Ask any cryptocurrency company what their biggest challenge is, and they’ll likely tell you “legal and regulatory issues.” The legal and regulatory environment surrounding cryptocurrency is complex, uncertain, and changing by the day. In the U.S., no one agency has sole jurisdiction over cryptocurrency, and different agencies have varied interpretations of what cryptocurrency is (largely reflecting the agency’s statutory mandate). The federal government considers cryptocurrency to be money for the purposes of the Bank Secrecy Act and anti-money laundering regulations. Most states also consider cryptocurrency to be money, and therefore require cryptocurrency businesses operating within the state to obtain a money transmitter license. The Commodity Futures Trading Commission (CFTC) has classified bitcoin, and by extension other cryptocurrencies, as a commodity, thereby granting the Commission jurisdiction over futures and other derivatives involving cryptocurrencies. The CFTC does not regulate commodity spot markets, except for cases of fraud and manipulation. While bitcoin and other cryptocurrencies are classified as commodities, any sort of investment vehicle that holds cryptocurrency and offers ownership interests in the vehicle will be considered a security subject to SEC registration. Finally, the IRS considers virtual currency to be property subject to capital gains taxes.
Successfully navigating this complex web of regulation is extraordinarily difficult, and costly for startups, especially those founded by technologists with no previous experience in the financial services industry. Given this challenge, it’s understandable why many cryptocurrency firms have turned to former top regulators for assistance. To highlight this point, I created the following table identifying several former high-level regulators and the cryptocurrency firms they are currently working for, as either director or advisor. This list is by no means exhaustive, and it excludes former prosecutors and less senior regulators. Nonetheless, it highlights an emerging trend.
| Former Regulators Serving as Directors or Advisors at Cryptocurrency Companies | |||
| Name | Former Role | Current Role | Firm |
| Arthur Levitt | SEC Chairman | Board of Advisors | Omniex – cryptocurrency trading platform |
| Arthur Levitt | SEC Chairman | Advisor | BitPay – bitcoin payment service provider |
| Sheila Bair | FDIC Chairman | Board of Advisors | Omniex |
| Sheila Bair | FDIC Chairman | Board of Directors | Paxos – distributed ledger based settlement platform |
| Ben Lawsky | New York State Superintendent of Financial Services | Board of Directors | Ripple – real-time gross settlement system, currency exchange and remittance network |
| Juan Zarate | Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes | Board of Directors | Coinbase – digital currency exchange |
| Rajeev Date | Deputy Director of the Consumer Financial Protection Bureau | Board of Directors | Circle – peer-to-peer payments technology company |
| Lawrence Summers | Secretary of the Treasury | Advisor | Xapo – bitcoin wallet |
| Mark Wetjen | Commissioner, Commodities Futures Trading Commission | Board of Directors | LedgerX – cryptocurrency asset management platform |
| Bart Chilton | Commissioner, Commodities Futures Trading Commission | Advisor | Omega One – trading platform for cryptocurrencies |
The Revolving Door’s History
Former top regulators serving as advisors, directors, or even employees at regulated firms is nothing new – the practice has a long and troubled history in the financial services industry. In 1900, assistant Treasury Secretary Frank Vanderlip agreed to become a vice-president at City Bank, a position he would not occupy until more than a year after accepting it, all the while remaining at Treasury.[1] Ninety-eight years later, Robert Rubin resigned as Treasury Secretary, and a few months later took a vaguely defined job at City Bank’s successor, Citigroup, as Chairman of the Executive Committee of the Board; he also served alongside John Reed and Sanford Weill, Chairmen and Co-Chief Executive Officers, in a newly constituted three-person office of the Chairman.[2] Of course, the revolving door swings the other way as well, most famously at Goldman Sachs – derisively referred to as Government Sachs by its critics. Both Mr. Rubin and Henry Paulson were former chairmen of Goldman Sachs prior to serving as Treasury Secretary.
While there is no shortage of examples, quantifying the exact impact of the Washington-Wall Street revolving door is difficult. In fact, some have argued that concerns around the revolving door are overstated, and that the practice may actually have some benefits. Sophie Shive and Margaret Forster found that in the quarter after hiring former regulators as top executives, market and balance sheet measures of firm risk decrease significantly and measures of risk management activity increase.[3] Shive and Forster also found no evidence of quid-pro-quo behavior between firms that hire ex-regulators and the regulatory agencies themselves. David Zaring argues that the revolving door may improve the caliber of applicants for government jobs and incentivize better performance amongst government employees.[4]
Perhaps the most powerful argument against the revolving door lies not in data, but in perception. When former high-level regulators go to work for firms they used to oversee, it creates the impression that regulators serve their own interests and not the public’s. This perception erodes the public’s trust in regulatory agencies, ultimately rendering these agencies less effective.
