Too Many Cooks in One Kitchen? The Question of US State Regulation over the Crypto Market

The global growth projection of the cryptocurrency market is at 11.1% for 2021-28.¹ It could turn into another gambling mechanism, the future of payments — or anything in between. Therefore, one must stop and think strategically about how and where to regulate.

In its current stage, this market is becoming increasingly global, with companies operating across geographies. (Among multinational companies, one could find Coinbase, Binance, Kraken eToro, and many others.) This market is one of the most exciting tools to democratize investments, creating access to capital for individuals from diverse backgrounds. However, it is also incredibly risky — often allowing young, unexperienced consumers, to create lifelong losses.²

With the US Congress unable to pass crypto legislation, state regulators have been taking over the field. As a result, there are discrepancies and differences among US states, negatively impacting consumers and companies. Within a global crypto market, multiple states regulating in the absence of singular, Congressional action is hurting both consumers and businesses.

Current Situation: Regulation

As of now, the US Congress is yet to pass clear regulation regarding crypto, with most representatives hesitant to clearly define what crypto is — and what are the boundaries to its usage. The struggle to regulate the crypto industry stems from several roots, including the inability to define whether it’s a security or a currency (driving different regulators for each), pressure from the industry itself (viewing compliance as costly), partisan divides, and knowledge arbitrage between regulation and companies and others.³ As a result, the US is behind the EU and many Asian countries in regulating the field. But more importantly, it also means that actual disputes and issues occurring within the system are left unresolved.⁴

For example, there’s an outstanding case by the Securities and Exchange Commission (SEC) against Coinbase and Binance (among others) on the topic of whether the tokens traded on them are actually securities (i.e., “investment contracts,” representing actual ownership/investment in real-world investment). As there’s no clearly defined regulation, the outcome is that the courts are forced into defining de-facto what the traded tokens are.⁵

This lack of regulatory clarity results in state regulators taking over and providing guidelines — to the best of their abilities. Among such regulators, one can find the New York Department of Financial Services (NYDFS), implementing crypto regulation across the board, as well as legislation in Washington state. However, their jurisdictions are limited to New York and Washington — resulting in discrepancies impacting both customers and providers.

Why Can You Trade in New Jersey, But Not in New York

Kraken is a crypto exchange platform (i.e., a platform on which one can buy and sell crypto).⁶ It operates globally, as well as in the US, with a little caveat: “at this time, Kraken does not offer services to residents of Washington state (WA) and New York (NY).” On its official website, the company proceeds to explain “…the cost of maintaining regulatory compliance in some states can be very high, forcing us to make hard choices about whether cost justifies doing business in the state.”⁷

More specifically, in 2017, Washington state was the first to introduce regulation of digital currency markets, creating a set of regulatory requirements for companies to follow in order to operate in the state. Among the requirements, every provider will have to maintain a virtual reserve of crypto that meets a 1:1 ratio to what it retains on behalf of customers and will have to acquire licensing by the Washington’s Department of Financial Institutions.⁸ In 2018, NYDFS has started to require companies to get a BitLicense, which is a business license for virtual currency activity. Many complied. Others, like Kraken, have refused — and stopped operating in those states.⁹

Leaving the normative questions regarding Kraken’s activity off the table, one needs to ask themselves if this is what’s really creating a desired equilibrium. For example, yes, New York residents can’t use Kraken. However, they can simply move to a neighboring state, like New Jersey, or use an account listed under a family member or a friend living in New Jersey. Kraken, on the other side of the equation, needs to implement additional processes to avoid onboarding New York and Washington state residents, as well as perform ongoing scanning of users to ensure no user became a New York or Washington resident. Furthermore, they must create an off-boarding system, with an asset liquidation process, for the users that used to have accounts.

As a result, consumers get hurt (including financial and operational complexity) and costs for running the company are higher (decreasing profitability and returns to investors), and the overall market gains multiple added complexities to it.

What Should be Done

As such, the regulatory gap created by the lack of a national regulation requires an immediate address. There are two distinct options one could consider:  

1. Push Congress to regulate by requiring the US national level to make unified decisions, affecting all states. A financial market regulation which affects two neighboring cities in two different ways is a bad financial regulation. While states should have a say, there should also be a baseline, setting up general rules of action across territories.
2. In the absence of a Congressional agreement, move to create partnerships between states. Earlier, I discussed two different regulations, presented by New York and Washington. Without going into details, both are reasonable, carefully drafted regulations. However, they are two distinct regulations — which means that companies that choose not to opt out are required to comply to both. Such regulations, while protecting customers, are creating further complexity in the market. Therefore, it would be reasonable to recommend further steps to create synergies between regulators operating in different states — but within the same country.

In the absence of a regulatory action from Congress, states taking matters into their own hands and protecting their consumers is better than nothing. The choice to continue developing regulation on a state level becomes even simpler with the approach of an election year and an ever-growing divide between Republicans and Democrats.

However, the growing complexity of the market, consumer mobility, and the sheer promise that it holds, result in an inevitability that there will have to be a national regulation. It is the best way to enable the crypto market to grow in a way that will maximize consumer and company benefits from it.

To conclude, the facts are simple: this market is growing and will continue to grow. The state mechanism vs. a national mechanism is creating complexity and reducing benefits from all sides. Therefore, it is up to Congress to define a regulatory path and actively step into the market.

1. Fortune Business Insights, “Market Research Report, 2021-2028,” Cryptocurrency Market, April 8, 2024, https://www.fortunebusinessinsights.com/industry-reports/cryptocurrency-market-100149. ↩︎
2. Nathaniel Popper, “Robinhood Has Lured Young Traders, Sometimes With Devastating Results,” The New York Times, September 25, 2021, https://www.nytimes.com/2020/07/08/technology/robinhood-risky-trading.html. ↩︎
3. John Soroushian and Phillip Meng, “Cryptocurrency Regulation and the 118th Congress,” Bipartisan Policy Center, March 14, 2023, https://bipartisanpolicy.org/blog/crypto-and-118th-congress/. ↩︎
4. Jesse Hamilton, “Crypto Won’t Get Long-Awaited U.S. Rules in 2024, But the Courts May Steer Its Future,” coindesk.com, December 18, 2023, https://www.coindesk.com/consensus-magazine/2023/12/18/crypto-wont-get-long-awaited-us-rules-in-2024-but-the-courts-may-steer-its-future/. ↩︎
5. Hamilton, “Crypto Won’t Get Long-Awaited U.S. Rules in 2024, But the Courts May Steer Its Future.” ↩︎
6. Kraken, “About: Why Kraken,” accessed April 3, 2024, https://www.kraken.com/why-kraken. ↩︎
7. Kraken, “Where Can I Use Kraken?” accessed March 4, 2024, https://support.kraken.com/hc/en-us/articles/360001368823-Where-can-I-use-Kraken-. ↩︎
8. Drew Atkins, “New Bitcoin Regulations Shake up Washington State’s Cryptocurrency Industry,” Geekwire, August 1, 2017, https://www.geekwire.com/2017/new-bitcoin-regulations-shake-washington-states-cryptocurrency-industry/. ↩︎
9. Evelyn Cheng, “Kraken Cryptocurrency Exchange Says It Will Not Comply with New York Inquiry,” CNBC, April 18, 2018, https://www.cnbc.com/2018/04/19/kraken-cryptocurrency-exchange-says-it-will-not-comply-with-new-york-inquiry.html. ↩︎