President Joe Biden’s executive order directing agencies to come up with a federal-wide approach to regulating digital assets appropriately has garnered widespread attention. But as Judge Louis Brandeis once said1states are laboratories of democracy. True to form, states are moving quietly and methodically in the cryptocurrency space. For example, bipartisan coalitions of state attorneys general are meeting later this month and in April to discuss their regulatory authority in the cryptocurrency space. Legislation has been introduced in California to allow California government agencies to accept payments via digital currencies. This month, Wyoming updated its strong statutory cryptocurrency regime by passing the Decentralized Autonomous Organization Amendments, which essentially clarify how people join, leave, and vote in a Decentralized Autonomous Organization (“DAO “). Indeed, state-level activity in the digital asset space has been flat for several years. In fact, Nevada has since 2017 accepted a blockchain as an electronic record and recognized the validity of smart contracts. While the federal government’s recent directive to study digital assets is a crucial step in the right direction, states have been steadily moving forward. The digital asset industry will want to consider its state-level approach with the areas referenced below in mind.
Representations made to consumers
One of the few bipartisan issues of our time involves Democratic and Republican attorneys general asserting their authority to combat practices they deem unfair, deceptive, or abusive by those who offer financial products or services to consumers. The more consumers are affected, the more likely it is that a state attorney general will review statements made to consumers. We should expect to see state regulators playing a bigger role in enforcement as digital assets become more mainstream. Indeed, the state-level review has already begun. For example, New York Attorney General Letitia James won a $3 million default judgment against Coinseed (a now-defunct cryptocurrency trading platform) and its CEO for selling securities without registering as a broker. State prosecutors also accused the CEO of fabricating his experience to market the platform. As digital assets grow, companies would be wise to consider the state-level implications of any public statements made regarding these digital assets.
The rise of stablecoins
Stablecoins have the potential to help beginners understand cryptocurrencies. However, not all stablecoins are created equal. For example, fiat-backed stablecoins are backed by fiat currency (e.g. US dollar). Again, state regulators are already reviewing these digital assets. For example, in February 2021, Attorney General James reached a settlement agreement with Tether, a cryptocurrency trading platform. Tether claimed to offer a stablecoin backed by the US dollar. Attorney General James alleged that the cryptocurrency was not fully backed by US dollars. In the settlement agreement, Tether agreed to pay $18.5 million in penalties and cease doing business with New Yorkers.
In light of the state’s attorney’s general actions to date, it would be wise to consider how states would respond to public statements regarding commodity-backed stablecoins (which are backed by various commodities, including ‘gold). Additionally, algorithmic stablecoins (which themselves do not have collateral but rather rely on an algorithm to increase or decrease the supply in circulation) possess an increased level of decentralization. The decentralized nature of these assets presents a unique risk to consumers and is therefore part of the bipartisan consumer protection efforts of state attorneys general.
Risk monitoring procedures
Another area that will increase the general appeal of digital assets is crypto payment processing. These conduits enable the acceptance of digital payments in exchange for fiat currency. This is an exciting and developing area that has the potential to remove marketers’ and consumers’ hesitation. However, again, state regulators are already vigilant. For example, payment processor Stripe paid $120,000 to resolve allegations made by Massachusetts Attorney General Maura Healey that it should have put in place more robust risk monitoring and fraud prevention processes. to protect consumers. Several takeaways from the Stripe settlement include the need for payment processors to have monitoring procedures in place to detect and investigate duplicate accounts with shared bank accounts, identify and escalate law enforcement requests, investigate consumer complaints of merchant fraud and train employees in risk monitoring. procedures. As cryptocurrency becomes more mainstream, centralized companies offering crypto services would be wise to audit their risk monitoring processes with an eye on state regulators.
If the activity of state regulators regarding financial lending is any guiding star, crypto lending will come under scrutiny. Here, the centralized platforms act as intermediaries for the execution of the crypto lending process by taking control of the assets of the lenders and the collateral for the borrowers. Thus, Know Your Customer and Anti-Money Laundering compliance assessments will be essential. To the extent that a platform uses smart contracts for the execution of lending procedures, state regulators may be interested in the information collected to execute the contract (for example, if off-chain information is used, the source of the information and the accuracy of this information).
Agile state regulators and legislatures are poised to continue taking action on digital assets. States across the country, including Wyoming, California and Nevada, have already passed laws. State attorneys general actively and jointly plan the future of their regulatory authority. Companies in the digital asset industry should consider their state-centric approach in conjunction with President Biden’s executive order studying the federal government’s approach to regulation.
1 The actual quote is: “It is one of the happy incidents of the federal system that a single courageous state can, if its citizens so choose, serve as a laboratory; and try new social and economic experiments without risk to the rest of the country. New State Ice Co. vs. Liebmann285 US 262, 311 (1932) (Brandeis, J., dissenting).