Michael J. Casey is CoinDesk's Chief Content Officer.

Another week, another clash between regulators and the cryptocurrency community, this time with the most high profile company in the space: Coinbase. This week’s newsletter dissects the news that the U.S. Securities and Exchange Commission (SEC) had threatened to sue the company over its proposed crypto lending program, Lend, and in doing so had demanded information on clients that had inquired about it. This is not how regulation should be done.

Keeping with the theme, our podcast was lucky to have another Washington insider as its guest for the second of a two-episode dive into the regulatory climate in Washington. Sheila Warren and I get the lowdown from Rep. Tom Emmer (R-Minn.), who among other roles is the co-chair of the Congressional Blockchain Caucus.

Have a listen after reading the newsletter.

Why crypto regulation needs fixing

After Coinbase complained Wednesday about the SEC’s threat to sue the crypto exchange company over its proposed stablecoin lending program, known as Lend, the Crypto Twitter lawyer community rose up, almost in unison, with a predictable refrain.

In essence: “This is clearly an unregistered security. You don’t understand the law. Be quiet.”

I’m starting to believe that, with the exception of a few crypto lawyers – see the newsletter’s “Conversation” section for examples – the legal profession, with its revolving door relationship with regulators, is the problem here. Because while a letter-of-the-law reading of the Howey Test says enabling holders of Circle’s USDC stablecoin to generate interest constitutes a security offering, it misses the point. And by point, I mean that enforcing outdated laws is counter to the public interest.

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The Coinbase-SEC spat is a good example of why our financial regulatory system needs fixing.

It’s hard not to conclude that the existing suite of financial laws – laws that a divided, dysfunctional Congress seems unable to update for 21st century technological realities – serve only to protect the interests of Wall Street and wealthy investors, at the cost of the general public.

Worse, this stasis leads to a default position on macro and monetary policy that perpetuates the low-interest rate environment and deepens that divide.

Frustration is justified

Could Coinbase CEO Brian Armstrong, who accused the SEC of “sketchy behavior” been a little more diplomatic? Perhaps. It’s not how most public companies address their regulator.

But there’s justification in the crypto community’s frequent frustration over a lack of clear guidance from the agency – along with that of SEC Commissioner Hester Peirce, who shared similar sentiments with me on CoinDesk TV’s “All About Bitcoin” show last week. There are real innovative opportunities within crypto to provide valuable, safe, useful products to savers, if only policymakers would devise an appropriate regulatory framework.

This is not to say there shouldn’t be rigorous regulation of centralized custodial entities such as Coinbase, which have fiduciary duties to their customers in ways that fully decentralized crypto projects do not. But using the blunt instrument of securities laws is counterproductive, especially when the crypto industry has tools for storing and trading assets that offer greater security and transparency than the heavily intermediated financial system for which those laws are mostly designed.

What we need is a visionary legislative overhaul. And for that we need Congress to recognize that crypto technology is inherently transformative and that, with the power of permissionless, open-source innovation, has the potential not only to spur economic growth and support U.S. technological leadership but – if, and only if, it is implemented and regulated properly – can foster financial inclusion and address economic imbalances.

Let’s listen to billionaire entrepreneur Mark Cuban, who in a series of tweets Wednesday encouraged Coinbase to continue to “be aggressive in their engagement with the SEC” and argued that the crypto industry needs “exemptions like the internet got in the [1990s].”

The problem is that Congress is sadly short on visionaries. Yes, a growing list of U.S. lawmakers get the importance of this tech – listen to this week’s “Money Reimagined” podcast episode to hear from one, Rep. Tom Emmer (R-Minn.). But the dominant posture toward crypto on Capitol Hill is currently hostile.

Vocal, influential players like Sen. Elizabeth Warren (D-Mass.) are vociferously attacking the industry – seemingly unaware, or perhaps without caring, that she’s playing into the hands of the incumbent financial institutions she made a career out of fighting.

So, with comprehensive action in Congress difficult, the default response is what Cuban appropriately described as “regulation via litigation,” with inter-agency turf wars and power plays driving action rather than forward thinking.

Little guy loses

The upshot is that good faith technological alternatives to the costly traditional banking options are thwarted. Nowhere is this more relevant in the crypto lending and borrowing space.

Stablecoin lending offers a viable alternative to the anemic rates in traditional banking. Coinbase was offering 4% on USDC loans versus around 0.01% on most savings accounts. And whereas The New York Times last week said regulators viewed with “alarm” these offerings as a too-good-to-be-true “shadow banking,” the rate differentials are really the result of a differently structured risk management system.

Partly, the differential is possible because intermediary-free blockchain and smart-contract execution enables near real-time settlement of tokens and cuts out a lot of the hidden human and legal friction in the traditional credit business. The rest reflects the intense speculative activity in cryptocurrencies, which fuels constant short-term borrowing demand from both long- and short-position traders for whatever coins they are betting for or against in the spot or derivatives markets.

A regulator might say, “Well, there’s the problem: There’s too much speculation in crypto. We don’t want mom and pop’s money exposed to that volatility.” But the truth is that while there might be counterparty delivery risk if borrowed stablecoins are traded on poorly regulated exchanges (a risk Coinbase would mitigate through its borrower vetting process) the most solidly managed tokens, which includes USDC, are mostly devoid of price volatility.

Also, think about it: Why do people speculate on crypto? One reason: Many see an alternative to an expansive monetary system that’s paying zero rates, fueling inflation and driving an ever-growing divide between the privileged investors with access to surging financial assets and those that don’t.

If you cut off the latter group from offerings like Coinbase’s, all you’re left with are opportunities for the former – a group whose wealth meets “accredited investor” standards, ensuring providers can market offerings to them without SEC registration. The majority of Americans are left with zero-rate bank accounts. How is that in the public interest?

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Michael J. Casey is CoinDesk's Chief Content Officer.