By large crypto this week is doing crypto things. Bitcoin is sometimes above twenty thousand and sometimes below it, and then it rotates back and forth over and over again. This gives people a feeling that this is a place they are going to be for a while. When it comes to the big substantive things, all of the stories are about the continued fallout of Three Arrows Capital and Luna contagion, and how it's all going to resolve. In the area of regulations and policy making, however, a new legal advisory notice from the US office of government ethics prompts a fascinating question that is about crypto and how policy is made in this space. A larger conversation about the relationship of policymakers and regulators to financial assets. The question is who should the people in charge of making policy be allowed to shape the future crypto rules.
A new legal advisory notice was issued by the US Office of Government Ethics, which deals specifically with the executive branch so they do not have authority over Congress or anything like that. This new notice has barred US officials who own cryptocurrencies from working on crypto-related policies and regulations that could affect the value of their assets. This directly applies to all White House staff and the employees of all federal agencies including the federal reserves, the treasury department, etc. The notice clarifies that the deterministic section applicable to securities does not apply to crypto holdings and the securities exception allows government officials to hold small amounts of securities while performing related regulatory tasks. Concerning direct holdings of crypto, these exceptions have been removed entirely. The example they use in the notice demonstrated clearly that an employee is asked to work on a regulation that would require all cryptocurrency to be fully backed by United States currency. If the employee owns $100 stablecoin XYZ that is not backed by United States currency, he/she cannot participate in the regulation until, and unless, they divest their interests of stablecoin point XYZ. The regulation is anticipated to have a financial impact on the value of stablecoin XYZ and no regulatory exemption applies. To put it in specific terms, holding $100 of DAI would exclude a government official from working on any stablecoin legislation.
The note does articulate the mutual fund exemption more clearly for crypto holders within the government as well. The minimum section for sector-specific mutual funds allows government officials to hold up to $50,000 of mutual fund stock related to policy areas they are working on, which means that a government official holding this amount worth of crypto-related mutual funds will not be required to recuse themselves from work involving crypto regulation. The explanation of this exemption also clarifies that crypto funds are considered within the financial services sector, meaning that the total exemption is $50,000 of mutual fund stock across both crypto and traditional equities.
This sounds somewhat arbitrary, capricious, illogical, and inconsistent. The notice is not about creating new ethics guidelines for a new industry, yet it is about applying existing guidelines to the crypto asset class. To be very clear, there is an existing exception allowing government workers to hold certain types and amounts of securities while working on related regulations, but there is officially no exception for direct crypto holdings.
While some agree that this is good and a step toward preventing regulatory capture on the cryptocurrency issue, this notice received many backlashes and discontentment, saying this creates a bias towards non-experts or even people who actively dislike crypto. They complained that this insure maximum ignorance of all policymakers working in crypto by kicking anyone out who has ever used the technology, similar to those that are working on internet policy are not allowed to use the internet. People are disappointed not only because who know the most about crypto and have the most conviction about crypto are not allowed to work on legislation about crypto, government employees who completely lack any understanding of cryptocurrency and stablecoins, or who actively dislike them are rather permitted to work in the US crypto policy.
Regulators said a parody of traditional finance (TradFi) is important when dealing with cryptocurrencies issue. However, even people who have not been engaged yet, need to be able to use crypto and blockchain to learn and make better decisions. Holding no crypto while a person is writing crypto legislation will make learning difficult. Certain complex topics like DeFi learn best by participating. Educated staff and public trust are crucial for sound policy. Trying to make a parody of TradFi rules would hard to make a fair environment for crypto development as there is a significant contrary in the DeFi and TradFi ecosystem.
The rejection of the parody argument says that this type of lack of exemptions should be applied more broadly. The debates regarding ethics norms around concerns of regulatory capture are super important and certainly not just concerning crypto. Politicians, regulators, and policymakers are all big weird mixtures of incentives. A lot of time, those incentives lead them to strange places that are not really in line with some greater good that we imagine they're supposed to be striving for. Oftentimes, those incentives are about much more immediate re-election things than deep down into the value of some financial assets.
