Crypto’s regulatory turf war
After its latest market crash, which has cost investors a combined $2trn, there are calls for crypto to be more closely regulated. But who should be responsible for digital assets?
This article was featured in Issue 6 of Orbit TRC Magazine, Global Relay’s exclusive publication focusing on Technology, Risk, and Compliance.
Industry Leaders say failures are to be expected. But real people lost real money”Paige Pierce, owner and CEO of Bley Investment Group Inc.
Cryptocurrencies have lost $2trn in value since the 2021 peak. That is astounding: $2trn dollars of retail and institutional money wiped out in a year. A sample of the carnage includes the collapse of both Celsius, a high-profile crypto lender, and the Voyager exchange; the crash of UST (an algorithmic stablecoin) and the correlated destruction of the LUNA token.
Influential cryptocurrency industry leaders have talked about how these conceptual, architectural, and technological failures are to be expected as innovative technologies develop. But remember, real people lost real money. And they’re asking how this could happen, and where the US regulators are.
The short answer is that who has the legal authority to regulate digital assets has not been decided by the US Congress. It hasn’t even defined types of digital assets. In the meantime, while Congress works, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are jockeying to be
the regulator of digital assets.
The SEC was established in 1934 as an independent government agency, accountable to Congress, charged with regulating securities
markets in the US. Its primary function is to oversee organizations and individuals in the securities markets, including securities
exchanges, brokerage firms, dealers, investment advisers, accounting for public companies and investment funds.
In 1974, the federal government established the CFTC as an independent agency to regulate the derivatives markets, which includes oversight of commodities-based options and futures, and US swaps markets. Because there are options and futures contracts on cryptocurrencies, the CFTC has been involved in digital assets for about a decade.
Through established securities and derivatives rules and regulations, as well as federal statutes, the CFTC and SEC work to ensure that derivatives and securities institutions operate safely, tell the truth about their products and services, and treat investors “fairly and honestly”.
The chair of the SEC, Gary Gensler, has laid claim to digital assets as securities. His stance is that almost all crypto assets are securities, so cryptocurrency exchanges should be registered with the SEC. Gensler is widely recognized as an adversary you don’t want to step in the ring with. The industry awaits clarifying legislation from Congress (see feature, p26).
CFTC Chairman Rostin Behnam’s position is that digital assets are typically commodities. The CFTC’s jurisdictional claim is not new. In 2014, then CFTC Chair Timothy Massad testified in the Senate that, “Derivative contracts based on a virtual currency represent one area within our responsibility”. In the interim, Chair Behnam underscored the CFTC has not only “been a forceful and disciplined cop on the beat” but has dedicated resources to understanding and regulating the burgeoning digital asset market and brought over 50 enforcement cases.
We have a duty, as an industry, to engage with Congress to pass common sense legislation to protect the expanding and diverse cryptocurrency investing community. Democratization of markets is a worthy objective, but it comes with a profound duty of care to the most vulnerable market participants.
In June 2022 two unlikely allies in the Senate introduced a comprehensive bipartisan Bill to bring digital assets within the federal regulatory perimeter. Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) introduced the Lummis-Gillibrand Responsible Financial Innovation Act. It has pulled a great deal from the impressive body of digital asset-focused legislative work done in the State of Wyoming over the past five years, combined with markets expertise from the State of New York.
The Bill proposes to establish joint authority between the SEC and CFTC with respect to digital assets. It grants the CFTC exclusive
jurisdiction over digital assets, subject to certain exclusions. And it contemplates the idea of a digital asset self-regulatory organization (SRO) that could make initial determinations, subject to SEC and CFTC oversight, as to the legal classification of particular digital assets.
“Digital assets” are defined for the first time, as are many other items. There will be intense focus on the definitions in this Bill, with the hope of eliminating uncertainty over the boundaries of SEC and CFTC jurisdiction. Both Senators are seeking industry engagement in the legislative process, so please don’t sit on the sidelines if you have something to contribute.
Another bipartisan bill was introduced on August 3, by Senators Debbie Stabenow and John Boozman, along with Senators Cory Booker and John Thune. As with the Lummis-Gillibrand Bill, The Digital Commodities Consumer Protection Act of 2022 gives the CFTC new tools and authorities to regulate digital commodities.
In 2021, the SEC’s annual budget was $3bn and the CFTC’s $355m. Along with the work required to get the Bills passed, it is critical Congress funds the CFTC to provide the resources to meet its expanded mandates in these Bills. If investor protection is the goal, Congress must pass digital asset law soon, assign authority to a primary regulator, and fund the work. Now is the time.
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