Why US regulation is failing the cryptocurrency test

The US is a funny country. We have so many financial regulators that we sometimes wind up without proper financial regulation. Cryptocurrencies represent the latest example.

The trade in bitcoin and its brethren has grown too big to be ignored — and yet that is what has happened. No official public data exist on prices, volume or volatility. No single authority regulates crypto exchanges. No one can be certain investors are being properly protected.

Even folks in the libertarian crypto world are wondering when the federal government will step in. Mike Novogratz, a fund manager who has helped lead the charge into the asset class, told CNBC there would be “relief” in the market once rules of the road were set and suggested Congress give the job to Gary Gensler, head of the Securities and Exchange Commission.

“When Gary finally addresses it, it will be good,” Novogratz said of his fellow Goldman Sachs alumnus. “He would love to regulate all the crypto. He doesn’t have the mandate.”

It all amounts to a particularly American regulatory failure. Waiting for Gensler to get his hands on all the crypto has turned into the Wall Street equivalent of waiting for Godot.

The underlying difficulty is that US financial regulation is fragmented. There are multiple federal banking and market authorities, with overlapping jurisdictions, plus state regulatory systems. As Jamie Dimon, JPMorgan Chase’s chief executive, put it in his annual letter to shareholders: “There is no one real authority that can co-ordinate all the moving parts and bridge differences.”

In the long run, this is not entirely a bad thing. Checks and balances are as American as apple pie or junk bonds; having so many regulators serves as protection against any one of them messing up.

But this system has its weaknesses. New products that are neither fish nor fowl in a regulatory sense can fall through the cracks. Crypto is hard to regulate because it is hard to define. While true believers call cryptos currencies, US regulators view them differently. Bitcoin, for instance, has been deemed a commodity. Other cryptos are seen as securities.

This resulting confusion helps explain why neither the SEC nor the Commodity Futures Trading Commission is directly regulating crypto exchanges such as Coinbase. No one has given them the job — a source of frustration for the regulators.

Congress, in its fashion, is on the case. Elizabeth Warren, the Democratic senator, wrote to Gensler this month to ask whether the SEC “has the proper authority to close existing gaps in regulation that leave investors and consumers vulnerable to dangers in this highly opaque and volatile market”.

Gensler’s response, due by July 28, will undoubtedly be persuasive. But whether it will prod legislators to act quickly is another matter. If history is any guide, Congress will wait for things to fall apart before deciding how they should have been put together in the first place.

The resulting impasse is exacerbating anxieties that regulators are falling further behind the curve. The crypto craze reminds many Wall Street veterans of the unregulated rise of credit default swaps in years leading to the financial crisis. Like crypto, CDS were hard to characterise, being a form of insurance that was not regulated as such, and were seen by their advocates as being too cool to be overseen by mere bureaucrats.

“It took a crisis to focus our attention on products like CDS,” said Sarah Hammer, managing director of the Stevens Center for Innovation in Finance at the University of Pennsylvania’s Wharton School. “In some ways, crypto is more challenging than derivatives because it falls into many different regulatory laps.”

The irony for participants in the crypto markets is that they might be better off if a cop like Gensler was already on the beat. The various parties could get to know each other and reach some sort of an accommodation. It could even be a relief, as Novogratz said.

Now, the best way for regulators to get a handle on the crypto markets may be to come out swinging, using their general enforcement powers to set things straight. The SEC has already brought scores of crypto cases. Dan Berkovitz, CFTC commissioner, recently raised doubts about the legality of any derivatives deals taking place on decentralised finance, or “defi”, programs that use blockchain technology to cut out intermediaries.

It could get very interesting. I find myself reminded of that moment in the film All About Eve when Bette Davis turns to her guests and presents her forecast for the evening to come. “Fasten your seat belts,” she tells them, “it’s going to be a bumpy night.”

gary.silverman@ft.com