The Breakdown - Should the People Making Crypto Policy Own No Crypto?

Episode Date: July 8, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.    The U.S. Office of Government Ethics released rules this week that executive branch staffers who owned crypto would not be allowed to work on any crypto-related regulation. NLW explores the pros and cons of this, and expands the discussion to ethics and financial conflicts of interest more broadly.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “The Now” by Aaron Sprinkle. Image credit: fStop Images - Antenna/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

I do think debating ethics norms around concerns of regulatory capture is super important, and certainly not just with regard to crypto. Politicians, regulators, policymakers are all big, weird mixtures of incentives. A lot of time in Washington, those incentives lead them to strange places that aren't really in line with some greater good that we imagine they're supposed to be striving for. Oftentimes, those incentives are about much more immediate re-election-thing things than they are about juicing the value of some financial assets. Welcome back to The Breakdown with me, NLW.

It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.i.o, chain aliasis, and FtX. And produced and distributed by CoinDesk. What's going on, guys? It is Thursday, July 7th, and today we are asking the question of whether the people making crypto policy should not be allowed to own crypto. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, leave a review, or if you want to dig deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit.orgly slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with

FTX. So, by and large, crypto this week is doing crypto things. Bitcoin. is sometimes above 20,000 and sometimes below it, and then it rotates back and forth over and over again, and I have a feeling this is a place we're going to be for a while. When it comes to the big substantive things, all of the stories are about the continued fallout of 3AC and Luna Contagion and how it's all going to resolve. In the area of regulations and policymaking, however, a new legal advisory notice from the U.S. Office of Government Ethics, I think, prompts a really fascinating question, that is at once about crypto and how policy is made in this space, but also I think begets a larger conversation about the relationship of policymakers and

regulators to financial assets. In question is what should the people in charge of making policy be allowed to own? So let's get into the specifics here. As I mentioned, a new legal advisory notice was issued by the U.S. Office of Government Ethics. This is the ethics body that deal specifically with the executive branch, so they don't have authority over Congress or anything like that. This new notice has barred U.S. officials who own cryptocurrencies from working on crypto-related policy and regulation that could affect the value of their assets. This directive applies to all White House staff and the employees of all federal agencies, including the Federal Reserve, the Treasury Department, etc. The notice clarifies that the de minimis exemption applied to securities

does not apply to crypto holdings. The securities de minimis exemption allows government officials to hold small amounts of securities while performing related regulatory tasks. In relation to direct holdings of crypto, these exceptions have been removed entirely. The example they use in the notice demonstrates the ramifications quite clearly. Quote, employee is asked to work on a regulation that would require all stablecoins to be fully backed by United States currency. Employee owns $100 in stablecoin XYZ that is not backed by United States currency. Because the regulation is anticipated to have a financial impact on the value of stablecoin XYZ, and no regulatory exemption applies, employee cannot participate in the regulation until and unless they divest their interest in stablecoin

XYZ. So to put it in specific terms, holding $100 of die, for example, would exclude a government official from working on any stable coin legislation. The note does articulate the mutual fund exemption more clearly for crypto holders within government as well. The de minimis exception for sector-specific mutual funds allows government officials to hold up to 50,000 of mutual fund stock related to policy areas they're working on, which means that a government official can hold this amount worth of crypto-related mutual funds while not being required to recuse themselves from work involving crypto regulation. The explanation of this exemption also clarifies that crypto funds are considered within the financial services sector, meaning that the total exemption

is $50,000 of mutual fund stock across both crypto and traditional equities. So if this sounds somewhat arbitrary, capricious, illogical, inconsistent, you are not the only one feeling this way. An important note is that this notice isn't about creating new ethics guidelines for a new industry. It's about applying existing guidelines to the crypto asset class. To be very clear, there is an existing exception allowing government workers to hold certain types and amounts of securities while working on related regulation, but there is officially not that exception for direct crypto holdings.

