A Political Economy of the 2022 Cryptoverse

As revolutionary a year as 2021 was for the cryptoverse, 2022 promises even more significant legal developments that will shape market structure and potential. There is an evolving political economy in the cryptoverse, driven by a competition between market actors and sovereign governments who recognize the way that key assets and activities are defined will make all the difference for their regulatory treatment and their prospects for free societies. The coming year promises to be significant in that many governments are feeling a sense of urgency to land their legal regimes around more established norms. In a new white paper, we review the key questions we will be asking and key concepts that we will be tracking to try to discern the runway lights through the thickening competitive fog.

We first explore the key categories around which regulation must be wrapped: assets, activities, and infrastructure. In any given scenario, answering what activity is being conducted with what asset on what infrastructure is helpful for clarifying the interests that may be implicated by that triangulation. We identify pertinent trendlines around these categories and what to watch in 2022 for material movement in the regulatory landscape. In the second part of the white paper, we highlight the interested communities whose decisions and behavior, whether through legislation, regulation, or free market innovation, will influence the continuing emergence of a new order.  Similarly, we highlight relevant themes on which such parties have been focusing, and where we expect them to make an impact in the coming months.

Triangulating Regulatory Efforts. Fundamentally, government action must be addressed at some particular asset or activity. There are myriad categories of assets and activities in the cryptoverse, and each of them is better understood by the infrastructure on which it relies. The process of categorizing and clarifying the legal status of various crypto assets and activities is likely to be a central piece of the 2022 crypto story.

• Assets:  Absent novel legislation on the Hill, for which there currently seems limited prospects, regulators will seek to corral various assets into commonly held definitions for securities, derivatives, commodities, and currencies. The willingness of market actors to accept such categories will largely depend on their own proficiency in and preparedness for the compliance architectures necessary to hold and deal in assets in each such category.
• Activities: Equally as important as (and significantly driving) the asset categorization is the activity being conducted with each asset. Different categories of activities will be painted as conduct understood within known regulatory frameworks. Key asset activities include: initial coin offerings, trading, exchange facilitation, custody, lending, the creation and sale of non-fungible tokens, and more.  
• Infrastructure: Though longer on the tail of regulatory action, equally as interesting will be the way regulators contemplate engaging with the infrastructure that facilitates crypto commerce and the parties that develop and maintain such infrastructure. The original vision for the bitcoin blockchain (and Ethereum and others) was one, by its very structure, of a decentralized system beyond the ability of any single party to control information or influence outcomes. Akin with that vision, many have argued that it is simply impossible to regulate blockchain activities. Yet, as described above, governments worldwide will continue to influence distributed ledger technologies largely through regulation of specific asset categories and the activities conducted on relevant infrastructure. We expect that the notion that regulation would simply push activities into other jurisdictions is untenable in a world of growing international regulatory coordination across most significant marketplaces (where crypto activities haven’t already been banned). Particularly noteworthy will be the impact of the evolving regulatory landscape on protocols previously thought beyond regulation, on the specific platforms facilitating crypto activities – particularly exchanges, and on Layer 2 technologies that will continue to create a diverse range of previously inconceivable commercial possibilities.

Taken as a whole, a triangulation of assets, activities, and the infrastructure on which they are housed can provide clearer terms for a discussion about the regulatory climate. Yet, as much as legal outcomes are the result of a constantly emergent order, and as ideal as the vision of a digital world free from interference may have been – people will always have an influence over the shape of things to come.

Understanding Interested Players. Technology will always be governed by the people who create, maintain, and regulate it. In the U.S., key players will have outsized influence in the coming year.

