Want Your Crypto Startup to Survive? Embrace Reality and Build a Regulatory Moat

This week SEC Chair, Gary Gensler, caused a stir in the crypto community when he spoke about regulating the industry, going as far as saying, “This asset class is rife with fraud, scams and abuses in certain applications.”

He’s not wrong. Scams have dramatically increased in the U.S., skyrocketing towards the end of 2020 as seen in the chart below.

Is this sustainable? No. Unless you’re OK with millions of users getting scammed each year. But even then, the system will probably never make it fully mainstream without being able to operate securely for the masses.

Is this desirable for the industry? No. Unless you’re a scammer. Period.

And what’s more, the SEC Chair appears to be a general supporter of the technology, at least from a market innovation perspective as he explained in an interview with CNBC’s Squawk Box:

Like all industries in the U.S, “rules of the road” exist as Mr. Gensler says. These new rules of the road, whatever they end up being, are a ticket to growth for the crypto firms that play their cards right. Regulation is inevitable — those who see that and accept that can use it to their advantage.

And some major players are welcoming regulatory clarity as well. MicroStrategy founder and CEO, Michael Saylor, kept it short and sweet simply saying that it will “benefit bitcoin.”

Three Ways Crypto Firms Can Build a Regulatory Moat

Regulatory moats require resources and time to build. But once in place, it is very difficult for competitors to play catch-up, especially as regulations evolve.

1. Build for Today’s (and Tomorrow’s) Regulations: As much as possible, build products and services around current regulations. For example, crypto firms have largely developed assets without registering them with the SEC as a security. This saves a lot of time and money on compliance which is not to be discounted. But walk-through the thought exercise of a firm that is proactive in working with the SEC. Even if that firm does not register a security, they are far better positioned for survival when and if regulation is passed. Another example is stablecoins. The STABLE Act did not become legislation, but could you imagine if a stablecoin voluntarily chose to follow the Act’s guidelines and get a banking charter, get Fed approval, and attain FDIC insurance? The libertarian-leaning DeFi crowd may not appreciate that stablecoin in particular, but the mainstream market, both consumers and corporations, may feel a bit more comfortable with that stablecoin, especially those who are new to crypto which is most of the adult population in the United States.
2. Accept, Leverage, and Then Change KYC/AML Norms: Even though research has shown that “anti-money laundering policy intervention has less than 0.1 percent impact on criminal finances, compliance costs exceed recovered criminal funds more than a hundred times over, and banks, taxpayers and ordinary citizens are penalized more than criminal enterprises” the fact is that AML/KYC/CDD/BSA and any other regulatory acronym invented to prevent fraud and terrorism are the norms in our current regulatory environment. Adopting these practices is adopting mainstream practices which means for many mainstream consumers, they will be comfortable knowing that your crypto firm is “making sure” (notice the quotes) that they, and the rest of your clients, are not attempting to commit fraud or other unwanted acts. Plus, waiting three days to get funds from BlockFi or Coinbase is better than waking up and learning your funds have been stolen. Not only will most mainstream consumers appreciate this, but the regulators will too. And once you prove to the regulators that you are willing to work with them, now a dialogue can occur. And overtime, just maybe, some of the crypto community’s greatest minds, working with regulators, will revamp AML/KYC/BSA/CDD to leverage open-source (maybe blockchain) technology to replace the system that is only working 0.1 percent of the time.
3. Partner with Banks: As cryptocurrency becomes more widely adopted along with potential increased regulation, partnering with banks can marry together a strategy of regulatory compliance and access to mainstream markets. Larger banks spend about 3% of non-interest expenses on compliance alone. Regulation is not taken lightly in banking because banks cannot survive without taking it seriously. Partnering with banks can allow crypto firms to leverage their partner’s compliance expertise along with innovative crypto products. Firms like NYDIG are bringing to market bitcoin solutions via banking technology partners like Q2 and Fiserv that have the potential to reach the majority of American households through their community bank. NYDIG sees how the ecosystem operates and is tapping into the current banking technology infrastructure rather than attempting to build something completely outside of it. And NYDIG believes this strategy will pay off, as explained by Patrick Sells, Head of Banking Solutions at NYDIG:

“I think if we kind of pause today and you fast forward to 12 months, you would see over a thousand institutions rolling out NYDIG products. I think we’ll see that number grow as we move forward through the next 12 months.”

- Patrick Sells, Head of Bank Solutions at NYDIG

The Future of Crypto Needs Creativity and Compromise

There are more than three ways to build a regulatory moat in crypto but the point is that to survive and thrive in any business, founders need to live in reality in order to create the future. The centralized exchanges — the Coinbase’s and the Robinhood’s of the world — have grown with this mentality but for DeFi firms to grow, a healthy dose of compromise is needed along with the creativity.

As the billionaire hedge fund manager, Ray Dalio, says, “Embrace reality and deal with it.” Like life, the crypto industry is made up of people with many different perspectives and philosophies. It’s going to be the people who are willing to embrace reality, and the regulation that it brings, that will be able to help change reality for millions of people.