Making Sense of the Crypto Revolving Door
What should we make of the revolving door’s inevitable appearance in the cryptocurrency industry? For starters, there are clear differences between the cryptocurrency industry and the traditional financial services industry. As previously mentioned, the cryptocurrency regulatory landscape is rapidly evolving, and most firms operating in this space need help understanding, and complying with, the rules and regulations applicable to their business. Contrast this with the financial services industry, where the rules and regulations are firmly established[5], and large firms have sufficient resources on hand to comply. When a large financial firm appoints an ex-regulator to their board, they are likely trying to change regulation in some way, obtain regulatory forbearance, or repair a damaged reputation.
This does not mean that cryptocurrency firms aren’t trying to influence how they are regulated; they too engage in lobbying and advocacy, on their own behalf and through trade associations like Coin Center. By appointing former regulators to the board, or as advisors, these firms may also be trying to shape the future path of regulation. However, the cryptocurrency industry in the U.S. is small, and these firms don’t have the financial resources or political clout to make meaningful inroads on Capitol Hill and inside regulatory agencies. Also, most of the former regulators in the above table were not directly involved in regulating the cryptocurrency industry – because the industry had yet to develop or the regulator’s agency did not have jurisdiction – which may limit their ability to influence current regulators.[6] The one exception to the previous statement is Benjamin Lawsky.
Benjamin Lawsky and Ripple
From 2011 to 2015, Lawsky served as New York State’s Superintendent of Financial Services, where he led the development of New York’s BitLicense, a first in the nation licensing regime specifically for cryptocurrency businesses. The BitLicense is reviled by many within the cryptocurrency community because of the burdensome compliance requirements it imposes on firms. After the BitLicense went into effect, several cryptocurrency firms decided to pull out of the New York market rather than incur the application and ongoing compliance costs.[7]
Upon resigning as Superintendent, Lawsky started his own consulting firm that caters to financial services and fintech companies. In 2017, he joined the board of directors at Ripple, a cryptocurrency and payments company.
Lawsky’s appointment to Ripple’s board mirrors the more questionable past practices of the banking industry. Ripple is a well-established and well-funded company, and they had received the BitLicense prior to Lawsky’s arrival. While Ripple will undoubtedly benefit from Lawsky’s regulatory expertise, the company has significant resources at its disposal to comply with applicable laws and regulations.
Ripple’s main motivation for appointing Lawsky to the board may simply be to generate business – arguably the primary impetus behind the vast majority of board appointments across industries. The company’s ultimate success hinges on the willingness of other financial institutions to adopt Ripple’s own cryptocurrency, known as XRP, as a payments solution. For financial institutions worried about the possible legal and regulatory risks associated with utilizing XRP, Lawsky’s presence on Ripple’s board may be reassuring. Ripple essentially acknowledged this fact in the press release announcing Lawsky’s appointment: “[a]s Ripple’s newest board member, Lawsky will play an integral role in helping financial institutions adopt XRP for institutional use, which in turn removes the friction from global payments.”[8]
Why the Cryptocurrency Revolving Door is Different
While cryptocurrency firms may benefit from the knowledge and expertise of former regulators serving as directors or advisors, the primary factor motivating these appointments is a desire for legitimacy; and this is where the comparison to the traditional Washington-Wall Street revolving door breaks down. Unlike cryptocurrency firms, few people question the underlying utility or purpose of a bank and there is broad recognition that financial intermediaries are necessary to facilitate the flow of credit and help grow the economy.[9] Furthermore, the presence of one or more ex-regulators on a large[10] financial institution’s board of directors is unlikely to influence the willingness of customers and counterparties to engage with that institution. The cryptocurrency industry, on the other hand, operates under considerable suspicion by the general public and esteemed financial minds. Warren Buffett referred to bitcoin as “rat poison squared”[11] and Jamie Dimon called it a fraud.[12]
Even those that disagree with Buffett and Dimon may be unwilling to purchase cryptocurrency due to its volatility and concerns that their cryptocurrency may be stolen. In July, the Wall Street Journal reported that since 2001 there’s been 56 cyberattacks directed at cryptocurrency exchanges that have resulted in $1.63 billion in losses.[13]Overcoming these doubts and concerns is beyond the ability of any one firm, and beyond the scope of this article.
At the moment, cryptocurrency firms compete in a crowded marketplace for a limited number of customers with little to differentiate one firm from another. One way to stand out amongst the competition, grow market share, and attract investors, is to appear to be well-managed and well-governed, thereby making the firm more trustworthy in the eyes of potential customers and investors.[14] But trust is typically earned over time, after long periods of positive (without incident) performance.
