompasses some of these categories but includes entirely different ones, too: hazardous self-custody, vulnerable smart contracts, good and bad actors having equal access and public, pseudonymous and irreversible transactions. DeFi opens up a whole different problem set with which public policy is unfamiliar.
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The money crypto versus tech crypto distinction has come into brighter relief recently. Crypto OG Erik Voorhees and FTX CEO Sam Bankman-Fried’s recent discussion about regulatory policy touched often on this underlying distinction. SBF generally provided the perspective of money crypto while Voorhees often advanced the banner of tech crypto. Vitalik Buterin chimed in on Twitter that he would prefer slower investment mass adoption if it gave time for the tech to improve – a tech crypto perspective. The remarkably entertaining Bloomberg contributor Matt Levine astutely recognized a money versus tech distinction in his recent comprehensive treatment of crypto.
This distinction is in our face. It’s time we acknowledge it during regulatory debate. Failure to do just that has been muddling things for some time.
Money crypto has been the 800-pound gorilla in the regulatory debate so far. Money crypto captures far more popular attention, has a set of policy issues that need more immediate resolution (e.g., let Americans trade perpetual futures on margin), donates more to political campaigns, spends more on policy people, lobbyists and policy advertising, and generally is more sophisticated with how international, federal and state policy is created and implemented. Money crypto has thus been leading the agenda and defining the issues. “Regulatory clarity” has been the major policy talking point in large part because regulations are likely to open broader investor markets, not because developers want permission to write a new smart contract. Money crypto appears much more ready, willing and able to reach regulatory compromises that unlock new markets for their camp, even compromises that would present uncapped regulatory risk to tech crypto.
Money crypto has been driving the regulatory discussion, which has led many regulators to overemphasize the investment aspect of crypto. Digital assets are just things you buy low and sell high, they think.
Tech crypto has been in the backseat. Having less capital to throw at lobbying and policymaking, being less sophisticated with the ways of Washington, D.C., and not having as many existential regulatory questions pending, tech crypto has a much lower profile. Most legislators have heard of ether and its meteoric price rise. Few understand that Ethereum is a computing platform. Almost no one understands the protocols being built on it.
But the balance in advocacy is very much shifting, which should make for a smarter discussion. And this shift is not by accident. Tech crypto sees regulators now scrutinizing peer-to-peer networks, unhosted wallets, smart contracts and the like. The specter of peer-to-peer (P2P) regulation is now on the horizon, and therefore as a matter of growing necessity tech crypto is committing more resources into policy development and advocacy.
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We see this trend manifested in the recent response to the Digital Asset Commodity Consumer Protection Act, which sits with committees in the U.S. House of Representatives and Senate. While money crypto – especially a considerably active major CeFi player that will remain nameless – has been pushing for its passage, tech crypto has been howling that vague and ambiguous provisions would permit the CFTC plenary authority to regulate P2P protocols. Those criticisms have put the bill sponsors and some in money crypto at a disadvantage. That is a good sign.
As tech crypto starts playing a more important role in the conversation, we should embrace both sides. Neither is good or bad – rather, their relationship is symbiotic. Most people only care about tech crypto because money crypto has helped the price go up, and the price goes up only because tech crypto is making something that enough people believe may actually change the world for the better. Yet, acting like they are the same frustrates a competent debate of the policy issues.
It also confuses regulators. If there is no gap between money crypto and tech crypto, then regulators like the Securities and Exchange Commission (SEC) have a rhetorical basis to prescribe the same regulatory solution across both spaces.
“Because we obviously get to regulate the investment side, we should regulate the tech side, too,” is the logic. Properly framing the two sides would ideally result in agencies acting more like FinCEN has to date. That agency in 2020 saw a rushed rule looking to hobble unhosted wallets, and properly resisted (to the extent they were able) their U.S. Treasury Department bosses. They knew that their congressional mandate could be extended to money crypto, which often engages in money services business, but extending their supervision to tech crypto was beyond their authority.
A coherent approach would mean addressing money crypto regulation first and then getting to tech crypto later. Money crypto is much more readily regulated. While we may be far from great at it, we have experience regulating intermediated financial systems. We could and should prioritize working out all the messy but important details, including custodial requirements, know-your-customer (KYC) and balance sheet transparency, that must be resolved in CeFi. By focusing on a properly regulated CeFi first, we would address that part of crypto which is undeniably larger, more exposed to retail, and more connected with TradFi.
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While we are doing that, we can evolve our views and hopefully reach greater consensus about risks and mitigation strategies relating to the global, permissionless P2P crypto space. This approach makes sense in no small part because of how early in its evolution DeFi is, and the near certainty that it will meaningfully evolve over the coming years. Some of that change will inevitably address many risks we see today.
We should be more appropriately reactive when it comes to money crypto versus tech crypto. Advocates should mobilize swiftly to confront the folly of any law or regulation that seeks to expand the definition of a virtual asset service provider (VASP) or a crypto asset service provider (CASP) to technology providers or platforms. When we hear “same rules for DeFi and CeFi,” we should call out the flaw and the resulting policy incoherence.
While their differences are important, money crypto and tech crypto need each other. In the short and medium term, tech crypto gets a massive influx of ideas, energy and talent because of investment interest. These are the most important ingredients to keep marching the path of innovation. Money crypto needs these protocols to win over the long term for these tokens to actually be worth something. But these two sides of crypto are not the same, and both our engagement approach and policy goals should reflect that.