Regulate centralized actors but leave DeFi alone

Coinbase CEO Brian Armstrong has pushed for stricter regulations on centralized crypto actors but says decentralized protocols should be allowed to flourish given that open-source code and smart contracts are “the ultimate form of disclosure.”

Armstrong shared his views on cryptocurrency regulation in a Dec. 20 Coinbase blog where he proposed how regulators can help “restore trust” and move the industry forward as the market continues to recover from the damage done by FTX and its shock collapse.

But decentralized protocols aren’t part of that equation, the Coinbase CEO emphasized.

“Decentralized arrangements do not involve intermediaries [and] open-source code and smart contracts are “the ultimate form of disclosure,” Armstrong explained, adding that on-chain, “transparency is built in by default” in a “cryptographically provable way” and as such should be largely left alone.

8/ To get there we need to preserve the innovation potential of this technology. Regulation should focus on intermediaries (the centralized actors in cryptocurrency), where additional transparency and disclosure is needed.

— Brian Armstrong (@brian_armstrong) December 20, 2022

The Coinbase CEO said that “additional transparency and disclosure” checks are needed for centralized actors because humans are involved, with Armstrong hoping FTX’s fall “will be the catalyst we need to finally get new legislation passed.”

Exchanges, custodians and stablecoin issuers are “where we’ve seen the most risk of consumer harm, and pretty much everyone can agree [that regulation] should be done,” he added.

Armstrong advised the U.S. starts with the stablecoin regulation pursuant to standard financial services laws, suggesting that regulators enforce the implementation of a state trust charter or an OCC national trust charter.

At this current point in time, U.S. Senator Bill Hagerty has introduced the Stablecoin Transparency Act that is expected to soon pass into the Senate in the coming months.

Armstrong added that stablecoin issuers shouldn’t have to be banks unless they want fractional reserves or to invest in risker assets but issuers should nonetheless have to satisfy “basic cybersecurity standards” and establish a blacklisting procedure in order to comply with sanction requirements.

Once stablecoin regulation is sorted out, Armstrong suggests that regulators target cryptocurrency exchanges and custodians. 

The Coinbase CEO suggested that regulators should implement a federal licensing and registration regime to enable the exchanges or custodians to legally serve people within that market, in addition to strengthening consumer protection rules and prohibiting market manipulation tactics.

As for commodities and securities, Armstrong acknowledged that while the courts are still figuring things out, he suggested that the U.S. Congress should require the U.S. Commodities Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) to categorize each of the top 100 cryptocurrencies by market cap as either securities or commodities.

“If asset issuers disagree with the analysis, the courts can settle the edge cases, but this would serve as an important labeled data set for the rest of the industry to follow, as, ultimately, millions of crypto assets will be created,” he said.

Related: DeFi regulations: Where US regulators should draw the line

Given the international reach of cryptocurrency–based businesses, Armstrong also urged regulators from all countries to look beyond what’s happening within its domestic market to consider the implications that a foreign business may be having on its citizens.

“If you are a country who is going to publish laws that all cryptocurrency companies need to follow, then you need to enforce them not just domestically but also with companies abroad who are serving your citizens,” said Armstrong, adding:

Don’t take that company’s word for it. Actually go check if they are targeting your citizens while claiming not to.”

“If you don’t have the authority to prevent that activity […] you will unintentionally be incentivizing companies to serve your country from offshore,” Armstrong explained, adding that “tens of billions of dollars of wealth have been lost” because countries have turned a blind eye on what practices their subjects have fallen victim to abroad.

Armstrong added that in order for the industry to be properly regulated, a collaborative effort from companies, policymakers, regulators, and customers will be required from financial markets all around the world — particularly those from G20 countries.

Despite the complexity and variety of issues needing to be resolved, Armstrong said that he remains optimistic that significant progress can be made in 2023 on the legislative front.