Can US Regulators Ever Address the Challenges of Decentralization?

Over the last few weeks, several exchanges including Binance, Bittrex, and Poloniex have started withdrawing services from US users due to the ongoing and increasingly uncertain regulatory environment.

Among these is Bancor, which was perhaps a surprising addition to the list, given that it operates as a decentralized liquidity network and not as a centralized exchange. After all, one of the central tenets of truly decentralized systems is that they are open to everyone.

Bancor addressed this in its announcement about the withdrawal of service. The post explains that although US users will be banned from using the Bancor network website through an IP blocker, the Bancor protocol itself is a set of smart contracts on the blockchain and a non-custodial system. Therefore, while US users won’t be able to access the protocol using the interface in the same was as non-US users, Bancor has no ability to block anyone from using its protocol.

This raises some interesting questions about the US lawmaker’s ability to regulate blockchain and cryptocurrencies. For Bancor, it also brings up a point raised by SEC Director William Hinman last year. If a blockchain or cryptocurrency is “sufficiently decentralized,” should it be subject to securities legislation?

The Rocky Road So Far

Since the ICO madness of 2017, there have been seemingly endless discussions about whether or not the US will introduce cryptocurrency or blockchain regulations. The position seems to change depending on which way the wind blows.

The crux of the question is always based on the Howey Test, a decades-old legal precedent that determines whether or not a particular transaction constitutes a sale of securities. At the start of 2018, SEC Chairman Jay Clayton famously stated that “every ICO I’ve seen is a security.”

However, William Hinman gave his “sufficiently decentralized speech later in the year which appeared to contradict this view. Hinman’s statement referred to the fact that, in a decentralized network, there is no specific person or group who is expected to carry out essential managerial or entrepreneurial efforts. This is a critical point from the Howey test in establishing whether a transaction is an investment contract.

The F Word

As Bancor is decentralized, perhaps it could pass this “sufficiently decentralized” test. However, the company is right to be prudent in light of the previous comments made by Jay Clayton. Although there have been no further clarifications issued recently, the regulatory discussion is once again hotting up due to the fact that Facebook has announced its foray into the world of cryptocurrency with its Libra project.

Facebook’s plans clearly don’t sit well with the US regulators though. Immediately after the announcement, Congresswoman Maxine Walters called on Mark Zuckerberg to delay his plans long enough for regulators to intervene. Since then, several parties, including the Bank of International Settlements, have commented on Libra’s potential to disrupt existing financial systems. Therefore, it seems that it’s only a matter of time before the US regulators make some kind of a pronouncement on digital currencies.

The Big US Exchange Freeze

Of course, Facebook isn’t proposing a truly decentralized cryptocurrency like Bitcoin. However, the regulatory uncertainty is now sufficient for Banco and several crypto exchanges to start taking measures to reduce or eliminate their services in the US.

Circle-owned exchange Poloniex announced back in May that it would be withdrawing nine tokens from US markets. The company later issued a blog post openly criticizing the US regulatory approach, stating it was “stifling innovation.”

A few weeks later, Bittrex announced it would be withdrawing 32 cryptocurrencies from trading for US users. While it didn’t expand on the reasons for this, the announcement alluded to the regulatory situation with the statement “we will continue to advocate for laws and regulations that foster innovation.”

Perhaps the biggest shock for traders came from the news that Binance would close its doors to US traders entirely. The good news is that the company is planning to launch a US-compliant exchange similar; however, it’s not currently known when this will happen.

Binance recently expanded its offering into a decentralized exchange (DEX) developed on it’s own blockchain. Like Bancor, the company will geoblock users in the US from accessing the Binance DEX from the user interface. However, like Bancor, the company can only block users from the interface and not exclude them from the decentralized blockchain itself.

A Crypto Desert?

Even within Congress and among different members of the SEC and other US regulatory bodies, there is no clear agreement about the direction regulation should take. Furthermore, any move by the US government to act against Facebook doesn’t necessarily equate to the same actions against cryptocurrencies, given that Libra is a distributed ledger owned and operated by a group, rather than an open, decentralized network. Nevertheless, if US crypto users aren’t to continue missing out, it’s high time for the regulators to make a decision one way or another. Otherwise, the US risks becoming a crypto desert.