Gary Gensler is like the person you know who talks a lot without saying anything at all.  The current U.S. Securities and Exchange Commission (SEC) Chairman has proposed twice as many regulations (53!) as his predecessor in half the time.  He has also launched more than 50 enforcement actions against crypto companies during that period.  Yet there is still almost no clear guidance for the crypto market on how it’s expected to operate in the United States. 

For all of the crypto market chaos caused by the likes of FTX, the SEC does not receive nearly its fair share of the blame.  That is starting to change.  The Congressional Committee on Financial Services grilled Gensler this week on his agency’s approach to regulating crypto markets.  The elevator speech summary is basically Gensler: 

• Refusing to directly answer whether Ethereum (the second-largest cryptocurrency) is a security or commodity (he was asked multiple times);
• Reiterating his view that “most crypto tokens are securities”, but offering no guidance on how crypto market participants could actually register with the SEC; and  
• Acting indifferent when pressed that his aggressive approach was driving the industry from the United States.

Look, I understand that Gensler and other regulators are under a lot of heat following the FTX debacle.  Gensler was also “the cop on the beat” (as he likes to say) when LUNA spectacularly collapsed.  He probably thinks he has political cover to be aggressive and tough on the crypto industry.  Unfortunately, his current approach has created massive uncertainty, it has unfairly applied traditional finance rules to a fundamentally different and more decentralized market, and his overly-aggressive tactics have added more instability and regulatory risk.

Let’s analyze his current approach and suggest what should be improved. 

Uncertainty has caused crypto market chaos  

While Gensler has stated that “most crypto tokens are securities”, he has continued to spar with his regulatory neighbor, The Commodity Futures Trading Commission (CFTC), over which agency has the authority to regulate cryptocurrencies.  

“You’re punishing digital asset firms for allegedly not adhering to the law when they don’t know it will apply to them. It’s nonsensical.”

– Patrick McHenry (R-N.C.)

There is a legitimate debate on whether virtual currencies are commodities or securities.  Although in fairness to the SEC, any good lawyer would advise crypto clients that the SEC has taken the position through enforcement actions and insider trading cases that they have jurisdiction over almost all of the cryptocurrency industry.  That’s especially true if an investment in a “common enterprise” could have “reasonable expectations of profit from the efforts of others” (see the Howey Test). 

Most tokens give that “reasonable expectation” to investors.  Invest in our project, we’ll give you this token, and in exchange you should reasonably expect to profit.  This article is of course not legal advice, but most competent securities lawyers would probably conclude that the fact pattern I just gave is investing in a security. 

The bigger issue is Bitcoin and Ethereum.  The SEC has a harder case to make with those types of virtual currencies because they operate far more like currencies and commodities compared to securities.  But clearly Gensler doesn’t completely agree.

Although why can’t the SEC clearly come out and say they disagree?  Is it any surprise that this unwillingness to give clear industry guidance as opposed to one-off talking points like “most crypto tokens are securities” has caused mass confusion?  Should we be shocked that a crypto firm like FTX, which was run by an American, could and should have been regulated out of the U.S. if only the SEC and other regulators had set clear guidelines?          

Where are Democrats here?  Many of them took money from Sam Bankman-Fried, but many Republicans did too.  Yet it’s recently only been Republicans in Congress who have seen the value of promoting an industry that offers beneficial technology from the blockchain to the tokens themselves.  Continuing in the current environment would be like asking U.S. capital markets to operate without the Securities Acts of 1933 and 1934.  

It would be chaos.   

Unfair application of traditional finance rules to crypto

Despite securities laws, rules, and regulations being designed for traditional financial markets, the SEC has decided they can adapt them to cryptocurrency too.  This is terribly misguided.  While many of the risks are similar – money laundering, fraud, etc. – the markets operate in fundamentally different ways. 

A great example of this is the fragmentation of traditional financial markets compared to crypto.  In the former, the broker, exchange, clearinghouse or settlement agent are all typically different intermediaries.  In crypto, they can often be the same entity.  Coinbase, for example, is an exchange and a broker who services customers.  The SEC does not register exchanges with customers, however.  That’s completely foreign to them!

Applying the same regulatory framework to fundamentally different markets is like expecting the Federal Communications Commission to police every type of media the same way (wait a second…).  It doesn’t work.  It doesn’t tailor the regulatory framework to the market structure, which in turn fails to effectively encourage innovation and investment in the industry.

Even if crypto firms want to be good market participants and register their firms or tokens with the SEC, it’s unclear how they can register.  The firms that have tried this route usually get the same response from the SEC.  Silence.

That continued silence speaks volumes to the crypto industry.  It translates to: “We don’t want any crypto industry in the United States.  Period.”         

Overly-aggressive enforcement has created unnecessary regulatory risk 

As previously mentioned, Gensler’s SEC has issued over 50 enforcement actions against crypto firms in less than 2 years.  All the while only slightly updating existing guidance on how the industry should operate.  Not to mention staying silent on major issues like whether Ethereum is a security (*cough* because it would ignite a major turf battle with the CFTC *cough*). 

Before taking aggressive enforcement action against companies operating in a foggy gray area, perhaps we could take Brad Sherman’s (D-CA) advice: pass legislation to categorize all crypto assets as securities.  Maybe carve out exceptions here and there.  It’s reasonable to require disclosure and provide investor protection for many crypto products, but the requirements need to be clear.

When Gensler was asked whether he was concerned that his aggressive enforcement approach could be driving crypto firms from the United States, he responded with the following:

“I’m trying to drive it to compliance and if they’re not complying with the laws then they shouldn’t be offering their products to U.S. investors”

– Gary Gensler

This brings us full circle to the point on uncertainty.  The uncertainty created by the SEC has contributed to crypto market chaos.  Unleashing a wave of enforcement actions amidst this uncertainty only adds fuel to the burning crypto dumpster fire in the United States.  No sane investor, crypto firm, or other market participant wants any part of that risk. 

I think the words of Coinbase CEO Brian Armstrong sum it up best: “The US has the potential to be an important market in crypto, but right now, we are not seeing that regulatory clarity needed.”

If the SEC continues along this path, the United States will find itself in the situation described by SEC Commissioner Hester Peirce: “Rather than embracing the promise of new technology as we have done in the past, here we propose to embrace stagnation, force centralization, urge expatriation, and welcome extinction of new technology.” 

While the crypto industry has certainly had its missteps and disasters in the past year, the SEC is not without fault.  Their actions have actively contributed to crypto market chaos.  If the industry leaves the United States, Gensler and the SEC will only have themselves to blame.