Who Are You Trying to Protect?

The SEC recently decided to expand the set of acceptable custodians for digital assets in a way that effectively lowers the required standards. We think that is a net positive for investor protection. But only because the digital asset service provider ecosystem under the SEC is so absurdly warped and distorted that users had a huge incentive to escape and use unsupervised services.

Lowering the bar protects investors only because fewer of them will opt-out of the regulatory regime entirely and enter the markets without any protection at all.

What Are We Even Doing Here?

People often forget when considering new regulations, or a changes to existing regulations, or even a single new regulatory decision the reason for all of this stuff: helping and protecting people. At least in a financial regulation context all this machinery exists largely to solve one simple and age-old problem: once a bad actor gets your money it is far easier for them to abscond with it than for you to make them give it back.

That asymmetry, plus the fact that a highly mobile bad actor can steal from a large number of victims, is the social harm financial regulations aim to address. This is the reason restaurant regulators and bank regulators are organized and funded differently. There are temporal, geographical and mechanical bandwidth limits in the restaurant industry that do not exist in financial services. A person in California cannot get food poisoning over the internet from a scam compound 10,000 kilometers away. For financial protection to work the cops need a longer reach.

And the most basic problem when it comes to designing regulations to tackle this problem is similarly age-old: not all people are the same. Setting aside individual preferences for a moment we can all agree that a single parent living with limited-to-zero savings and children with medical problems should have a lower financial risk tolerance than a wealthy retiree investing money that would otherwise be spent on expensive cars, travel and wine. That does not mean for every pair of individuals in those situations we actually observe the retirees to have a higher risk tolerance. But, objectively, one of those people is in a better position to bear losses than the other.