For the past five years, cryptocurrency entrepreneurs have been at loggerheads with US regulators over an existential question: whether certain digital assets are securities, or investment contracts that must be registered with the Securities and Exchange Commission. The stakes are high – if a cryptocurrency is considered a security in a US court, it basically dies in the US crypto ecosystem. That’s because it can’t currently be traded on any cryptocurrency exchange, as none of them have a national stock exchange license.
Two weeks ago, the SEC filed a complaint in federal court claiming that nine tokens available for trading on Coinbase were securities, and the decree initially sounded like a step toward more regulatory clarity. But the SEC didn’t explain what makes the tokens different from other cryptocurrencies, and after the complaint came out, Coinbase published a blog post titled “Coinbase doesn’t list securities. End of story.” The episode was just the latest sign that the gap between the industry and regulators has never been wider.
“The SEC chairman has publicly argued that digital assets other than bitcoin are securities,” says Jai Massari, a former partner at law firm Davis Polk and now CEO of blockchain startup Lightspark. Still, crypto companies have “necessarily taken the position that digital assets are generally not securities,” she says. It’s a fantastic place for an industry to be, with almost 100% disagreement between regulators and companies on a fundamental issue. “How this plays out in the coming months will shape the future of much of the existing crypto industry,” Massari says.
Until now, the SEC has kept an arm’s length away from defining which cryptocurrencies are securities, providing ambiguous guidance in public and private meetings with companies, according to securities lawyers Forbes talked to. In its recent claim that nine Coinbase-listed tokens are securities, it invoked a set of guidelines called Howey test to present their argument. But the test is too vague and malleable to yield clear results, Massari and Davis Polk partner Joe Hall wrote. Meanwhile, the cryptocurrency industry has continued to march forward with the implicit belief that few digital assets are securities.
In January 2021, when President Biden selected Gary Gensler as the new chairman of the SEC, many in the industry pointed out that Gensler had taught a blockchain course at MIT and hoped he would provide more regulatory clarity about which digital assets are securities. But that hasn’t happened, and that’s largely because of the political mire Gensler would find himself in if he did, says Joe Hall, who has been a Davis Polk partner for 23 years and has worked on crypto regulation since 2013.
“When it’s a trillion-dollar market, any SEC chairman needs to know that if he or she wades into it, it can be all-consuming and put them in the middle of a food fight between traditional financial services and crypto companies. It’s the worst kind of battles to be in, he says. “You have vested interests on both sides. It can consume an incredible amount of time and resources … you have to deal with your overlords on Capitol Hill.”
The “Pottery Barn rule” – a principle of “you break it, you buy it” – also worsens the situation for regulators. If the SEC says a certain cryptocurrency is not a security, it is treated as an endorsement, lawyers say. Later, if something goes wrong with the asset and consumers lose a lot of money, Gensler will be heavily criticized by congressional oversight committees and the media, according to Hall.
“It’s easy to criticize the SEC from the outside,” Hall adds. “But I know exactly why they do it. There’s just no benefit from an individual’s point of view to stick their neck out and actually try to solve the problem. It’s a lot easier to impose enforcement actions against people for breaking the laws.” A spokesperson for the SEC declined to comment for this article.
As crypto companies continue to operate despite the risk of SEC enforcement actions, Hall does not believe that these businesses are acting naive, or that they believe they can safely ignore what the SEC is doing. For better or for worse, they just keep going despite the risk and uncertainty. “If you weren’t willing to live with regulatory uncertainty, there’s just no way you could operate in the industry,” he says.
Recently, crypto companies have developed the financial strength and confidence to go head-to-head with the SEC. In late June, crypto asset manager Grayscale sued the SEC for not allowing the company to convert the Grayscale Bitcoin Investment Trust (GBTC), a bitcoin-based investment vehicle it issued in 2013, into a spot bitcoin exchange-traded fund (ETF). ), which would make the investment more accessible to the average American investor.
How will the fundamental disagreement between regulators and industry be resolved? “There’s no point in hoping that someone at the SEC or a change in guard will result in the cavalry riding in,” Hall says. “We really need to turn to Congress to address that.”