Crypto Regs: Square pegs and round holes leave room for AI theft

Crypto regulation is finally becoming a serious possibility in Washington DC. It is a difficult task but what we have seen from Lummis-Gillibrand Responsible Financial Innovation Act (which I’ll refer to as the Lummis-Gillibrand crypto bill in this piece) is heartening even if it’s again more of Washington’s traditional politics. The authors of the bill are to be given a great deal of credit, since introducing any legislation is a troublesome process in the country’s hostile politics. In addition, they have gone to great effort to try to fashion crypto regulation in the context of our Depression Era’s securities rules. Even for lawyers it is a mind-numbing exercise.

The effort to regulate, rather than join the Chinese and merely ban crypto, is an important goal. But it misses the urgency of the moment. Our international opponents are exploiting the weakness of our securities laws to fund nuclear weapons to attack us. Even the UN is warning us. Nor is there any sense that the US financial markets will address this level of security problem.

The Lummis-Gillibrand crypto bill presumes that the actors in the cryptocurrency space are fair minded, or at least manageable. History shows that they are not. The effort to fit the proposed regulations into our current Washington wars between then SEC and the CFTC merely dilutes the potential to solve the problem of crypto regulation. It creates an opportunity for more fraud and will demand a follow up law in a year or so to address the problems of theft and international crime.

What is in the bill

Even a short synopsis of the proposal is lengthy. The Lummis-Gillibrand Responsible Financial Innovation Act Section-by-Section Overview is over 2,300 words and covers sweeping areas of both crypto and the Federal regulatory structure. The proposal makes a noble effort to define the crypto assets that are to be regulated. To its credit it finally gives some definitions for:

· Digital Assets

· Virtual Currencies

· Payment Stablecoins

· Decentralized Autonomous Organizations

· Fungible Digital Assets

· Digital Asset Exchanges

· Broker Clarifications

· Digital Asset Lending Agreements

This is the short list of important items. It is a list, however, which is sure to be superseded quickly in the rapidly innovating crypto market. The bill does distinguish between commodities or securities, but these are merely American law categories. Digital assets do not fit well or easily into them. And while we can create enough legal fictions to regulate digital assets using these terms, the distinction between commodities and securities in the digital space is essentially arbitrary, even if it follows current law. The cryptocurrency space is by definition a digital space and there is no mathematical function, uniquely creating a commodity or security.

The bill makes a good faith effort to move the ball forward and should be applauded for it. The authors implicitly note there will need to be a continuing effort in regulation. Indeed, the real power in the Act is given to an Advisory Committee on Financial Innovation. The Committee is a potpourri of regulators and interested members of the public whose job is to provide continuous information on how to revise the regulation.

Why we should fix it now

The efforts to fix this regulation should not wait. It should start now.

The essential question is whether US crypto regulation is going to be as smart as Chinese or North Korean AI in crypto theft. The question is not mere speculation. In a recent article Will Artificial Intelligence Hone North Korea’s Cyber “All-Purpose Sword”? the authors provide a detailed discussion of the use of AI in the cyber theft area.

The US officials typically believe that the go-slow and careful approach has borne fruit. It has done so by some measures since the US has avoided most of the very public failures of cryptocurrency adoption internationally. And as we have seen with the Lummis-Gillibrand crypto bill, we are beginning to see some progress legislatively now. Nevertheless, by going slow we have simply given time for our adversaries to advance their AI against us and the cryptocurrency market.

Investor implications:

1. Federal regulation should be expected to be relatively comprehensive and to occur early next year.

2. Foreign theft can be expected to continue at an accelerated pace.

3. Crypto investors should exercise a very high level of caution and diversify their investments.

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This article is not intended as investment, tax, or financial advice. Contact a licensed professional for advice concerning any specific situation.