It is understandable to debate regulatory capture but let us put it in the broader context, and not just single crypto randomly. Lots of people out there want to revisit congressional ethics and what they look like as relates to Congress people being able to trade against advanced knowledge of moves that the government is going to make. There were multiple Fed officials over the last year resigned over these types of concerns. Federal Reserve vice chair Richard Clarida resigned in January of this year after admitting that he had failed to disclose financial transactions in February 2020. He was the third top Fed official at that time to resign over trading in advance of Fed policy shifts during Covid. In February 2007, he moved between one and five million dollars out of a bond fund into stock funds. This was just days before Fed Chairman Jerome Powell started talking about the Fed cushioning the economy as the pandemic hit the US. Initially, this move from bonds into stocks was all that had been reported, but months and months later he updated his disclosure to show that he had sold one to five million of the same fund three days before buying. In other words, Clarida sold between one and five million dollars worth of stock as markets were starting to churn, and then re-bought it as they got reassured by the Fed. Boston Fed President Eric Rosengren has also been under fire and had to resign for buying and selling stocks and real estate-linked assets at the same time the Fed was going to ease Covid impacts on markets, so clearly, this is not just a crypto issue.
Besides, the discussion of parody needs to be applied to other financial assets. This is important as we can see from the Fed example it's hardly like crypto is the only area where conflicts of interest into politics. Crypto was treated by the US government as a financial asset, yet exactly what type of financial asset continues to be debated. Provided that the restrictions enacted on cryptocurrency, need to be applied to other financial assets as well. There is a need to prohibit everyone who works on the policy around golds, securities, commodities, and also housing from owning any of the things that they are working on regulation around. As such, excluding people from ownership of all assets is not a smart approach, especially if it is conducted by the authorities.
American politics does think that “fair” means the policymakers and legislators shouldn't be able to own anything, which is completely impractical. Assets are how wealth is built and denying all policymakers access to participate in asset ownership of any kind would mean that we are selecting our policymakers and regulators for people who are either 1.) so ideologically driven that they do not care which is going to lead to extremes on both sides of the aisle or 2.) so motivated by their perception of their power that they do not care at all. The perspective these "neutral folks" bring in would be largely homogeneous because they would not be bringing experience from other sectors and areas of the economy into the policy discussion and discourse. In this connection, we are talking about a group of politicians who are homogeneous, hyper-ideological, and motivated most of all by feeling powerful.
What could be an alternative?
This conversation around regulatory capture and conflicts of interest is important. First of all, disclosure regimes are obvious. A lot of the problems of conflicts of interest are opacity, which does not give people a chance to review actions through that lens. So part one is disclosures and there are a lot of ways to make disclosures even more powerful, especially in an on-chain world where officials' public addresses would be known. Someone may argue that they could be hiding assets in other wallets, but this will be mere outright lying in committing fraud which is a wholly separate thing from good-faith public officials disclosing their assets.
Secondly, the authorities could offer a second opportunity that doesn't preclude people from ownership are rules around what they can and cannot buy and how. Fed policymakers and senior staff are now prohibited from active trading and will be able to purchase only diversified vehicles like mutual funds. They also have to give forty-five days' notice and get prior approval from internal ethic staff for all purchases and sales. What is more, they have to hold all investments for at least one year. These are very onerous terms, which forty-five days of prior approval mean you are simply not market timing based on private information. There are some completely reasonable rules to abide by during one term and it is a choice that people get to make and stick with it. Thus, there could also be analogous rules for crypto that severely limit what people can buy, hold, sell, etc.
People who do not own crypto and even people who dislike crypto can also be part of the conversation on how to regulate it and should have a seat at the table, but more importantly, we need rules that do not exclude the experts and the most engaged.