So let's talk now about the arguments against this from the chattering classes. The first argument is that this creates a bias towards non-experts or even people who actively dislike crypto. Dr. Nick A says, ensure maximum ignorance of all policymakers working in crypto by kicking anyone out who's ever used the technology. Smart. Brian Ford uses the face palm emoji and says, this is the equivalent of, quote, those that are working on internet policy are not allowed to use the internet. I wrote the White House memo on Bitcoin in 2014. This is short-sighted. Dutica, the head of OTC Options trading at Cracken, says those who know the most about crypto and have the most conviction about crypto, shall not work on legislation about crypto. Laura Thomas,

who is ex-CIA, says just what we need. People crafting policy who have no real-world experience of it. And finally, Mike Duda says U.S. Office of Government Ethics Legal Advisory Notice, paraphrased, only U.S. government employees who completely lack any understanding of cryptocurrency and stablecoins or who actively dislike them shall be permitted to work on U.S. crypto policy. Now, a small variant of this particular complaint is that even for people who haven't engaged yet, it's really important for them to be able to actually use crypto and blockchains to learn and make better decisions. Ron Hammond, who's the Director of Government Relations at the Blockchain Association, says this is a tough one in my opinion.

I know regulators who are struggling to attract crypto experts due to similar rules. Parody to Tradify rules is important, though. I purposefully didn't hold crypto while I was writing crypto legislation, and that made learning difficult. But that was the early days of crypto policy in 2017. However, Congress has their own set of rules and disclosures for crypto, stocks, etc. One thing is for certain. Complex topics like Defi, I learned best by participating.

Educated staff and public trust are crucial for sound policy. Now, Ron mentioned parity to tradify rules, and that was a big theme following this announcement. Lily Frankis wrote, Thankfully, we do the same for equities and fixed income. Oh, wait, of course we don't. Henry Devalon said, do this for houses next. Dysopia Breaker followed that up. Do it for land.

We'll come back to this particular argument in just a minute. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security-first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io.

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with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. A more subtle point came from the Cybercode twins, who pointed out that people who are actually using the technology for an important purpose are now blocked out. They write,

So they are saying to immigrants up yours, your remittances must not be in stable coins either if you send funds to family in a different country. So you can see some pretty common themes from the crypto crowd around how they feel about this. What about those who think it's a good thing? Travis Kimmel writes, this is good and a step toward preventing regulatory capture on the issue. To those offering banal rejoinders, regulatory capture is bad, even if it's concurrently happening elsewhere. So this is then a rejection of the parody argument saying that, in fact, this type of lack of exemptions should be applied more broadly. Indeed, others took rejection of the parody argument even further. Aaron Lodes, who previously worked on Elizabeth Warren's campaign, wrote,

cool, now apply this to literally everything else. And I actually think that this is the super-revealing an important part of this discussion. For some Jemokes, this combo is just about crypto, but I believe that the broader context is much more important. I do think debating ethics norms around concerns of regulatory capture is super important, and certainly not just with regard to crypto. Politicians, regulators, policymakers are all big, weird mixtures of incentives. A lot of time in Washington, those incentives lead them to strange places that aren't really in line with some greater good that we imagine they're supposed to be striving for. Oftentimes, those incentives are about much more immediate re-election-things than they are about juicing the value of some financial assets.

So point one is, yes, let's debate regulatory capture, but let's put it in the broader context, not just single out crypto randomly. Indeed, lots of people out there want us to revisit congressional ethics and what they look like as relates to Congress people being able to trade against advanced knowledge of moves that the government is going to make. We've also had to multiple Fed officials over the last year have to resign over these types of concerns. Federal Reserve Vice Chair Richard Clarita resigned in January of this year after admitting that he had failed to disclose financial transactions in February 2020, right as COVID was on its way to the U.S. He was the third top Fed official at that time to resign over trading

in advance of Fed policy shifts during COVID. On February 27th, he moved between $1 and $5 million out of a bond fund into a stock fund. This was just days before Fed Chair Jerome Powell started talking about the Fed cushioning the economy as the pandemic hit the U.S. Now, initially, this move from bonds into stocks was all that had been reported, and the Fed called it a, quote, pre-planned rebalancing of Clarita's portfolio. But then, months and months later, he updated his disclosure to show that he had sold $1 to $5 million of the same fund three days prior to buying it.

In other words, Clarita sold between $1 million worth of stock as markets were starting to tweak and then re-bought it as they got reassured by the Fed. At the time, a closer eye was on Richard Clarita and the rest of the Fed, because Dallas Fed President Robert Kaplan and Boston Fed President Eric Rosengren had also been under fire and had to resign for buying and selling stocks and real estate-linked assets at the same time the Fed was going ham on COVID-impacted markets. So clearly, this is not just a crypto issue. Point two is this discussion of parity with other financial assets. This is really important.

