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Should cryptocurrencies be regulated like securities? Financial regulators have been pondering this question for some time. In a Briefing Paper published today by the Cato Institute’s Center for Monetary and Financial Alternatives, I suggest that securities regulation would only seem warranted in certain clearly circumscribed cases. For the most part, cryptocurrencies should be treated like commodities.

It has been nearly a decade since “Satoshi Nakamoto” laid the intellectual foundations for Bitcoin, the first cryptocurrency platform. Since then, more than 1,600 peer-to-peer networks have emerged to disrupt established intermediaries. Cryptocurrencies, even in the comparably bearish first half of 2018, have an aggregate market capitalization of nearly $300 billion.

While policymakers’ attention has gradually turned to designing an appropriate regulatory framework for this emerging technology, policy uncertainty persists. On one hand, some policymakers recognize the potential for cryptocurrencies to increase competition, reduce transaction costs and improve capital formation opportunities for firms. On the other, statements from regulators at the SEC and CFTC, the two agencies most closely monitoring the development of cryptocurrencies, have been unclear, equivocal, and sometimes outright contradictory.

In April, former CFTC chairman Gary Gensler suggested that ether, the cryptocurrency of the Ethereum network, should be treated like a security. This designation would have forced onerous new registration requirements on platforms that hold ether in custody and for trading, while making access to Ethereum by retail buyers more difficult. Furthermore, because the Ethereum platform provides the infrastructure for many other cryptocurrencies, such a move would have compromised the viability of large parts of the cryptocurrency market.

Fortunately, these risks have receded into the background since William Hinman, Director of the SEC’s Division of Corporation Finance, argued in a recent speech that ether, in its present form, wouldn’t qualify as a security because the Ethereum platform is heavily decentralized. The SEC’s classic test for a security defines it as (1) an investment of money (2) in a common enterprise (3) with the expectation of profits (4) from the efforts of others. In Hinman’s opinion, developments since the launch of Ethereum in 2014 mean that the platform presently fails to meet criteria (2) and (4).

The next step is to give Hinman’s welcome pronouncement regulatory heft. In the Briefing Paper released today, I propose that the SEC and CFTC formally establish a distinction between functional cryptocurrencies, such as Bitcoin and Ethereum, and promises of cryptocurrencies to be delivered in the future. Cryptocurrencies in the first category do not meet the criteria for a security and should be regulated as commodities. Those in the second category may be securities, depending on the individual circumstances of each issue.

The launch of cryptocurrencies is often preceded by what is, somewhat misleadingly, called an initial coin offering (ICO). An ICO involves the exchange of money today for the delivery of units of cryptocurrency in the future, where the funds are used to build a new platform. ICOs are a way for startups to raise capital, so in some circumstances they may tick the four boxes in the SEC’s security test. In particular, when buyers in an ICO are able to trade their holdings before the launch of the application, the contracts could constitute securities. In other cases, however, ICO agreements may simply be advance purchases of a good or service and not tradable before the platform goes live. Those agreements more closely resemble forward contracts and should be regulated like them.

In the paper, I propose just such a two-tier regulatory structure for ICOs, recognizing that some of them may fall under the securities laws, but that this will be determined by the circumstances of each case.

Apart from being consistent with Director Hinman’s position, the suggested approach balances consumer protection and the duties of financial regulators with an open environment for cryptocurrency innovation. It recognizes that most of the fraud about which the SEC has expressed concern happens at the ICO stage, so buyers might benefit from increased disclosures then. But it also takes account of the fact that excessive regulation of functional cryptocurrencies would stifle the market and throw a spanner in its further development, with few countervailing benefits in the form of market stability or consumer protection.

It is time for policy to catch up to the exciting development of cryptocurrency markets. But catching up shouldn’t mean smothering the technology with regulation, nor crudely applying the securities laws to all cryptocurrencies. The reality of this emerging market favors a more judicious approach.

[Cross-posted from Alt-M.org]

President Trump recently held an event with some of the relatives of people killed by illegal immigrants in the United States.  Afterward, the White House sent out a press release with some statistics to back up the President’s claims about the scale of illegal immigrant criminality.  The President’s claims are in quotes and my responses follow.

