Amid the era of encrypted regulation, the United States is falling behind.

The US is lagging behind in encryption regulation.

A crackdown on the gambling and firearms industries in the United States a decade ago is being replayed in the world of cryptocurrency today.

Written by: Michael Nadeau

Translated by: Luffy, Foresight News

Note: This article is the second part of The DeFi Report’s series on US cryptocurrency regulation and policy-making. Please read the first part, “Where Will US Cryptocurrency Regulation Go From the Conflict Between SEC and Coinbase?”

Image source: Coinflip

Operation Choke Point

Law enforcement actions against the cryptocurrency industry have been frequent since January this year. On January 3, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) issued a joint statement emphasizing the “cryptocurrency asset risks faced by banking institutions.”

The regulatory purpose should be to reduce fraud, punish bad behavior, encourage responsible innovation, and protect investors. But some have claimed that law enforcement actions may lead to more dangerous things, which they call “Operation Choke Point 2.0,” meaning even more than before Operation Choke Point 1.0.

So what is Operation Choke Point 1.0, the government’s official name, and why is the initiative considered illegal and unconstitutional? What similarities are there with today’s cryptocurrencies? What can we learn from it?

Overview

Operation Choke Point was an initiative launched by the US Department of Justice in August 2013.

Essentially, it was a collaborative effort to “strangle” unfavorable industries (gun dealers, credit repair services, cigar manufacturers, dating services, telemarketers, online gambling, etc.) by cutting off their banking services channels.

Don’t like an industry? Send a message to the bankers behind it.

– Former FDIC Chairman William Isaac 11/21/14 (in a sharp op-ed in The Wall Street Journal)

I think the activists at DOJ and FDIC are abusing their power and authority and punishing legitimate businesses. In fact, they are using the government as a weaponized force to maintain their ideological beliefs.

– Chairman of the House Financial Services Committee Sean Duffy, March 24, 2015

The Choke Point operation was “to force banks to identify customers that do things government officials find objectionable, like selling guns or fireworks from their store. Then, cut these customers off from financial services, close their accounts.”

– American Bankers Association Frank Keating

While the government denies any wrongdoing, the email history paints a different picture. In fact, senior FDIC regulators were passing along information about industries they “can’t stand” while instructing banks to close the accounts of perfectly legitimate businesses.

After over three years of controversial litigation, multiple congressional investigations, and ultimately a presidential administration change, the “Choke Point” operation against legal American businesses finally came to an end.

Choke Point officially ended in August 2017, with the FDIC settling multiple lawsuits with victims frozen out of the financial system.

FDIC also pledged to “restrict the power of FDIC personnel to close bank accounts” in addition to monetary settlements.

Cryptocurrency is facing a similar crackdown

Surprisingly, all of this has happened in the last decade, something that should not happen in America. But it is happening again, right under our noses.

Cooper & Kirk was a law firm that defended victims during Choke Point 1.0. According to their recent report on the topic, history is repeating itself. They outline the following similarities:

  • Democratic control of the White House

  • FDIC Chairman from Choke Point 1.0 reappointed

  • Banking relationships targeted against specific industries

  • Prudent banking regulators issuing unofficial guidance documents and engaging in secret coercion, threats, and behind-the-scenes pressure

  • Banks afraid of the regulators, and thus succumbing to their authority. “Choke off our disliked customers, or we’ll choke you off through audits and examinations.”

The current state of cryptocurrency is different from what it was a decade ago:

  • There is a singular focus on cryptocurrency.

  • It is a global innovation industry.

  • There are more retail and sophisticated investors.

  • Cryptocurrency is important to key financial and payment infrastructure.

  • The industry involves public companies and major financial service providers.

Red Alert

We try to avoid jumping to conclusions, but circumstantial evidence doesn’t look good.

According to Cooper & Kirk, it’s not just one event that suggests multiple regulators are working together to “ban” unfavorable industry players.

That being said, we want to highlight the Signature Bank closure event.

On March 12, 2023, Signature Bank was seized by the FDIC. The company is one of two banks that provide services to large cryptocurrency companies to facilitate 24/7 global market liquidity. The other is Silvergate, which ceased operations on March 8th.