Most cryptocurrency firms, operating on limited venture funding, do not have enough time to earn customers’ trust. Rather than wait, some firms have resorted to importing trust through their advisory board or board of directors. The presence of a former high-level regulator on the board lends instant credibility and legitimacy to the firm, and allows the judgment of the ex-regulator to stand in for the judgment of customers and investors. Customers may assume that their funds are safe with a given cryptocurrency firm if the former head of the FDIC or SEC has decided that that firm is worthy of their service as a director or advisor. The same is true for investors, who may assume their investment is safe because the former Treasury Secretary is advising the company. Not only are these assumptions wrong, but depending on the situation, the presence of a former regulator or senior government official on the board of directors may actually make the company less safe.
Recent research by Jeremy Kress highlights the potential consequences for a firm when its directors are overextended.[15] Kress draws on multiple examples to demonstrate that directors who serve on multiple boards are simply too busy and distracted to fulfill a director’s basic duty of oversight. Take Wells Fargo for example, who in 2014, just after the first media report of the firm’s fraudulent sales practices, had nine – out of thirteen – independent directors that served on three or more public company boards.
Former top regulators and senior government officials are in high demand, and those that serve as directors or advisors at cryptocurrency firms are stretched especially thin. Take former SEC Chairman Arthur Levitt for instance. In addition to serving as an advisor at Omniex and BitPay, Levitt serves on the boards of Bloomberg LP and Motif, and as an advisor at Promontory, SoFi, Figure, and PeerIQ.
Former FDIC Chair Sheila Bair is also extraordinarily busy. In addition to serving as a director at Paxos and advisor at Omniex, Bair is a director at Thomson Reuters, Host Hotels & Resorts, Inc., Industrial and Commercial Bank of China Ltd., and Avant. Bair also serves on the International Advisory Council to China Banking Regulatory Commission, the International Advisory Board for Santander, the Systemic Risk Council, and the board of The Volcker Alliance.
While their name recognition and reputation may lend credibility to the cryptocurrency firms they serve, the sheer number of outside commitments make it impossible for Mr. Levitt or Ms. Bair to play any kind of meaningful role, or even know what is going on, at these firms. Customers and investors who think Ms. Bair’s or Mr. Levitt’s involvement is some kind of stamp of approval should think again.
The Risks to Ex-Regulators
Former regulators and senior government officials have their own unique reasons for joining a given advisory board or board of directors. But, considering the practice as a whole, it is clear that a primary factor is money. Top regulators make considerably less than what they could make in the private sector, and many consider board appointments as an opportunity to make up for foregone earnings. For example, in 2017, former Federal Reserve Board Governor, Elizabeth Duke, earned $483,000 in total compensation for serving as a Wells Fargo’s director (she chairs the board as well).
While director and advisor compensation for ex-regulators at cryptocurrency firms is likely to be much less than what Ms. Duke earns – we can’t say for certain because these firms are privately held – these appointments come with much less scrutiny and criticism than appointments to serve on large bank boards. This is understandable considering the long history of the Washington-Wall Street revolving door and the government’s historical willingness to bail out large financial institutions that get into trouble.
For former regulators, serving as a director at a for-profit company is not a risk-free proposition. Robert Rubin’s reputation suffered tremendously after Citi had to be bailed out by the federal government in 2008, and Ms. Duke’s reputation continues to suffer as Wells Fargo attempts – so far unsuccessfully – to clean up from its “sales practices” scandal. The stakes are not as high for cryptocurrency company directors, but there are still risks. Should a cryptocurrency company get hacked, resulting in the loss of customer funds, customers and investors would rightly question the role the board played in ensuring the firm adhered to appropriate cybersecurity standards, and the reputations of the directors would suffer as result.
For directors, there is more than reputation at stake. Serving as a director comes with specific duties and responsibilities. Should directors violate their fiduciary duty, they may be held liable for any resulting monetary damages to the company or stockholders. Given the unique risks associated with cryptocurrency, and the uncertain and evolving regulatory landscape, fulfilling this fiduciary duty may be challenging. This is likely why some ex-regulators prefer to serve in an advisory capacity. These advisory relationships are nebulous, and in the U.S. at least, carry no legal obligations. Advisory boards have been common practice in the technology industry for a number of years, as they provide start-ups with expertise, contacts, and credibility. They can be particularly helpful when the founder is young and lacks experience in running a company; in these cases, the advisory board can serve as a sounding board and help mentor the CEO.
When a cryptocurrency company appoints a former regulator to its advisory board, they are likely doing so for credibility reasons. Take former Treasury Secretary Larry Summers, who serves as an advisor to bitcoin wallet provider Xapo. Summers may be a brilliant macroeconomist, but he has little experience in the private sector, and I’m assuming his knowledge of bitcoin wallets and the bitcoin wallet industry is limited. Therefore, it is fair to wonder what kind of advice Mr. Summers is offering.