As we can see from the Fed example, it's hardly like crypto is the only area where conflicts of interest enter politics. And I will remind that when we're discussing parity, we're not looking at Congress as the OGE is only focused on the executive branch. I definitely resonate with this parity argument. Crypto is treated by the U.S. government as a financial asset. exactly what type of financial asset continues to be debated, but a financial asset nonetheless. Having different rules just because it's crypto, like killing these de minimis exemptions, just seems dumb to me. Point three is the do-it-for-housing-next argument, and as tempting as it might be to see this as just a Twitter gotcha, I think there's a lot of truth here.

So many parts of policy come back to financial assets, or at least assets that can be financialized. Should we prohibit everyone who works on the policy around gold, around all securities, around all commodities, and yes, around housing, from owning any of the things that they're working on regulation around? If we start excluding people from ownership of all assets, we create our own type of warped incentives. And this is really where the larger debate comes in. There is a subsection of American politics that really does think that fair means that policymakers and legislators shouldn't be able to own anything. This is first completely impractical. We'd be creating a situation where public service requires effectively a vow of financial okayness. I don't want to be hyperbolic and say a

vow of poverty, but assets are how wealth is built. And denying all policymakers' access to participate in asset ownership of any kind would mean that we are selecting for our policymakers, for our regulators, for people who are either one, so ideologically driven that they don't care, which is going to lead to extremes on both sides of the aisle, or two, so motivated by their perception of their own power that they don't care, both of which seem pretty scary to me. What's more, let's say we did this. The perspective these folks would be bringing in would be largely homogeneous because they wouldn't be bringing experience from other sectors and areas of the economy into the policy discussion and discourse. So what we're talking about then is a group of politicians who are

homogeneous, hyper-ideological, and motivated most of all by feeling powerful. Call me, crazy, but I'm not sure that sounds real good. So what might the alternative be, given that I said before that this conversation around regulatory capture and conflicts of interest is important? First of all, disclosure regimes are obvious. A lot of the problems of conflicts of interest is their opacity. It's not giving people a chance to review actions through that lens. This is why every day at the beginning of this show, I mentioned that I work with FTX outside of them just being a sponsor. A lot of the time, that means I recuse myself from discussing plays where FTX is in the news. But when it's so big that I have to at least mention it, that gives

you, the listeners, the power to decide what lens you're going to view my take on it through, how big a grain of salt you're going to listen with. So part one is disclosures, and there are a lot of ways to make disclosures even more powerful, especially in an on-chain world where officials' public addresses would be known. But, you say, they could be hiding assets in other wallets. Well, sure, but then they're just outright lying and committing fraud, which is a whole separate thing from good faith public officials disclosing their assets. A second opportunity that doesn't preclude people from ownership is rules around what they can and can't buy and how. I don't think it's at all unreasonable to say that during your time

in office and or while serving the government, there are severe restrictions on how you participate in different markets. Let's go back to the Fed example. Trying to get out ahead of some of these scandals, the Fed updated their conflict of interest rules last October. Fed policymakers and senior staff are now prohibited from active trading and will be able to purchase only diversified vehicles like mutual funds. They also have to give 45 days notice and get prior approval from internal ethics staff for all purchases and sales. What's more, they have to hold all investments for at least one year. These are very onerous terms. Forty-five days in prior approval means you're simply not market timing based on private information. There are also completely reasonable rules to abide by during

one's term. It's a choice that people get to make and then they stick with. There could absolutely be analogous rules for crypto that severely limit what people can buy, hold, sell, etc. At the end of the day, my TLDR is that I believe that this approach sets us up for bad policy. Of course, people who don't own crypto and even people who dislike crypto can be part of the conversation on how to regulate it. They should have a seat at the table. But making it a rule that you can't absolutely excludes experts and the most engaged. Yet, here we are, once again, trying to deal in nuance when we're talking about the U.S. government. So perhaps this is all a pipe dream. Either way, I want to say thanks again one more time to my sponsors, nexo.io, chain aliasis and FtX. And thanks to you

guys for listening. Until tomorrow, be safe and take care of each other. Peace.