Coinbase Proposes Regulatory Framework For Digital Assets – Finance and Banking

To “animate an open and constructive discussion” on
the future of digital assets, Coinbase Chief Policy Officer Faryar
Shirzad proposed a regulatory framework.

The proposal, entitled “Digital Asset Policy Proposal:
Safeguarding America’s Financial Leadership (dApp)”
includes:

• establishing a separate regulatory framework for digital
  assets;




• identifying one regulatory authority for digital asset
  markets;




• improving transparency in the digital asset markets and
  supporting market efficiency to “protect and empower”
  digital asset holders; and




• supporting interoperability and, in turn, fair competition and
  “responsible innovation.”

Mr. Shirzad stated that the proposal takes into consideration
(i) “the blockchain-driven and decentralized evolution of the
internet” and (ii) the development of a “digitally
native” category of assets that “empowers unique economic
use cases.”

Commentary

The government is not going to create a regulatory structure
that is based upon the technology used to represent or transfer an
asset. Nor should it. Proper regulation should be focused on (i)
the purpose of an asset and (ii) its users, not on its technology
or form. There are ways in which certain digital assets are
unique; i.e.,  those digital assets that split
the difference between being utility tokens and investment assets.
Attention to SEC Commissioner Hester M. Peirce’s proposal,
which would provide a safe harbor under the securities laws
for digital tokens, is in order. While her proposal
is not nearly as far-reaching in scope as the proposal made by
Coinbase, it would build in a practical manner on the existing
regulatory structure.

Commentary

Coinbase’s proposal is one of a number of approaches to
digital asset regulation intended to address the exponential growth
in the digital asset
markets (see, e.g., the Token Taxonomy Act of 2021, the Digital Asset Market Structure and Investor
Protection Act, and the Digital Commodity Exchange Act of 2020). While
the likelihood of the proposal becoming law is quite slim, elements
of the Coinbase approach may be useful to incorporate into the
existing financial regulatory structure, and may serve to clear up
the regulatory uncertainty that currently exists regarding digital
assets.

That said, the proposal raises a number of important
regulatory questions. For example, the proposal asserts that
“digital asset markets operate differently from traditional
financial markets,” yet it argues that the new
framework “should incorporate the principles and best
practices from regulations that govern traditional financial assets
where the characteristics of particular digital assets merit doing
so” (pages 11-12). If digital asset markets operate
differently from traditional financial markets, where exactly do
the characteristics of digital assets merit the application of
traditional regulatory principles and best practices? The proposal
does not attempt to answer this important question.

The proposal recommends that “Congress should recognize in
law that all digital assets, including digitally native
versions of traditional financial assets, should be subject to
a new regulatory regime for digital assets” (page 12)
(emphasis added). The proposal does not appear to explain what
exactly distinguishes digitally native versions of traditional
financial assets from non-digital versions of such assets. Why
should the regulatory framework to which an asset is subject be
different solely due to the digital or non-digital nature of the
asset? The proposal does not say.

Fundamentally, the proposal appears to be based on a common
refrain heard from advocates of digital assets – that the
decentralization and disintermediation offered by the blockchain
and distributed ledger technology underlying digital assets
will offer investors more efficient and accessible financial
markets, and reduce transactions costs and related legal fees. To
some extent, the efficiencies and cost-reductions offered by
such technologies are evident. However, proper financial
regulation should take into account more than cost efficiencies
offered to investors. The scope of what constitutes “investor
protection,” particularly with respect to speculative
instruments such as digital assets, should also include
considerations of (i) the current role of financial intermediaries
and (ii) the risks of market power. Too intense a focus on
disintermediation and decentralization can serve to underemphasize
(or even overlook) the degree to which (i) financial
intermediaries are, in effect, deputized within the existing
regulatory framework to act as regulatory agents that serve to
impede the potential for market abuses, and (ii) the number and
range of financial intermediaries serves to actually decentralize
financial markets and reduce regulatory costs for market
participants.

While the proposal puts forth some important investor protection
measures through disclosure requirements, as well as anti-fraud and
anti-manipulation provisions, its promotion of “housing all
digital asset activities under a regulated MDA” raises
critical policy questions involving the centralization of various
financial intermediary functions in a single entity, including how
to mitigate the potential for conflicts of interest. 

Cadwalader’s Steven Lofchie contributed to this
comment.

Primary Sources

1. The Coinbase Blog: Digital Asset Policy Proposal -
   Safeguarding America’s Financial Leadership




2. Coinbase Digital Asset Policy
   Proposal

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