American Regulators Have a Hard Job
I’ve made some comments critical of regulators in the past, as I think it’s important to be intellectually honest. Despite this, I have some people I am privileged and honored to call friends at places like the Federal Reserve, CFTC, JFSA, MAS, and NYDFS, among others. They aren’t perfect (who is — certainly not me!), but I think they genuinely care about trying to get things right. They don’t always achieve that, but I want to be clear I’m not a conspiracy theorist who thinks the entire regulatory space is motivated by animus against humanity1.
That’s not to say everything is perfect (quite the reverse, in some ways). I don’t want people to miss the fact that there are some underlying structural problems facing both US regulators and, to be blunt, the entire US financial system that ultimately require a bit of thought. But we also need to be fair about what is going on here.
I want to start with three key points about the position that most regulators are in to help educate the crypto community about why things are going the way they are. Then I want to give some updated commentary on my views about the space moving forward, and which regulators are performing well and why.
Regulators are Underpaid and Understaffed
Do you know people at the CFTC are paid? Hint: it’s not a lot relative to financial services or law in general. How about the SEC? Hint: it’s also not a lot relative to financial services or law in general.
Put differently: there’s likely at least one second year analyst or something at a combination of JPM / Goldman Sachs / Morgan Stanley who made more money than the highest paid person at any of the agencies I just referenced.
Think about that for a moment. Some 20-year-old kid, who has one year of experience and was trading Pokémon cards or something before showing up at a bank, earns more than our highest paid civil servants.
This creates some problems: talent retention and attraction are difficult, morale often sucks, and the people you get either are there for non-monetary forms of compensation (status, prestige, profile, or just caring about doing the right thing), or you get low performers who are lazy. That’s not a specific comment about any agency, that’s a statement about what that kind of pay disparity does. I would take a step further and say this is also systemic across the entire span of US regulatory agencies, not just the financial regulators, and it’s probably one of the most infuriating things about our government at times.
Also, you don’t have nearly enough people to compete with the small army of snakes and sharks2 at all the banks and hedge funds. This is before we throw the live grenade that is crypto into this mix.
Regulators Get All the Blame and None of the Credit
This is something we are terrible about as a society. The problem extends to journalists, to academics, to politicians, and to the general public. It has to do with the way the human brain works, and how we are wired to over-index on concrete bad things that happened while lacking that awareness about bad things that were avoided. Don’t believe me?
When was the last time someone said “fuck yeah” to the CFTC for implementing the tremendous hairball that was Dodd-Frank without breaking the derivatives markets and (mostly) moving everything to collateralized and cleared? Anyone? Anybody?
Okay, so maybe that was a hard one. How about the SEC? Has anyone actually had something nice to say about the agency’s efforts to overhaul money market fund structure and the changes to rules post-crisis that have, it seems, actually pretty dramatically improved the functioning of that space and forced people out of somewhat broken prime funds and into much more functional government money market funds?
Still tumbleweed and empty roads, huh?
Okay, rough. Then let me give you a super easy one: I’m sure that the Basel 3 reforms that the Federal Reserve has been championing are obviously, transparently, and globally popular, the subject of glowing press coverage and consistent and loud praise for everyone at the banking regulators working on extremely granular and specific details like specific risk add-ons for full look through methods for off-balance sheet insurance vehicles held by banks, right?
Fuck. Does nobody pay attention to any of this shit?
This is the problem regulators face. When they do good things, they get no praise and usually industry insiders bitch to them constantly because it erodes “competitiveness” or “profitability”. Worse, because they say that every single time (like the Italian footballer who falls down anytime gets within 5' of them), it’s hard to determine the noise from the signal of when a proposed change is actually bad enough that people will pull back from legitimate economic activity3.
You know what does get regulators lots of attention, though? When things go wrong. And it’s not the good kind of attention. They get blamed for everything. Sometimes justifiably, but often not justifiably, and the refrain of both “WHY DID YOU NOT DO SOMETHING” and “DON’T YOU CARE ABOUT THE CHILDREN” will be loud, constant, and worst of all, in all caps.
What this leads to is a very risk-averse decision-making framework, because all of the feedback they are receiving from the outside world point in one direction. Regulators have virtually no personal upside for allowing innovation, for championing transformation and the improvement of financial systems in terms of access, quality, and reliability (so long as the baseline system functions already, even if poorly), and certainly don’t get bonus points for making hard decisions in the face of pressure that yield long-term benefits.
But everyone will always yell at them when stuff breaks.
Regulators Don’t Have the Reps or Information
When you are a regulator, there’s a few things that are necessarily true of your job:
You are something of a generalist, as nobody regulates like just money market funds and thinks about nothing else (and if you do, please message me, I promise I will send help because nobody deserves that). You know who does think about almost nothing but money market funds? All the people managing money market funds. Thus, you are always outclassed in terms of subject matter knowledge and reps by the opposition.
You don’t have day-to-day knowledge. You don’t have to close your books and deal with breaks. You aren’t having irrational clients scream at you about market activity on a daily basis. You aren’t making mistakes and troubleshooting things and fucking up and losing money in ways that make you learn to perform or get fired. In short, you don’t have the scars and the lessons that you only get by doing in markets.
You don’t have the budget or resources of your opponents. I know people believe the government has infinite money (and in a technical sense, this may be true), but this does not mean it’s specifically the regulators who have that money. In fact, I can assure you that it is not. They don’t have infinite staffing. They don’t have super expensive consultants everywhere. And they sure as hell don’t have the ability to win a war of attrition with the industries they regulate, thanks to how the court system works in America4).
