Several prominent leaders representing nearly every aspect of both traditional and cryptocurrency finance have jointly submitted a letter to the U.S. Securities and Exchange Commission urging the regulator to modernize its methods.
In the letter, published late last night, bitcoin core developer Bryan Bishop, former Morgan Stanley managing director Caitlin Long, e-commerce coding pioneer Chris Allen, founder of Ernst & Young’s blockchain team Angus Champion de Crespigny and fund manager attorney Gavin Fearey warned the SEC against certain types of enterprise adoption.
Long considered a boon to the cryptocurrency space, the letter argues that enterprise adoption could actually corrupt some of bitcoin’s inherent benefits if not properly overseen. Specifically, the letter warns against practices employed by the Intercontinental Exchange (ICE), which owns the New York Stock Exchange and recently announced its intention to launch a cryptocurrency exchange of its own.
Among a number of recommendations made in the letter, Bryan Bishop, who has been contributing to bitcoin’s core code since 2014, argues that the biggest change the SEC needs to implement is to partner directly with cryptocurrency engineers to develop a new kind of regulation.
“Bitcoin is fundamentally a technological system with many nooks and crannies,” Bishop told Forbes. “It’s the concept that rules can be enforced using software, math and cryptography rather than policy.”
Specifically, the letter, dated September 19, 2018, argues that restrictions should be put in place on how Bakkt, ICE’s planned cryptocurrency exchange, might handle cryptocurrency when it launches.
In a section headed “We caution against applying rules to digital assets in ways which do not reflect their strengths,” the authors of the letter warn that the traditional financial practice of storing customer funds in a single account would undermine some of the core strengths of cryptocurrency.
“Digital assets are natively segregated, and maintaining this natural segregation at all times would best protect investors by conforming to the architecture of digital asset technology,” according to the report.
By storing all customer funds in a single place and lending out or otherwise investing the stored cryptocurrency, the process known as “commingling” could devalue bitcoin by creating more liquidity than there are assets to back it. As a result, the process would in part recreate some of the very dynamics that led to the financial collapse of 2007 and 2008.
Further, bitcoin is a bearer bond instrument, unlike the vast majority of securities that are physically stored by the DTCC and only virtually traded. As a result, commingling of bitcoin from multiple owners into a single account could create a “honeypot” that attracts hackers looking to steal the bitcoin, according to the letter.
In addition to concerns about commingling, the letter warns against another generally accepted practice called “rehypothecation,” in which one organization claims ownership of an asset in its balance sheet, but lends the asset to another party that also marks the asset on its balance sheet, and so on.
The letter concludes:
“We believe that current SEC rules surrounding custody do not reflect the risks inherent in managing digital assets and do not use the technical strengths of the technology. These technical strengths have the potential to lead to a stronger, more robust custody environment. To better understand these possibilities, to build to strengths of technologies, and to not harm its advantages, we recommend that the SEC engage with those who are experienced with technology, such as cryptographic engineers, software developers, Bitcoin exchanges, smart-contract designers, blockchain developers, and existing digital-asset managers to ensure best practices are implemented.”
Just a week after Caitlin Long, a co-author of the letter, first expressed similar concerns in an article on Forbes, Bakkt CEO Kelley Loeffler published a blog further elaborating on the planned cryptocurrency exchange services. In the post Loeffler clarified that the “bitcoin contract will not be traded on margin, use leverage, or serve to create a paper claim on a real asset.” If the exchange follows the guidelines Loeffler laid out, it would put an end to many of the concerns expressed in the letter.
But Long remains concerned that since the practices are permitted by current regulations, there’s no reason to believe they won’t be implemented with the new crypto assets. Expanding on those concerns are new developments by another institutional bank, Citigroup, which this month announced a cryptocurrency custody solution that will rely on Digital Asset Receipts designed to give investors a way to gain exposure to cryptocurrency without actually owning it. That’s exactly what Long and her co-authors are concerned about.
“Don’t treat bitcoin like a normal financial instrument—it’s not,” she told Forbes. “Don’t apply old rules to the new system.”