According to a 2011 government report, the arrests attached to the criminal alien population included an estimated 25,000 people for homicide.

Criminal aliens is defined as non-U.S. citizen foreigners, which includes legal immigrants who have not naturalized and illegal immigrants.  The 25,064 homicide arrests he referred to occurred from August 1955 through April 2010 – a 55-year period.  During that time, there were about 934,000 homicides in the United States.  As a side note, I had to estimate the number of homicides for 1955-1959 by working backward.  Assuming that those 25,064 arrested aliens actually were convicted of 25,064 homicides, then criminal aliens would have been responsible for 2.7 percent of all murders during that time period.  During the same time, the average non-citizen resident population of the United States was about 4.6 percent per year.  According to that simple back of the envelope calculation, non-citizen residents were underrepresented among murderers.

In Texas alone, within the last seven years, more than a quarter million criminal aliens have been arrested and charged with over 600,000 criminal offenses.  

We recently published a research brief examining the Texas data on criminal convictions and arrests by immigration status and crime.  In 2015, Texas police made 815,689 arrests of native-born Americans, 37,776 arrests of illegal immigrants, and 20,323 arrests of legal immigrants. For every 100,000 people in each subgroup, there were 3,578 arrests of natives, 2,149 arrests of illegal immigrants, and 698 arrests of legal immigrants.  The arrest rate for illegal immigrants was 40 percent below that of native-born Americans. The arrest rate for all immigrants and legal immigrants was 65 percent and 81 percent below that of native-born Americans, respectively.  The homicide arrest rate for native-born Americans was about 5.4 per 100,000 natives, about 46 percent higher than the illegal immigrant homicide arrest rate of 3.7 per 100,000.  Related to this, the United States Citizenship and Immigration Services recently released data that showed the arrest rate for DACA recipients about 46 percent below that of the resident non-DACA population.

More important than arrests are convictions.  Native-born Americans were convicted of 409,063 crimes, illegal immigrants were convicted of 13,753 crimes, and legal immigrants were convicted of 7,643 crimes in Texas in 2015. Thus, there were 1,749 criminal convictions of natives for every 100,000 natives, 782 criminal convictions of illegal immigrants for every 100,000 illegal immigrants, and 262 criminal convictions of legal immigrants for every 100,000 legal immigrants. As a percentage of their respective populations, there were 56 percent fewer criminal convictions of illegal immigrants than of native-born Americans in Texas in 2015. The criminal conviction rate for legal immigrants was about 85 percent below the native-born rate.

Criminal Conviction Rates by Immigration Status in Texas, 2015

Murder understandably garners the most attention.  There were 951 total homicide convictions in Texas in 2015. Of those, native-born Americans were convicted of 885 homicides, illegal immigrants were convicted of 51 homicides, and legal immigrants were convicted of 15 homicides. The homicide conviction rate for native-born Americans was 3.88 per 100,000, 2.9 per 100,000 for illegal immigrants, and 0.51 per 100,000 for legal immigrants.  In 2015, homicide conviction rates for illegal and legal immigrants were 25 percent and 87 percent below those of natives, respectively.

Homicide Conviction Rates by Immigration Status in Texas, 2015

Murderers should be punished severely no matter where they are from or what their immigration status is.  There are murderers and criminals in any large population, including illegal immigrants.  But we should not tolerate the peddling of misleading statistics without context.  What matters is how dangerous these subpopulations are relative to each other so the government can allocate resources to prevent the greatest number of murders possible.  Thus, enforcing immigration law more harshly is a very inefficient way to punish a population that is less likely to murder or commit crimes than native-born Americans.  Illegal immigrants, non-citizens, and legal immigrants are less likely to be incarcerated, convicted, or arrested for crimes than native-born Americans are. 

“A crisis is a terrible thing to waste,” is a phrase coined by Stanford economist Paul Romer. Politicians are always in search of new crises to address—new fires to put out—with rapid and decisive action. In their passion to appear heroic to their constituents they often act in haste, not taking the time to develop a deep and nuanced understanding of the issue at hand, insensitive to the notion that their actions might actually exacerbate the crisis.

