In crypto circles, the term “the flippening” refers to a hypothetical event in which a smaller blockchain network surpasses the Bitcoin network in size. Right now, the crypto world is experiencing another sort of flippening: in the dynamic between state and federal regulation of blockchain activity. Lately, the prospect has arisen that crypto’s backers will have to start worrying more about the states than the feds. So far, states like Wyoming and Texas, and some cities, have been the ones passing laws encouraging cryptocurrency activity. Federal lawmakers have moved more slowly, while federal agencies have expended considerable effort enforcing existing financial rules on the free-wheeling industry. That dynamic hasn’t exactly gone away, but in recent days, lawmakers in Washington have advanced an accommodating framework for regulating crypto. At the same time, policymakers in New York have advanced more exacting rules on two fronts. This week Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand , D-N.Y., introduced their much anticipated cryptocurrency legislation, which, as expected, limits the businesses and users that can be taxed on their crypto. Some executives are also expressing fresh optimism about the Biden administration’s posture. Yesterday, the head of ETFs at Grayscale, a cryptocurrency investment firm that has mounted an aggressive campaign to pressure the Securities and Exchange Commission into approving a spot Bitcoin ETF, said it was only a matter of time before the agency does so. “It’s not that long ago that there really was a question of if this was going to happen,” said the executive, David LaValle, at an industry gathering in Austin. “And now it’s clearly a question of when it’s going to happen.” Meanwhile, it’s New York State that has emerged of late as a source of more exacting crypto regulation. Last week, the state legislature passed a two-year moratorium on cryptocurrency mining powered by fossil fuel plants, which Gov. Kathy Hochul, a Democrat, is now considering signing into law. On Wednesday, New York’s Department of Financial Services codified its standards with strict new guidance for dollar-backed stablecoin issuers that would require full backing and regular audits. In many of its particulars, the guidance goes beyond the stablecoin provisions in the Lummis-Gillibrand bill, which defers in places to state-level rules. (Though the guidance follows the collapse of the algorithmic stablecoin TerraLuna, whose designers tried and failed to maintain a dollar peg through the use of financial engineering, New York has specified that it only applies to dollar-backed stablecoins.) Some issuers welcomed the added clarity, saying it would shore up public trust in stablecoins. Eric Soufer, who leads crypto at the public affairs firm Tusk Strategies, said his client, the stablecoin issuer Paxos, was “happy” with the new rules. But Soufer, who has worked as an adviser to former state attorney general Eric Schneiderman and other officials in New York, said the industry remains wary that a spate of state-level rulemaking could get complicated quickly. “People are worried about a patchwork across 50 states,” he said. “Most of the regulated entities are looking for the feds to assert themselves.” What do the developments mean outside of New York’s borders? The mining moratorium could serve as a model for those in other states. As for the stablecoin rules, even if other states don’t emulate them, they could still dictate the way the industry works around the country, the way automakers have had to adapt to California’s strict fuel efficiency standards. State standards can hold far-reaching sway in the digital realm, too. Alexander Grieve, a crypto lobbyist at Tiger Hill Partners, cited the influence of the California Consumer Privacy Act, a 2018 law that goes beyond federal data privacy protections, in thinking through the implications of New York’s rules. “Given New York’s importance as a financial nexus, and the number of crypto and traditional firms there that will need to use stablecoins,” he said, “it may become a similar de-facto national standard in the absence of codified federal standards.” Blockchain technology was invented to circumvent government control and to bypass political borders drawn on maps. That was the vision, anyways. For now, its proponents will have to contend with the messy realities of American federalism.
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