Can Regulators Ever Keep Up With Crypto Markets?

The New York State Department of Financial Services (NYDFS) is setting out to tackle a massive regulatory object: How crypto exchanges like Coinbase, Gemini and others list – and perhaps more importantly, delist – tokens. According to a new public service announcement, the call to update the agency’s guidance builds upon and will try to formalize existing working standards.

But the move is much more than just government incrementalism, and could have nationwide and even global implications.

My colleague Jack Schickler does a good job breaking down today’s announcements. In short, the agency laid out three aims: set policy so NYDFS licensees are more proactive in assessing legal, reputational and market risks during the coin listing process, update the number of “greenlisted” coins (today limited to bitcoin, ether and stablecoins from PayPal and Gemini) and open a public comment period for industry participants to say their piece.

While “just” a state financial regulator, whatever the NYDFS does often makes an imprint worldwide. Even in an increasingly globalized world, New York remains a main hub for economic activity and capital formation, and so the agency is a leading organization in setting reporting and communication standards that echo across the financial landscape. If you can make it here, you can make it anywhere.

So too for crypto, in an interesting way and despite The Blockchain’s globalized nature (some might say “geographical decentralization,” but you don’t have to). Take just the NYDFS’ track record when bringing regulatory enforcements: a few of these cases have quite literally reshaped the industry, like in the case of Tether that reset the bar for stablecoin transparency.

It’s true the agency’s so-called BitLicense didn’t quite become the model for crypto oversight that its architect, the lawyer and former public servant Benjamin Lawsky, set out to achieve. But the collected bundle of rules, recommendations and guidance has been a major influence on the development of the digital asset industry in the U.S. – with many insiders thinking it set the pace for regulators to try to squeeze crypto inside the box of established rules, rather than address crypto’s particularities head on.

Its legacy is certainly mixed. It’s arguable the NYDFS has protected New Yorkers from countless crypto business failures and bankruptcies over the years, and especially during the year of pain in 2022 when now-defunct crypto lenders like Celsius and BlockFi imploded. These firms were barred from offering services in the state, and just anecdotally I know more than a few people who were attracted by the (now obvious) unsustainable interest rates, who are now thankful not to be a bankruptcy estate creditor.

But the highly restrictive Bitlicense system hasn’t always paid off, (even putting aside the hypothetical profits would be Celsius users might have seen riding the bubble up). Licensees including exchanges like Xapo, bitFlyer and the U.S. wing of Bitstamp, aren’t exactly known for their major foothold in the New York or U.S. crypto trading markets.

Worse, despite the fact there are only 30-odd firms with a BitLicense, it doesn’t even have a 100% hit rate when it comes to protecting businesses and consumers. The now shuttered Genesis Global Trading unit of CoinDesk sister company Genesis operated under the aegis of New York State, for instance, with seemingly no practical benefit.

Either way, measuring whether regulations are “worth the cost” is a futile act. Especially in the world of crypto, where all of the real use cases are essentially ungovernable and where all excitement takes place well outside of walled gardens like Coinbase and Gemini. Mass market crypto has so far come around on a four-year timetable, and it’s only during bull markets that centralized retail crypto lending, crypto credit cards, et cetera can sound like a good idea.

The reason why the NYDFS’s recent announcement could have a global impact is because it deals with whitelisting and blacklisting tokens and because crypto trading is a global phenomenon. In the grand scheme of token prices, it doesn’t really matter whether this or that custody firm is awarded a BitLicense, but it sure does matter whether Coinbase will list or delist a token (even if the “Coinbase bump” is today muted).

The agency has seemingly taken a special concern for market stability when it comes to delisting tokens. In the announcement, NYDFS Superintendent Adrienne Harris noted that on occasion certain tokens will slip through or change, so that if they were once thought to be “OK” to list now need to be removed without further damaging consumers.

To my mind, that seems challenging if not impossible – and not because crypto firms are unwilling to comply or that regulators are incompetent. Just in terms of market structure, when something is both globally distributed yet also illiquid (i.e. a cryptocurrency) it’ll be prone to price spikes. Token prices are abjectly tied to reputation and it seems hard to imagine a world where Coinbase being required to delist some such token wouldn’t be read as a death knell, if only temporarily.

Further, changes to how companies “self certify” the tokens they list may mean fewer bad apples get in to begin with, but when it comes to spinning up regulatory working groups and delisting coins with an “Department-identified weakness or vulnerability,” it seems hard to imagine The Compliant will be able to move quick enough to delist tokens that are actually a problem.

This is especially true because the process of delisting a token requires several steps to remain aboveboard, like announcing the announcement and giving the public appropriate time to react.

See also: Kill the BitLicense | Opinion

Take BALD, the recent pump and dump token that inaugurated Coinbase’s L2 network, which launched on a Sunday, amassed a market cap of over $50 million by evening and then popped the following Monday morning. How could a regulator predict something like that?

Well, the simple fact is that they’re not even going to try – instead they’re limiting their essentially limiting their purview to overseeing a supposed “greenlist” of pre-approved tokens rather than taking an actual swing at the on-chain tokens that pop into existence and can actually do harm.

By lengthening both the listing and delisting processes, consumers aren’t really being benefited. These rules will likely only mean domestic bucket shops like Coinbase continue to lose out to overseas bucket shops like Binance.

It just seems that, at least in this very narrow sense, the aims of regulations aren’t square with the realities of crypto trading. And that there’s a difference between good intentions and good policy.

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