An example of that lack of understanding was made apparent in a press release by the office of House Majority Whip Steve Scalise (R-LA) on June 22 supporting legislation that packages together over 70 bills (H.R.6) aimed at addressing the opioid (now mostly heroin and fentanyl) overdose crisis. The bills mostly double down on the same feckless—often deleterious—policies that government is already using to address the crisis. The release stated, “Whip Scalise highlighted a Slidell, Louisiana family whose son was born addicted to opioids, a syndrome called NAS, as a result of his mother’s battle with addiction.” 

The press release quoted Representative Scalise:

I highlight Kemper, a young boy from my district in Slidell, Louisiana. He was born addicted to opioids because his mother, while she was pregnant, was addicted to opioids herself…this example highlights something the Centers for Disease Control has noted. That is once every 25 minutes in America a baby is born addicted to opioids. Once every 25 minutes. That’s how widespread it is, just for babies that are born.

Before crowing that the “House Takes Action to Combat the Opioid Crisis,” as the press release was titled, Representative Scalise should get his science right. No baby is ever born addicted to opioids. As medical science has known for years, there is a difference between addiction and physical dependence—on a molecular level. Drs. Nora Volkow and Thomas McLellan of the National Institute on Drug Abuse pointed out in a 2016 article in the New England Journal of Medicine that addiction is a disease, and “genetic vulnerability accounts for at least 35 to 40% of the risk associated with addiction.” Addiction features compulsive drug use in spite of harmful, self-destructive consequences.

Physical dependence, on the other hand, is very different. As with many other classes of drugs, including antidepressants like Prozac or Lexapro, long-term use of opioids is associated with the development of a physical dependence on the drug. Abruptly stopping the drug can lead to severe withdrawal symptoms. A physically dependent patient needs the drug in order to function while avoiding withdrawal. Dependence is addressed by gradually reducing the dosage of the drug over a safe time frame. Once the dependence is overcome, such a patient will not have a compulsion to resume the drug.

NAS stands for Neonatal Abstinence Syndrome, a withdrawal syndrome resulting from physical dependence developed by the fetus due to the transplacental transmission of drugs being used by the mother during pregnancy. A combination of gradual opioid tapering with soothing and supportive measures resolves cases of NAS due to opioids.

In addition to opioids, cocaine can cause neonatal withdrawal syndrome, and alcohol has been long known to be a cause. In fact, much worse than NAS, Fetal Alcohol Spectrum Disorders (FASD) include head and face deformities, heart defects, and cognitive disabilities (none of which are sequelae in opioid-dependent newborns).

The distinction between addiction and physical dependence is important for a number of reasons. Because many people see addiction as a vice rather than a disease, stigmatizing a baby as being “addicted” can result in their growing up being seen and raised as manipulative and “bad.” Unlike babies born with fetal alcohol syndrome, these babies usually grow up to be normal, healthy children. It has also led some to advocate for the forced treatment of opioid-dependent pregnant women, a violation of their right to informed consent, considered an ethical violation by addiction specialists and medical ethicists alike.

The distinction is also important because the tendency of politicians and many in the media to use the words “addiction” and “physical dependence” interchangeably can conflate the two distinct conditions and feed the sense of urgency about the opioid overdose problem. This leads to policies that are not evidence-based and have unintended consequences. 

For example, multiple Cochrane systematic studies of chronic non-cancer pain patients on long term opioids have shown an addiction rate of roughly 1 percent. And a January 2018 study of 568,000 patients prescribed opioids for acute post-surgical pain found a total “misuse” rate of 0.6 percent. While it is true that most heroin addicts began their opioid abuse with diverted prescription opioids, as cheaper heroin and fentanyl have flooded the market in response to the cutback in prescription opioids, more and more non-medical users are beginning with heroin. A recent study found that 33 percent of heroin addicts entering rehab in 2015 reported their gateway drug was heroin. Yet, the government’s continued clamp-down on the manufacture and prescription of opioids causes many patients—including those in hospitals—to suffer needlessly, while the overdose rate continues to surge.

The overdose crisis will only be properly addressed once it is widely understood that it is primarily due to non-medical users accessing illicit drugs in a booming black market fueled by drug prohibition. Until then, members of Congress would be well-advised to stop the hysterical rhetoric and learn some science.

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