This is a difficult position to be in, as you can imagine. And you know what doesn’t help? When an industry is a wildly incoherent shitshow that mainly expresses itself through mutually contradictory tweets, wildly inaccurate marketing materials riddled with basic factual errors on day 1 things like FDIC coverage, and scam artists and self-promoters pushing any narrative they can for clicks.
You know, not to call out a specific industry or anything.
Now, Add Insanity
So what happens when you have all of these elements, and along comes a brash, chaotic, wild new form of technology that essentially does the following:
Insist it’s better and it’s going to destroy the legacy system
Do a huge amount of PR, raise a bunch of money in non-traditional ways, and completely fail to explain itself along the way
Lose most of that money to hacks, or just straight up steal it
Seriously. What did people think was going to happen? It should not be shocking that regulators are going to have a hysterically negative reaction to it. It’s mostly deserved.
When the number one priority is protecting main street investors, this sort of conduct is radioactive levels of toxic, after all. The active defiance of basic financial hygiene like operational controls, audits, multiple redundant systems, and even lip service to things like KYC is just absolutely wild to me.
In many ways, I’m surprised the regulatory reaction has been as positive as it has been in much of the world (though this is perhaps driven by the global macro view of taking economic share from the US).
As a result, we end up where we are in the United States: our banking regulators think that crypto is an existential threat to the financial system (as opposed to identifying there were multiple bad actors and the problem is not with the underlying technology), the SEC remains on the warpath, and the political will to do productive things is mixed at best.
What Should Crypto People Do?
I’m not often in the business of straight up giving advice to strangers, but here I’m going to do that and suggest the following.
One, have a little humility. One advantage regulators often have is that they’ve seen some shit. Listen to the concerns. Try to understand why they have them. Study financial history, especially financial crises. If you can speak their language and understand what they are worried about, you’re going to have a much better dialogue with them. Failing that, at least hire some consultants to get you up to speed here.
Two, those who are building compliance, risk, and security tools need to do a lot more education and outreach. If you run an exchange that is continually being accused of money laundering, you might want to instead show you are taking serious efforts to combat that and helping regulators catch the bad guys, as blockchain technology can be surprisingly good for that, as one example.
Three, call out bad rules when you see them, and don’t just give things away to regulators. However, the other side of this is that you need to call out bad actions in the crypto space and clearly identify them, and sometimes, you need to tell the truth and not narrowly talk your commercial interests. Rather, take your business hat off, put your consumer protection and citizen hat on, and get people up to speed even where it might not be in your favor.
Four, do the right thing yourself. If you don’t know how to build institutional grade, safe, secure, and robust financial operations (if you are ever handling customer money) or crypto operations, get help.
Simple, I know, but I think it would go a long way with at least some of the people in the regulatory world (who are genuinely good people, but just don’t have much tolerance for nonsense that harms consumers). You won’t win over everyone, and some of them are people on political power trips or with uninformed agendas, but… crypto has a fair share of crazies as well.
If you are in the space, you are reading this, and you care about what I just said but don’t know how to do this, I literally started a consulting firm for exactly this reason. Feel free to reach out. If I can’t help you, I can probably at least give you some thoughts and maybe point you at some people who can.
What Should Regulators Do?
My advice to most regulators would be the flip side of the coin, which is to do the following:
One, try to find trusted people in the industry that you can get in contact with so that you can accelerate your learning curve. One of the nice things about crypto is that a lot of people will just straight up talk to you. Those who run around the industry not giving a fuck about being judged by certain ivory tower types and instead learning everything they can as fast as possible will massively outperform here5.
Two, don’t buy the claims of crypto people without skepticism. There’s a lot of ideologically motivated folks who are light on facts. If you don’t get good answers to questions or they constantly talk about reinventing the financial system without knowing what maker checker controls around trades are, you are probably right to doubt. Get some second opinions. The tech being good doesn’t mean specific actors are good.
Three, also don’t buy the claims of financial institutions without skepticism6. This is the flip side of the coin: most of them would prefer crypto go away because it competes with them and might stop them from charging egregious fees due to their near-monopoly status to consumers. Don’t be part of screwing over the little guy to make sure a bank CEO gets their second yacht, either. These folks totally have an agenda and anything said to you by this crowd about crypto should be met with extreme skepticism, as most of them know very little.
Four, actually do the homework to know the facts. The next time a regulator tells me crypto is rife with money laundering without knowing the DoJ itself believes that there is more money laundering by percentage and amount in the traditional financial system, I’m going to throw something. More to the point, the structure of public blockchains and the tools emerging mean that over time, it’s probably a better system for interdicting illicit finance than opaque private bank transfers with limited information. Technophobia is one of the greatest long-term dangers to our financial system; don’t fall for it!
The best regulators in this space, like the CFTC, NYDFS, and JFSA, have struck a very strong balance between all of these forces by understanding the core mission: put consumer safety and fair conduct first, understand the market and the participants, insist on best practices, and work to create a level playing field.
To that end, if you’re a regulator reading all of this and have questions or need help, also feel free to reach out. I know how hard your job is already.
Likewise, no, most regulators are not out to protect the rich and screw over the poor, or whatever pet conspiracy theory of the day we have
Before anyone gets mad I called you that, I used to be one of you and I’m speaking from firsthand experience and self-incriminating, so please sit back down and hold your tomatoes until the end
The industry in general could use a little self-reflection here, both crypto and traditional finance, and being more judicious about when to deploy this to maintain intellectually honesty would probably go a long way
My main caveat here would be some of the banking regulators, who have much more expansive authority and could potentially do this, but likely at the small cost of destroying the banking system
Shout out to Caroline Pham
I’ve been in a meeting where a certain bank lobbying group was actively talking about how to persuade regulators to favor banks over crypto to reduce competition (little did they know crypto would do a better job of that than they ever could)