1. What does the SEC do?
Its chairman, Gary Gensler, and his Trump-era predecessor, Jay Clayton, said many digital assets have the hallmarks of securities. Gensler has spent the last year warning that the agency plans to take a tough line in enforcing its rules on these tokens. Concerns among crypto traders grew when the market regulator took the unusual step in late July to identify nine crypto assets it considered securities in an insider trading case. Seven of them were traded on Coinbase, the largest crypto trading platform in the United States. Separately, Bloomberg News reported that Coinbase is under investigation by the SEC over whether it listed assets for trading that should have been registered with the agency.
2. What does it mean for something to be a security?
In its simplest form, whether or not something is a security under US rules is essentially a matter of how closely it resembles shares issued by a fundraising company. To make this decision, the SEC applies a legal test, which derives from a 1946 Supreme Court decision. In this framework, an asset may fall within the jurisdiction of the SEC when it comes to investors money with the intention of profiting from the efforts of the organization’s management. In December 2020, the agency sued Ripple Labs Inc., for allegedly raising funds by selling the XRP digital token, which at the time was the third largest, without registering it as security. The SEC claimed that the company was funding its growth by issuing XRP to investors betting that its value would rise. The case is now a massive legal battle, with Ripple having hired former SEC chairwoman Mary Jo White as its attorney.
3. Why is calling a token a security issue?
For starters, such designations would make running a cryptocurrency exchange more expensive and complex. Under US rules, the label has strict investor protection requirements for platforms and issuers. This burden would put smaller platforms at a disadvantage against larger-pocketed competitors. Additionally, the exchanges would be subject to continuous scrutiny by regulators, which could lead to fines, penalties and, in the worst case scenario, prosecution if ever criminal authorities were involved. It could also mean the loss of future funding from investors who may be reluctant to face these increased compliance burdens and regulatory scrutiny. Proponents of increased regulation believe that security designations would result in more information and transparency for investors due to SEC disclosure requirements that would apply.
4. Who is against this approach?
Crypto enthusiasts say their businesses are decentralized in a way that makes old rules ill-suited, and crypto trading platforms argue the assets they list should be considered commodities, not securities . In the United States, the rules governing the trading of commodities and their derivatives focus more on ensuring that companies, producers and farmers can effectively use derivatives to hedge against the risks of commodity price fluctuations than on the role of small investors.
5. What does the crypto community want?
Efforts have been made on Capitol Hill to give the Commodity Futures Trading Commission, the US derivatives watchdog, more power to directly regulate crypto assets. Currently, he primarily oversees crypto futures contracts and has the ability to take enforcement action in the event of fraud or manipulation in the underlying market, as he has done in dozens of crypto cases. Crypto executives and traditional markets titans like Citadel Securities have joined an industry push behind a bill from top lawmakers on the Senate Agriculture Committee that would give more ground to the derivatives regulator – to costs of the SEC. Opponents of this approach say the securities-focused SEC rules provide more protections for family investors.
6. How do agencies split crypto?
To some extent, their approaches reflect their origins. The SEC was created following the stock market crash of 1929 and considers its primary mission to be to protect investors by requiring extensive disclosures by financial entities. The CFTC has its roots in the Ministry of Agriculture and helps farmers protect against droughts. The CFTC – and the US rules on commodities and their financial derivatives – are widely seen as a less onerous regulatory regime. So it’s no surprise that the crypto crowd desperately wants the CFTC to be their regulator and not the SEC.
7. Which parts are or are not considered a title?
The short answer is that beyond the biggest cryptocurrency, there is a lot of ambiguity. US regulators, including the SEC, agree that Bitcoin, which is by far the largest digital asset, is not a security. It was started by an unknown person or persons under the pseudonym of Satoshi Nakamoto and does not exist as a way to raise funds for a specific project. The second-largest token, Ether, was considered not a security during the Trump administration by a senior SEC official who flagged that while Ether may have started to qualify as a security – the Foundation Ethereum used it to raise funds – it had become something decentralized enough to not be one anymore. But after Ethereum moved to a system where coins that are “staked” play a role in recording transactions, Gensler said the fact that staked coins can earn interest could cause regulators to start treat them as security. The CFTC considers Ether a commodity, and the CME lists futures on it as well as Bitcoin.
Gensler said the agency could waive some of its rules to better accommodate digital assets, while ensuring investor protection, if exchanges work with the agency to register. However, he did not provide a roadmap for exactly how this could be accomplished. Meanwhile, lawmakers are weighing several proposals that could give the CFTC and U.S. banking regulators more power over parts of the asset class. At the same time, the SEC insider trading case, if successful, could also provide a clearer picture of which types of tokens qualify as securities and which should be considered commodities. In September, the White House released a series of reports that had been submitted by different agencies, claiming that together they constituted the first “comprehensive framework for the responsible development of digital assets”. But the reports have not resolved what has been a patchwork of overlapping approaches and jurisdictional battles.
9. Is this a problem elsewhere?
Yes. Globally, different regulators have taken a series of positions on whether to treat cryptocurrencies like securities. The UK’s Financial Conduct Agency regulates digital assets that it considers investments with redemption rights or profit sharing, while “payment tokens” like Bitcoin or “utility tokens” that give access to a service are not regulated. Singapore regulates both types, but under different laws. It considers coins that are digital representations of other assets, such as unlisted stocks, to be securities. In June, the European Union reached a tentative agreement to impose common cryptocurrency rules across all 27 member states and to develop a new legal framework to regulate public offerings of cryptoassets.
• A Treasury Department report on crypto regulatory issues.
• A look at the efforts of the crypto industry in Washington to avoid securities regulation.
• Gary Gensler’s first crypto interview after taking over as SEC chair with Bloomberg Businessweek.
• An OnPoint BGOV of cryptocurrency legislation being considered by Congress.
• A 2018 Bloomberg QuickTake shows how long these fights have been going on.
• The Executive Order on Crypto Regulation signed by Biden.
• An article on the SEC fight with Ripple.
• The UK FCA’s breakdown of regulated versus unregulated tokens.
More stories like this are available at bloomberg.com