• Regulators
  • SEC: Already in control of sweeping authorities that it can broadly interpret to apply to various crypto assets, the SEC will continue its efforts to shape crypto concepts through regulatory enforcement. (See, most recently, its definition of certain crypto lending platforms as securities offerings, here and here.) Amongst the SEC’s 2022 priorities, Chairman Gary Gensler lists:
    • the offer and sale of crypto tokens;
    • crypto trading and lending platforms;
    • stable value coins (stablecoins);
    • investment vehicles providing exposure to crypto assets or crypto derivatives; and
    • custody of crypto assets.   
  • CFTC: The CFTC considers virtual currencies, and an undescribed set of other crypto assets, to be commodities. However, it acknowledges that its authority to regulate “cash markets” is circumscribed. We expect it will be focused on expanding its authorities by engaging with Congress, as evidenced in a recent appearance before the Senate Agriculture Committee by CFTC Chairman Rostin Behnman, who beseeched Congress to develop a more fulsome regulatory framework with respect to digital assets. In particular, he called for greater CFTC oversight of “digital asset commodity cash markets” and greater coordination among federal regulators.
  • Fed: The Board of Governors recently announced policy sprints conducted with the OCC and FDIC that involved “preliminary analysis on various issues regarding crypto-assets.” Along with the OCC and the FDIC, the Fed has articulated a crypto-asset roadmap it intends to pursue in 2022, including:
    • Custody activities and ancillary custody services;
    • Facilitation of customer purchases and sales of crypto-assets;
    • Loans collateralized by crypto-assets;
    • Issuance and distribution of stablecoins;
    • Activities involving the holding of crypto-assets on a balance sheet; and,
    • Application of bank capital and liquidity standards to crypto-assets activities by U.S. banking organizations.
  • OCC: Acting Comptroller Michael Hsu has focused on what he calls a strategic vision for expanding the “bank regulatory perimeter,” asserting that fintechs are “rebundling” banking services and supervision of crypto firms is fragmented, yielding significant risks to “consumers, businesses, and financial stability” and demanding a “clarifying” of the “bank regulatory perimeter[.]” He has noted that “at the OCC, we have begun to increase our focus on the banks that provide services to large fintechs and facilitate synthetic banking outside of the bank regulatory perimeter.” Look for the perimeter to expand in 2022.
  • FinCEN: The Financial Crimes Enforcement Network possesses certain regulatory functions under the constellation of legislation referred to as the Bank Secrecy Act. It will continue to be engaged in the government’s mission to limit abuse of the cryptoverse by illicit actors, such as ransomware gangs seeking payment in digital currencies, organized crime seeking to launder money through the crypto system, and more.
• Hill Committees and Members: Influential Hill Committees and Members have conducted a steady stream of hearings on crypto assets and made regular public statements relating to the same. The issues identified in those hearings and concerns expressed in those statements all signal further focus on these issues in 2022. Whether sufficient momentum will give rise to legislation, as always, depends on extraneous factors and future events having no direct bearing on the questions at hand. Interested parties can look to the Senate Banking Committee, House Financial Services Committee, and Senate Agriculture Committee for emerging trends in the coming months.
• Institutional Actors: The main protagonists of the crypto explosion – the institutions innovating in the space – will, of course, continue to have a vested interest in engaging in public debates about the regulatory outcomes of the near future. Some are starting to converge around shared interests, such as those articulated by the Blockchain Association. Yet, this is by no means a monolithic category of actors. The various interests include payments infrastructure providers, exchanges, infrastructure product and service providers, and more.
• Traditional Intermediaries: The founding vision of bitcoin was, of course, to replace institutional intermediaries as a necessary component of payments systems. The world of crypto has expanded far beyond payments alone, but traditional financial institutions will continue to have a strong interest in the products and services they currently offer, new opportunities to evolve such offerings, and completely greenfield endeavors. Such institutions had a more limited presence in public policy debates in 2021, but they are likely to engage in the 2022 discussions. Like the more nascent institutional actors, their interests will be products of their own service offerings, business strategies and current compliance and regulatory obligations and hopes.
• Consumers: One interest group that has limited to no voice are the disparate, but growing, number of individual consumers who engage with crypto assets. Driven by the regulatory agenda, the debate about consumer protection is bound to be a central focus of 2022. Keep an eye, however, on how that topic is entangled with questions of market access. The solution sets that appear are likely to circulate around how regulation can protect such consumers while not creating high barriers to entry for market participants who can benefit from healthy, fair and honest product and service offerings, but may be disadvantaged by current market norms.

Conclusion

It is impossible to speak singularly of regulatory action covering “crypto.” There are a range of categories, activities, and interested actors, all of which will continue to converge into a constantly emergent order. Interested parties must track a range of questions and issues to discern meaning from the current complexity. For our part, we will look to triangulate assets, activities, and infrastructure – and seek to understand how a variety of actors interests bear and converge on such groupings. To be certain, these capabilities have applications far beyond what they imply for financial technology alone – to all of Web3. The coming year promises to be fascinating and surprising. Rarely do we confront epochs of such disruptive potential. In the free world, what comes in the next twelve to eighteen months will shape human potential for a long time to come.