You Can't Regulate What You Can't Understand: The Case for Modernizing Government Ethics Rules

Imagine designing an FAA safety protocol without ever seeing a plane, or legislating lightbulb efficiency without ever flipping a switch. It may be possible, but it certainly won’t yield sensible policy.

The internet defined the past few decades of innovation, and we believe crypto will define the next few decades. This means that drafting good regulation — regulation that doesn’t stifle or drive development overseas — is among the most critical issues for American policymakers today. But to truly understand crypto, it’s almost mandatory to actually use it.

The Rules

The tl;dr is that ethics rules effectively bar most government employees from owning crypto. Here’s a breakdown for employees in Congress and key agencies.

The link to the chart is available here.

Key Takeaways

• Disclosure rules, while comprehensive, are burdensome. In recognition of these onerous requirements, some exemptions exist for de minimis ownership of some assets. But the Office of Government Ethics — which prevents conflicts within the Executive Branch — last August issued a Legal Advisory noting that cryptocurrency and stablecoins do not benefit from a de minimis exemption. (OGE LA-22-04). Owning crypto, when otherwise !!!permitted, could trigger recusal obligations for agency employees unless a waiver applies. (See e.g., 18 U.S.C. § 208(a)).

• SEC employees are prohibited from owning any crypto regulated by the agency as a security, unless they are precleared to trade. (5 C.F.R. § 4401.102). Due to a myriad of jurisdictional and regulatory issues, we do not yet know which assets are securities. So this diktat serves as a blanket ban on owning all crypto, to the detriment of an agency that wants its staff to gain expertise.

• The CFTC’s primary statute and regulations broadly ban participation by CFTC employees in certain transactions of commodities. (7 U.S.C. § 13(c) and 17 C.F.R. § 140.735-2).

• Federal Reserve leadership and certain staff are prohibited from owning or controlling cryptocurrency, either directly or through targeted investment funds. (Federal Reserve, “Federal Open Market Committee—Investment and Trading Policy for FOMC Officials,” (eff. May 1, 2022)).

• Rules regulating Congressional members are vague; for example, House rules prohibit Members from using confidential information as a means “for making private profit,” but give little guidance on the scope of the phrase. (Code of Ethics for Government Service at ¶ 8). Rules instead grant discretion to Ethics Committees that are criticized for erratic enforcement.

• House and Senate members are prohibited from voting on questions which affect their pecuniary interest as part of a limited class. Senate Rules require Committee staffers to divest “substantial holdings” unless given permission to retain holdings. (Senate Rule 37.7).

Rules Should Not Ban Experimentation with Crypto

The origin of these rules was principled and well-intentioned; in the wake of Watergate and other scandals that rocked public trust in government, the U.S. passed the Ethics in Government Act of 1978 to fight corruption and require senior employees of the executive branch to submit public financial disclosures. The goal was admirable; no one condones government insider trading or policymakers that fail to prioritize the public’s interest.

But unlike other types of regulated technology, ethics rules as applied to crypto effectively prohibit all use by government employees. While crypto ownership by policymakers requires ethical boundaries, the rules should be modernized in order to empower government employees to develop good policies. This is particularly critical given:

• Following developments in crypto is uniquely difficult. The speed of innovation in crypto is breakneck, and keeping pace with new developments requires consistent engagement. Interacting with the technology is key to understanding it.

• Crypto is new. Unfortunately, crypto technology is so new that most policymakers did not have the opportunity to use Coinbase, OpenSea, or Uniswap prior to taking office. It differs from other types of technology in this way, creating a more significant learning gap once a staffer is bound by ethics prohibitions.

• Blockchain technology is inherently financialized, which unnecessarily triggers ethics rules that don’t exist in traditional tech. Many crypto use cases incorporate a financial component that triggers ethics rules, regardless of the number of pennies involved in a transaction. While using Google does not require owning a share of Google, utilizing almost any crypto service requires holding or transacting with a satoshi, wei, or other de minimis equivalent. As a result, these activities are effectively barred by the ethics rules at key agencies like the SEC, CFTC, and Federal Reserve.

To make good crypto policy, government employees need modernized ethics rules. We propose the following common sense boundaries:

• Threshold. For restricted policymakers, we propose an exemption to ethics rules that permits ownership of cryptocurrency under a threshold amount. Each covered policymaker’s wallet’s total portfolio value in USD must not exceed a certain dollar amount (e.g., $1,000). Any holdings above this threshold must be divested or placed into a blind trust. To account for outsized volatility or transaction fees, this value can also be indexed to particular metrics including inflation or gas fees (e.g., $1,000 + (Ethereum Average Gas Price x 120) which would consider gas for ten transactions per month), calculated, and announced periodically.

• Disclosure. Existing rules require policymakers to disclose all assets with a value exceeding $1,000 on annual personal financial disclosures. (See e.g., House rule 5 U.S.C. app. §§ 101, 102). ¹ In addition, key policymakers must periodically report throughout the year any transaction exceeding $1,000. ² While these rules should be harmonized with our proposal, they demonstrate that robust disclosure rules already exist to ensure policymaker accountability.

• Governance Activity. Policymakers with wallets holding governance tokens of DAOs should be prohibited from submitting, voting, or exercising related rights on governance proposals that create a conflict. These voting and governance rights can be delegated or assigned to a non-profit or educational institution.

• Enforcement. Like any other ethics rule, violation of any crypto ownership rules would accrue liability.

To make good crypto policy, government employees need modernized ethics rules. We also urge key policymakers to dedicate resources toward establishing a research or experimental wallet for their offices. Combined, these innovations could produce new understanding, better lawmaking, and a thriving American crypto economy.

Acknowledgements

John Heinemann, Dominique Little, Brendan Malone, Rodrigo Seira, and Justin Slaughter, Anne Kelley (Mercury Strategies), Langston Emerson (Mindset), and Charlie Schreiber (Mindset).