The problem for potential customers of, and investors in, companies like Xapo, is that they have no visibility into the structure and purpose of these advisory boards, nor do they know how these advisors are compensated, which would allow them to assess possible conflicts of interest. In a company blog post announcing the creation of their advisory board, Xapo simply lists each advisory board member along with a pithy quote related to bitcoin attributed to each member.[16] They end the post by stating: “We look forward to continuing to build the global Bitcoin ecosystem with the help of these accomplished leaders and visionaries from the worlds of finance, economics and public policy.”
Conclusion
The presence of former top regulators on the boards of cryptocurrency firms is in keeping with a long tradition of Washington’s revolving door in the financial services industry. Although it has drawn considerable scrutiny and outrage in the past, many argue that the revolving door has its merits, and that concerns are overstated. For cryptocurrency firms, one such benefit is access to someone who is intimately familiar with the complex web of rules and regulations that apply to cryptocurrency, and who can provide insights into how the regulatory response may evolve.
A more concerning motive for tapping former regulators as advisors and directors, is that it lends an aura of legitimacy to a product and industry that may not be legitimate. In June, researches from the University of Texas released a paper that found much of the run-up in Bitcoin’s price during 2017 was due to manipulation orchestrated by the Hong Kong exchange Bitfinex.[17] Furthermore, it has become increasingly clear that much of Bitcoin’s value – outside of mere speculation – is derived solely from its ability to facilitate criminal activity. In July, special counsel Robert Mueller indicted twelve Russian intelligence officials for allegedly attempting to influence U.S. elections in 2016.[18] The indictment notes that the conspirators used bitcoin to fund the purchase of servers, register domains, and make other payments “in furtherance of hacking activity.” According to the indictment, the “use of bitcoin allowed the Conspirators to avoid direct relationships with traditional financial institutions, allowing them to evade greater scrutiny of their identities and sources of funds.”
Former regulators and senior government officials that serve on the boards of cryptocurrency firms may genuinely believe in the transformative potential of cryptocurrency. But, the pecuniary benefits they receive for their service may be of little consolation if they’re wrong.
[1] Vanderlip would go on to play a crucial role in the creation of the Federal Reserve For more information on Frank Vanderlip and City Bank, read: “Borrowed Time: Two Centuries of Booms, Busts, and Bailouts at Citi” by Vern McKinley and James Freeman.
[2] https://www.wsj.com/articles/SB122826632081174473
[3] Shive, Sophie and Forster, Margaret, The Revolving Door for Financial Regulators (June 17, 2016). Review of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2348968 or http://dx.doi.org/10.2139/ssrn.2348968
[4] Zaring, David T., Against Being Against the Revolving Door (June 13, 2013). University of Illinois Law Review, Vol. 2013, No. 2, 2013. Available at SSRN: https://ssrn.com/abstract=2279015
[5] Of course these rules and regulations do change, but they do so much more slowly than what we’re currently seeing in the cryptocurrency industry
[6] Juan Zarate left the Treasury Department prior to Treasury’s determination that cryptocurrency is money for purposes of enforcing the Bank Secrecy Act and anti-money laundering regulations. In addition, Mark Wetjen left the CFTC prior to the Commission classifying bitcoin as a commodity.
[7] http://fortune.com/2018/05/25/bitcoin-cryptocurrency-new-york-bitlicense/
[8] https://ripple.com/insights/ripple-welcomes-new-board-member-benjamin-lawsky/
[9] Of course there are significant disagreements over the appropriate size and form of these intermediaries.
[10] Former high-profile regulators serve almost exclusively on the boards of larger institutions.
[11] https://www.cnbc.com/2018/05/05/warren-buffett-says-bitcoin-is-probably-rat-poison-squared.html
[12] https://www.cnbc.com/2017/09/12/jpmorgan-ceo-jamie-dimon-raises-flag-on-trading-revenue-sees-20-percent-fall-for-the-third-quarter.html
[13] https://www.wsj.com/articles/why-cryptocurrency-exchange-hacks-keep-happening-1531656000
[14] Not only does the presence of ex-regulators give a perception of legitimacy, but also consumers are naturally pre-disposed to trust “authorities” and this bias operates largely unconsciously. This is consistent with the “agency theory” put forward by Stanley Milgram in 1974
[15] Kress, Jeremy C., Board to Death: How Busy Directors Could Cause the Next Financial Crisis (March 26, 2018). 59 Boston College Law Review 877 (2018); Ross School of Business Paper No. 1370. Available at SSRN: https://ssrn.com/abstract=2991142 or http://dx.doi.org/10.2139/ssrn.2991142
[16] https://blog.xapo.com/announcing-xapos-advisory-board/
[17] Griffin, John M. and Shams, Amin, Is Bitcoin Really Un-Tethered? (June 13, 2018). Available at SSRN: https://ssrn.com/abstract=3195066
