Soon after Coinbase Global, Inc. filed a crypto rulemaking petition with the SEC in late July, the virtual industry began a lobbying campaign to support the online crypto trading platform’s request.
As of the afternoon of Aug. 22, 2022, almost 1,700 individuals or organizations signed a form letter specifically asking SEC Chair Gary Gensler for clear rules of the crypto road. Four individuals wrote their own letters to the SEC with a similar request.
“The potential for web3 is almost limitless, and we will all benefit if we can keep the innovation here in the United States,” the form letter states. “As consumers, developers, investors, entrepreneurs, small businesses, and platforms, we believe that for web3 progress and leadership to flourish, the United States needs well-designed regulation of the subset of crypto assets that are crypto securities, not ad hoc litigation or speeches that change depending on the politics.”
This has been a common refrain among critics of the SEC, especially Gensler because the chair sets the commission’s rulemaking agenda. He has maintained that the SEC has clear rules for the crypto industry, including for those who operate trading and lending platforms. If exchanges have digital assets that function like a security, then they need to follow the securities laws in full or get an exemption to follow scaled-down versions of the rules.
In an Aug. 19 opinion piece in The Wall Street Journal, Gensler again defended the commission’s stance, writing that the regulator treats crypto like the rest of the capital markets. This means that “securities laws that protect investors continue to apply even when new technologies come along.”
But digital asset entrepreneurs have said that determining whether their cryptos are securities is very difficult because of characteristics that are unique to the novel industry. And today’s securities laws were written for traditional securities, critics nonetheless have insisted.
Those who signed on to the petition firmly believe that Web3 is the future of the internet. The new blockchain-based web includes cryptocurrencies, non-fungible tokens, decentralized finance, among others.
However, some have been skeptical about the rosy picture that has been painted for Web3.
“Web3 promises to transform the experience of being online as dramatically as PCs and smartphones did,” according to an article by Thomas Stackpole in the Harvard Business Review in May.
“It is not, however, without risk. Some companies have entered the space only to face a backlash over the environmental impact and financial speculation (and potential for fraud) that comes with Web3 projects. And while blockchain is offered as a solution to privacy, centralization, and financial exclusion concerns, it has created new versions of many of these problems.”
Thus, regulators, including the SEC, have emphasized a public policy framework that protects consumers, businesses, and investors alike. As for the SEC, Gensler believes that businesses can thrive when they operate within a framework that is already set up: the securities laws. And most cryptos, he believes, have securities embedded.
The crypto industry is aware of the risks, especially with high-profile stablecoin market collapse in recent months. Thus, in asking for clear rules, the industry has used a tactic that emphasizes innovation; the U.S. will fall behind other countries that have rules that are hospitable to the crypto market.
“US crypto holders have no path to access crypto securities but to go offshore,” the form letter warned.
In the U.S., the form letter said that developers are chilled from creating the next web3 innovation. Businesses and platforms are not sure whether they can start their operation without SEC litigation. Consumers, entrepreneurs, and small business do not know whether something that is here today will get shut down tomorrow.
Gensler’s Rationale
In his Wall Street Journal opinion column, Gensler indicated that the issue is simple. Investors deserve protection whether companies make cars or provide customers a platform to trade their crypto currencies.
“Whether a car runs on gasoline or electricity, drivers and passengers deserve to be protected,” the SEC chief wrote. “There’s no reason to treat the crypto market differently from the rest of the capital markets just because it uses a different technology.”
To explain why he believes the majority of cryptocurrencies being traded today are securities, he cited the Supreme Court’s decisions over the decades. The high court “has made clear that the economic realities of a product—not the labels—determine whether it is a security under the securities laws,” Gensler wrote.
Moreover, he criticized the industry’s insistence that crypto lending should not be subject to regulation.
“On the contrary, the rules have been around for decades,” he wrote. While he did not mention it in his column, stock exchanges like Nasdaq follow strict rules to protect investors.
“The platforms aren’t following them. Noncompliance isn’t the inevitable result of the crypto business model or underlying crypto technology. Rather, it is as if these platforms are saying they have a choice—or even worse, saying ‘Catch us if you can.’
“As I said in a speech last year, ‘Make no mistake: If a lending platform is offering securities, it . . . falls into SEC jurisdiction,’” he added.
In the meantime, the Coinbase petition was deliberately submitted on the same day that the SEC filed insider trading charges against a former employee of the platform.
The complaint on the insider trading charges specified that certain crypto tokens that were traded were securities. (See SEC Charges Former Coinbase Manager for Crypto Insider Trading in the July 22, 2022, edition of Accounting & Compliance Alert.)
This article originally appeared in the August 23, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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