An earlier version of this post
Ask any cryptocurrency company what its biggest challenge is, and it’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).
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 adviser. This list is by no means exhaustive, and it excludes former prosecutors and less senior regulators. Nonetheless, it highlights an emerging trend.
Former top regulators serving as advisers or directors at regulated financial services firms is nothing new, so what should we make of the revolving door’s inevitable appearance in the cryptocurrency industry? For starters, there are clear differences between the two sectors. 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, and large firms have sufficient resources on hand to comply. When a large financial firm appoints an ex-regulator to its board, it is 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 advisers, 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.
While cryptocurrency firms may benefit from the knowledge and expertise of former regulators serving as directors or advisers, the primary factor motivating these appointments is often 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. Furthermore, the presence of one or more ex-regulators on a large 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
Even those who 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
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 among 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. 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 a major financial agency has decided that that firm is worthy of their service as a director or adviser. The same is true for investors, who may assume their investment is safe because a former Treasury secretary or other top official is advising the company.
Not only are these assumptions wrong, but depending on the situation, the presence of a former top regulator on the board of directors may actually make the company
While director and adviser compensation for ex-regulators at cryptocurrency firms is likely to be much less than appointments to serve on large bank boards, serving on a cryptocurrency firm’s board also comes with far less scrutiny and criticism. 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. However, serving as a director or adviser for a cryptocurrency firm is not a risk-free proposition. 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 startups with expertise, contacts and credibility.
When a cryptocurrency company appoints a former top regulator to its advisory board, they are simply renting that person’s reputation to improve the firm’s credibility. The problem for potential customers of, and investors in these firms, is that they have no visibility into the structure and purpose of these advisory boards, nor do they know how these advisers are compensated, which would allow them to assess possible conflicts of interest.
Ultimately, 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 advisers and directors, is that it lends an aura of legitimacy to a product and industry that may not be legitimate. Research has shown that
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.
