Key forces that define the US crypto regulation, and what is wrong with the SEC

US is one of the most important countries for the crypto industry, but it does have numerous regulatory issues. In the absence of a clear legal framework, different agencies fight over jurisdiction, with the SEC adopting an increasingly aggressive stance.

Many now believe the SEC is betraying its original purpose and playing anti-crypto politics. Here’s our take on its actions and some thoughts on what outcome they can produce.

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Regulatory certainty is a must for an industry to develop.

In case of crypto, regulators are far behind the technological (and ideological) innovation, and it usually takes them many years to start producing crypto-related laws. Even now, 14 years after the first Bitcoin block was mined, only a handful of countries have a comprehensive legal framework for the crypto industry.

One country where the absence of crypto regulation is particularly troublesome is the United States.

World’s biggest economic power not only counts numerous crypto users (21% of its population have already used crypto, according to NBC news poll of March 2022), the US also has a flourishing crypto business:

-          major crypto exchanges and custodians (Coinbase, Kraken, BitGo…)

-          leading DeFi companies (Lido, 1inch…)

-          the biggest share of Bitcoin miners (over 37% of hashrate)

-          most eminent NFT projects (BAYC & Cryptopunks, Art Blocks…)

-          biggest NFT marketplaces (OpenSea, LooksRare, Magic Eden…)

-          crypto tech & intelligence companies (Block, ConsenSys, Solana Labs, Blockdaemon, CertiK, Chainalysis…)

-          and finally, biggest crypto VCs (Andreessen Horowitz, Pantera Capital…)

The US also has a huge traditional finance sector, and it is increasingly interested in crypto: Chicago Mercantile Exchange has been trading Bitcoin derivatives since 2017, and crypto funds like Grayscale ($50 billion AUM)  are offering crypto exposure to accredited investors.

One could imagine the US well on its way to dominate the global crypto industry, were it not for its complicated legal situation. The country still does not have a clear legal framework, which means that different agencies treat crypto as they see fit – and this causes trouble.

Who defines crypto regulation in the US ?

The CFTC (Commodity Futures Trading Commission) has been claiming that cryptoassets fall under its authority, because they are commodities. It was the CFTC that allowed the CME to issue crypto derivatives.

The FinCEN (Financial Crimes Enforcement Network) is tasked with preventing money laundering. Together with the CFTC, it charged the BitMEX exchange for insufficient AML measures in 2021. Biden’s 2021 Infrastructure Bill also introduced harsh AML measures for everyone more or less related to crypto, but the Senate is still fighting over a number of its definitions.

The US Treasury, or more precisely its department charged with enforcing economic sanctions – the OFAC – made the headlines last year by banning Tornado Cash, a crypto mixer, for allegedly being used by the North Korean hackers.

The IRS sets rules for taxation and reporting on crypto-related activity, and the OCC ensures that national banks “demonstrate that they have appropriate risk management systems and controls in place” to engage with crypto.

However, among the federal agencies, there is one that seems to claim more and more authority over crypto and provokes an increasing controversy. It is the SEC, or Securities and Exchanges Commission.

The SEC vs crypto

The SEC’s primary mission is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation”. Let’s see how good of a job its has done in the crypto markets.

What is SEC’s authority over crypto?

The agency claims that most cryptocurrencies are securities and therefore must undergo the same registration requirements. Bitcoin “might” be one exception, said the SEC Chair Gary Gensler in September 2022 (although a 2018 ruling exempted both Bitcoin and Ethereum).

The SEC’s stance is an exception on the global scale, where most regulators who have tackled the subject admit that cryptoassets can have different nature.

How is the SEC enforcing crypto markets?

The SEC is known for arbitrarily picking its victims, accusing individual companies of issuing/dealing with unregistered securities. Most famous deeds include:

⚔️ SEC v Ripple lawsuit filed in 2020 for $XRP issued in 2012;

⚔️ pushing Coinbase to cancel its Lend product in 2021;

⚔️ filing (and winning) a 2021 lawsuit against a decentralized content platform LBRY for its token issued in 2016;

⚔️ charging Kim Kardashian for endorsing cryptoassets without disclosing her remuneration in 2022;

⚔️ fresh in 2023: charging crypto lender Genesis and exchange Gemini for unregistered offer and sale of their Earn product.

How does the SEC protect investors?

💸 The agency’s attack on Ripple led to $XRP losing value, and its investors have joined forced to prove that the SEC’s actions were harming them. The so-called “Ripple Army” now has an amici status in the litigation (read more here).

💸 Badly hit by the FTX crash and forced to halt withdrawals, Genesis now owes $900 million to Gemini’s Earn clients. The investors now worry that the lawsuit will further delay the prospects of getting their money back.

💸 Millions of FTX users have lost their money, prompting theories on why did Mr Gensler leave the FTX fraud develop unnoticed (too busy with frivolous lawsuits? sparing SBF because of his generous donations to the Democratic Party? because of some personal affiliation?...)

How does the SEC maintain fair and orderly markets?

🤹🏽 The American crypto industry has been pleading for the SEC to issue clear guidelines, but the agency refuses, arguing that cryptos are all securities based on a Howey test dated 1933.

🤹🏽 Any US crypto company that has issued tokens in the past is de facto in danger (LBRY Inc. announced its “death” last November, following the lawsuit).

🤹🏽 Even companies who actively seek to comply cannot be spared: Gemini’s Tyler Winklevoss said the company has been in discussion with the SEC for 17 months, and “they have never raised any prospect of enforcement until after Genesis paused withdrawals”.

How does the SEC maintain efficient markets?

🏛️Traditional financial products based on crypto are in demand all over the world, but unlike its counterparts in other countries, the SEC still refuses to approve a spot crypto ETF (exchange-traded fund), despite numerous requests since 2020.

🏛️The only crypto ETF authorized by the SEC is the one based on crypto futures regulated by the CFTC, which makes the end product more complicated and less efficient.

Can the SEC keep its course?

Last year, the SEC announced it would nearly double its crypto-dedicated staff and continue to “police wrongdoing in the crypto markets” 👮, all while still refusing to issue clear guidelines for it.

The SEC’s grip is tightening: last autumn, Gary Gensler even declared that Ethereum transactions must be considered as those that took place in the US, for its nodes are “clustered more densely” there.

The crypto community’s discontent is rising, and so do the efforts of the CFTC to get back the authority over a part of the crypto market it considers commodities. Several bills presented to the Senate last year aim at defining clear jurisdictions for the CFTC and the SEC.

Some state and municipal regulators, like Florida (and the city of Miami in particular), Wyoming, Texas, or the city of New York, try to implement as many crypto-friendly laws as they can to develop their crypto businesses.

However, many crypto intermediaries who cannot escape the SEC choose to leave the US for countries with a more comprehensive regulation and exclude the US users from their platforms to avoid trouble. Crypto lender Nexo is one of the last examples, while American financial firms issue their spot ETFs on the European stock markets (VanEck on Deutsche Borse, WisdomTree on Euronext… etc)

The crypto issue is very political in the US, and the power struggle is now hitting its all-time high, as the regulators acknowledge the importance of a crypto-specific law.