Both banks operate real-time payment platforms specifically tailored to meet the 24/7 liquidity needs of large cryptocurrency exchanges and market makers. This is critical infrastructure for the exchange of fiat and cryptocurrency, facilitating 24/7 global trading of crypto assets.

The FDIC’s sanctioning action is strange for the following reasons:

1. As of the end of 2022, Signature had $110.36 billion in assets, which could cover $88.59 billion in liabilities. Concerns about the spread of the Silicon Valley Bank incident escalated and $10 billion in deposits were withdrawn on March 10th. However, as of March 12th (the date of the enforcement action), the bank’s capital position had stabilized and the outflow of deposits had slowed, and the bank was able to pay. Therefore, the stated reason for the FDIC’s seizure of Signature Bank is “mismanagement,” and the FDIC itself acknowledges that the bank was solvent at the time of closure. Throughout the legendary history of the US banking industry, we cannot find another example of a bank being seized for “mismanagement.”

2. In Cooper & Kirk’s investigation into Operation Choke Point 1.0, a chief FDIC examiner was quoted as saying that if “a little ant, a $200 million bank fails,” the FDIC is not concerned.

3. Barney Frank, former congressman who drafted the Dodd-Frank Wall Street Reform and Consumer Protection Act, serves on the board of Signature and suggested that Signature Bank is a victim of political attacks.

We are not a large, high-tech lending institution. We are a large housing lender in New York City. We do not hold cryptocurrency on our balance sheet – we simply allow two of our commercial customers to transact with each other using cryptocurrency. We are a facilitator. Regulators want to use us to send a very strong anti-crypto signal.

4. According to two anonymous sources, the FDIC required Signature’s bidders to agree not to bid on Signet – the payment infrastructure that promotes global crypto market liquidity. This means that the critical infrastructure serving the crypto market has now been completely cut off, with many legitimate crypto companies no longer having a banking partner. Given the circumstances of the hasty sale of the bank, The Wall Street Journal believes that the FDIC’s action “confirms Frank and our suspicion that regulatory hostility to cryptocurrency was the motive for shutting down Signature.” When asked if it was legal to seize a bank that was capable of paying and then exclude certain assets of that bank from subsequent sales, Barney Frank said:

It’s worrisome. I’d like to know if we’re the first bank that’s been completely closed down without being bankrupt. If so, why? I think the NYDFS should answer that question. That’s why I speculate that the FDIC made us the sacrificial lamb to send a “stay away from cryptocurrency” signal.

For more information on this topic, you can check out Nic Carter’s interview with David Thompson of Cooper & Kirk, a law firm that defends victims in the Blockade Point 1.0.

What’s next?

Cooper & Kirk is calling on cryptocurrency companies to come forward and share their experiences over the past few months.

If the charges are true, we should expect Congress and the courts to crack down hard on unelected regulatory agencies abusing their power. Severe punishment is necessary because this sets a dangerous precedent that political power can be used to cut legitimate businesses out of the financial system for political reasons.

As far as the timetable is concerned, Cooper & Kirk expects the investigation and trial to take several years.

MiCA and the Regulatory Game

The attitude of the US Congress is split, with further divisions between the SEC and CFTC. Non-elected regulatory bodies, such as the FDIC, have implemented potential illegal practices in the crypto industry. The White House has also shown its attitude, with at least one senator forming an “anti-crypto alliance.” It’s a bit chaotic.

But the rest of the world is not like this.

With the recent passage of the MiCA regulation for the crypto asset market, the EU is showing the US that “your garbage is our treasure.”

The regulatory game has begun.

Why? Incentives. If cryptocurrencies really have the potential we think they do, the industry will create jobs and tax revenue worldwide. So why not thoughtfully regulate the industry and attract the best entrepreneurs to your jurisdiction?

Not just Europe, but the UK, Japan, and the UAE are actively pushing to become leaders in the new industry; Singapore, Switzerland, and Australia have been following the trend closely.

Just as the US is becoming more hostile to this industry, even China is now (via Hong Kong) getting back in the game.

But Europe is the first area to pass substantive legislation. Here are some key points about MiCA:

  • Passed by 500 votes to 30.

  • Expected to go into effect in July, with compliance for companies expected to start in 2024.

