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SEC Provides Early Blueprint for Crypto Regulation

On April 4, 2022, U.S. Securities Exchange Commission (SEC) Chairman Gary Gensler provided remarks virtually on the future of cryptocurrency and digital assets at a capital markets conference hosted by the University of Pennsylvania’s law school. It was Gensler’s first significant public comment since the Biden Administration issued its Executive Order on digital assets on March 9.  Gensler used the opportunity to make it abundantly clear that the SEC will be aggressive in both regulation and enforcement. 

Gensler focused on the SEC’s regulation in three areas related to digital assets: (1) crypto trading and lending platforms; (2) stablecoins; and (3) crypto tokens. 

Platforms: Gensler compared crypto trading and lending platforms, whether centralized or decentralized (DeFi), to traditional securities exchanges regulated by the SEC, and made clear that crypto platforms need to be registered and regulated to protect investors.  Gensler also noted that crypto platforms list both crypto commodity tokens, regulated by the Commodities Futures Trading Commission (CFTC), and crypto security tokens, regulated by the SEC.  Gensler indicated that he’s asked the SEC staff to work with the CFTC to consider how best to register and regulate crypto platforms that offer trading in both securities and commodities. Finally, as to crypto custody, Gensler indicated that he’s asked the SEC staff to work with platforms to get them registered and regulated to best ensure the protection of customers’ assets from hacking and theft.

Stablecoins: Gensler discussed how stablecoins, a class of cryptocurrencies backed by “stable” reserve assets, raise three important sets of policy issues. 

First, Gensler noted that stablecoins raise public policy concerns around financial stability and monetary policy.  For example, Gensler expressed the need to ensure that stablecoins are properly secured so they can in fact be converted to dollars one-to-one.  Gensler also noted that stablecoins are so integral to the crypto ecosystem that the loss of a peg or failure of an issuer could imperil a trading platform and may echo across the wider crypto ecosystem.  

Second, Gensler noted concerns that stablecoins, which are primarily used for crypto-to-crypto transactions, can be used for illicit activities.  In particular, Gensler discussed how stablecoins could be used by criminals to avoid the anti-money laundering, tax compliance and sanctions protections provided for in the traditional financial system.  

Third, Gensler stated that stablecoins raise issues for investor protection because three of the largest stablecoins were created by crypto trading or lending platforms themselves, and provide U.S. retail investors with no direct right of redemption.  Gensler noted that this relationship may lead to both conflicts of interest and questions of market integrity that would benefit from more oversight.

Crypto tokens: Finally, Gensler said that most crypto tokens are “investment contracts” (in other words, securities) under the Supreme Court’s 1946 Howey Test, which held that an investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.  Gensler emphasized the importance of getting crypto tokens registered with the SEC and requiring issuers of crypto tokens to comply with the SEC’s disclosure requirements, noting that “[a]ny token that is a security must play by the same market integrity rulebook as other securities under our laws.” 

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President Biden’s March 9 Executive Order called for federal agencies to recommend regulations to protect investors and promote responsible innovation in the digital asset space.  It is clear that the SEC intends to act on that quickly and aggressively.

Tags

fintech, cryptocurrency, securities

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