Will Crypto Winter Cool Wave of State Regulations?

It has so far been a brutal year for cryptocurrencies, with the value of assets like Bitcoin falling around 70 percent from last November. But to date, the so-called “crypto winter” has done nothing to slow the increasing rush by state lawmakers to ease the path for cryptocurrency use in their states.

Just What is Crypto Anyway?

One of the stark realities of digital assets is that most people have little to no idea what they are or how they work. A 2021 crypto industry survey of 1,000 people across the U.S., Mexico, and Brazil showed that 98 percent of those surveyed did not understand basic crypto concepts.  

In a recent blog post for Lexology, Alexandra Barrage, a partner with Davis Wright Tremaine LLC in Washington D.C., says that is in part because crypto isn’t necessarily a thing, but a vast network of “stakeholders, including consumers, technologists, miners, exchanges, issuers, wallet providers, venture capitalists, digital custodians (including banks), and regulators.”

Barrage says that understanding crypto’s ups and downs – and the legislation they might produce - necessitates understanding the differences between two of the most prevalent kinds of cryptocurrencies.

One is bitcoin, a volatile digital currency, and the other is privately-issued stablecoins, which are designed to maintain a stable value. Both bitcoin and stablecoins exist in electronic form, on a decentralized system, and neither are issued by a government. Certain stablecoins are designed to maintain a fixed value relative to a national currency (such as the U.S. dollar)and are backed by cash or other liquid assets.

That said, she notes that there are no uniform rules around stablecoins.

“Payment stablecoins are intended to be one to one with the dollar so that if you have a dollar in stablecoin it’s in some ways no different than having a dollar in your bank account,” she later told SNCJ in an interview. “One important difference is that the stablecoin dollar is not backed by government insurance like money in a bank account. The difficulty here is that it’s not necessarily clear what is backing any particular stablecoin because there is no uniform law that says it must be X, Y, or Z, or that it must be disclosed here, or how often. While there are various state laws, there is currently nothing regulating stablecoins at the federal level. This regulatory gap not only poses risks to consumers, but it also impedes responsible innovation for companies seeking to scale in the U.S.”

Dozens of States Introduced Crypto Bills This Session

That lack of uniformity and regulation has earned the industry a reputation as a “digital Wild West” that has both created millionaires and fostered bankrupting scams. It has also fostered ever louder calls for the industry to be regulated.

But with the federal government mostly taking a hands off approach, lobbyists for the crypto industry have turned their attention to statehouses to ensure that whatever laws happen there are in their favor.

According to the National Conference of State Legislatures, 37 states have collectively introduced hundreds of bills this session dealing with cryptocurrency and digital assets.

To date, adopted bills include:

Colorado HB 1053, which requires the state agriculture commissioner to create and deploy an online program that educates agricultural producers about blockchain technology.

Colorado SB 25, which requires the state treasurer to study the feasibility of using security token offerings for state capital financing and determine the extent to which the use of those tokens would be in the state’s best interest.

Florida HB 273, which creates a new definition for virtual currency and eliminates a requirement that crypto sellers have a Sunshine State money transmission license.

Idaho HB 583, which exempts cryptocurrencies from the state’s securities laws.

Virginia HB 263 and Louisiana HB 802, which allow banks and other financial institutions to provide customers with crypto custody services. Similar measures are still pending in Ohio, Kentucky, New Hampshire and Illinois, while a custodial bill in Mississippi (HB 1153) died in committee.

Washington (SB 5531) and West Virginia (HB 4511) adopted measures that include virtual currencies under their states’ unclaimed property laws.

A sampling of bills still pending:

California AB 2269, which would require anyone dealing in cryptocurrencies to be licensed by the state.

California AB 2689, which would allow the use of cryptocurrency to pay for any government services or debts, including taxes.

Bills in Massachusetts (HB 126, HB 4513) and Michigan (SB 888) would establish blockchain and cryptocurrency commissions.

Multiple bills in New Jersey (AB 1975, AB 2371) would implement a broad crypto regulatory framework in the Garden State.

California Gov. Gavin Newsom (D) also issued an executive order in May that made the Golden State the first to outline a comprehensive crypto regulatory framework. That order builds on a similar executive order issued by President Joe Biden in March.

Will Crypto Collapse Lead to Federal Policy? 

All of this activity comes at a time when the crypto markets have been in freefall, highlighted by the collapse of the stablecoin TerraUSD in May, which wiped out billions of dollars in value in just a few days. That was followed in June by crypto lender Celsius stopping withdrawals, which was followed days later by lender Babel doing the same thing amidst rumors it could soon undergo a major restructure. Voyager Digital’s bankruptcy in July is now under FDIC investigation over concerns it intentionally misled investors.

Financial observers say crypto’s fall is the result of a number of market-moving developments, from inflation and rising interest rates to the Russian invasion of Ukraine.

While states have taken the lead on crypto regulation, there is at least some interest in Congress to follow suit. In June, Sens. Kirsten Gillibrand (D-New York) and Cynthia Lummis (R-Wyoming) introduced a comprehensive proposal (US SB 4356) that would impose a wide-ranging number of regulations on the industry, including classifying digital currencies as “ancillary assets” that could be treated like commodities under U.S. law and fall under the jurisdiction of the Commodity Futures Trading Commission.

The legislation also contains a variety of tax relief measures.

It might not be the only crypto regulation the feds come up with this year. Forbes reported in early July that the Biden administration is working on legislation that would define and regulate stablecoins.

If so, they will still be well behind the European Union, which announced in early July an agreement on its own comprehensive regulatory framework that will require cryptocurrency businesses to be licensed and stablecoin issuers to hold reserves in the same way as banks. Crypto companies will also be held liable for losing investor assets and be subject to most traditional European market-abuse regulations.

Will States Forge Role in Federal Crypto Regulation?

While regulation has always been a touchy subject for crypto enthusiasts, there are those who think government regulation would go a long way toward stabilizing the industry. 

Tally Greenberg, head of business development at Allnodes, a platform that provides hosting, monitoring, and staking services, is one of those voices.

“Regulations will come up and they have to come up at some point, which would stabilize the market even further,” she told the financial newsletter NextAdvisor in early April. “That protects investors, so it’s a good thing. It’s not a bad thing.” 

Where those regulations ultimately are birthed is still to be determined. But with Washington D.C. locked in another round of election-year gridlock, states are still clearly moving forward with their own plans.

“States have been active in crypto for three or four years already,” Barrage says. “They have been the pioneers in seeding many of these companies by providing them the rules of the road that have helped them grow.”

She says the crypto industry has been so active in state legislatures in part because they know states will have a big say in whatever might eventually come out of Congress.

“To me, that’s the biggest question of all,” she says. “How do we have a meaningful role for states in oversight over the companies that they have licensed and chartered?”

--By Rich Ehisen

Roughly 3/4 of State Legislatures Have Addressed Crypto