  • Initial focus is on Centralized Crypto Asset Service Providers or “CASP”

  • Involves exchanges, OTC desks, stablecoin issuers, and token issuers.

  • Still studying DeFi and NFT, unlikely to see new rules before 2027.

  • Main focus is on illegal financing, investor protection, and USD-denominated stablecoins.

The specific implementation remains to be seen, but we think this is a good start, focusing on stablecoins and centralized service providers, allowing DeFi and NFT to continue to innovate.

We have reason to believe that the UK wants to become the global center for encryption and that Europe may be providing a template for the UK and other jurisdictions to follow. Meanwhile, the US is falling behind in the race for political and existing power structures.

Possible outcomes

The US continues or intensifies its harsh stance on cryptocurrencies. In this case, entrepreneurs will find it difficult to innovate in the US; financial institutions will be unable to offer products or services that utilize transparent public blockchains; RIAs (Registered Investment Advisors) will be unable to provide advice on cryptocurrencies to their clients; and crypto funds will be unable to raise capital, hindering the formation of capital within the industry.

This is a bearish case, but it is unlikely, and we estimate it to be less than 5%. Why? Incentives. When the incentives of policymakers align with those of industry participants, cryptocurrencies will have an opportunity to develop.

The US attitude towards cryptocurrencies becomes positive. We believe this possibility is greater. The FTX fraud case only lasted 6 months, and the market rebound was swift. But we think we may have already seen the worst. Why? The answer is still incentives. The unique diversity of crypto users will challenge policymakers who continue to use “crypto bros” as a scapegoat for other agendas. We believe the next bull market will be triggered by market liquidity returning and regulatory developments outside the US. When this happens, the US falls behind. Interestingly, as the US becomes more hostile to cryptocurrencies, China is becoming more friendly to them. Policymakers have already started to realize this. As we said, this is a regulatory game.

This is our basic scenario, with a timeline of 12-24 months.

The US attitude towards cryptocurrencies completely changes. Coinbase or Ripple reaches a settlement or wins a lawsuit against the SEC. Illegal actions were taken against crypto companies during Operation Choke Point 2.0. With the release of this news, policymakers and regulators face strong opposition, and the flames of “lack of trust in institutions” are thoroughly ignited among the people. Gary Gensler resigns from the US Securities and Exchange Commission. Congress introduces thoughtful new legislation and signs it into law. People generally believe that “cryptocurrencies are the future”. We see another wave of capital pouring into the US market. Shame is officially erased, innovation flourishes, and the US regains its leadership position in the crypto space.

This is a case for a bull market, with a timeline of 3-6 years.

Conclusion

Regarding US policy-making and regulation of cryptocurrencies, our views are as follows:

  • The SEC wants to apply the framework created in 1933/1934 to cryptocurrencies; this won’t work because crypto assets are fundamentally different from securities.

  • We need a new crypto regulatory framework to ensure proper disclosure and investor protection. The framework will ultimately come from Congress, the SEC, or the CFTC enforcing new rules.

  • Currently drafted legislative bodies have made some progress in this direction. While the executive branch (and presidentially-appointed regulators) are hostile to cryptocurrencies, the legislative branch seems supportive of responsible innovation.

  • The cases against Coinbase and Ripple (and now Binance) by the US Securities and Exchange Commission are worth watching, since the outcomes will affect future policy-making.

  • Incentives will change attitudes within Congress. Due to the unique diversity and nonpartisan nature of cryptocurrency users, we believe policymakers will find it difficult to be against the industry.

  • With our next election cycle approaching, Bitcoin and cryptocurrencies may become even more politically relevant.

  • Cryptocurrencies urgently need regulation and bad actors need to be weeded out. That being said, some of the actions taken by regulators seem to have gone beyond the law. We will closely monitor the work being done by Cooper & Kirk and their representation of the industry.

  • With the groundbreaking European legislation passed in July becoming law, the regulatory game is afoot. We think this will affect how US policymakers view cryptocurrencies.

  • Despite the challenges, we believe cryptocurrencies will eventually be appropriately regulated in a way that promotes innovation while protecting investors. It will just take some time, and our estimated timeline is 2-5 years.

We will continue to update Blocking; if you have any questions or suggestions, please contact us!

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