Both the head of the Commodity Futures Trading Commission (CFTC) and leader of the SEC agree that the crypto markets need regulating, and specific rules may help clarify which agency has authority to regulate various cryptocurrency activities. The client alert below discusses both CFTC Chairman Rostin Behnam’s comments and SEC
Back in 2013, the first cryptocurrency matter hit our desks. That was the beginning of the exponential growth of our digital assets practice. Recognizing the importance of the area, we launched this blog, Blockchain and the Law. In our first cluster of posts, we covered topics such as cryptocurrency taxation, blockchain and privacy, and issues surrounding initial coin offerings (or ICOs), one of the hottest issues at that time and a practice that still garners SEC scrutiny in 2022 (interestingly, there is still no consensus around when a digital asset, outside of Bitcoin, which is considered a commodity, is a “security”).
Today, blockchain-based innovations continue apace, continuously offering new opportunities (and raising challenges). In the push toward Web3 – with its decentralized, permissionless, tokenized core – there are a variety of new technologies and innovations, from DeFi to DAOs to NFTs to fan tokens to the Merge to the metaverse. We have been privileged to work with many of the most dynamic clients in helping them build businesses around these advances.
We were thrilled to host a three-day symposium from September 19-21, 2022 to highlight some of the hottest legal and business issues affecting digital assets, featuring a full slate of discussions among our attorneys and guests from the industry. At the symposium, we programmed virtual panels across a range of topics: SEC enforcement and securities regulation of digital assets, asset manager considerations surrounding digital assets, employee compensation and benefits issues, cryptocurrency AML considerations, digital assets in bankruptcy, decentralized autonomous organizations (DAOs), and sports and media trends and issues in Web3. The final day of the event culminated in an in-person reception and a “Voices from the Industry” panel featuring an eclectic group of executives from across the digital asset space talking about issues that are top of mind. In the span of a few days, we learned a lot.
The Securities and Exchange Commission (SEC) announced today that it would hire 20 additional positions to the Crypto Assets and Cyber Unit (formerly known as the Cyber Unit) within the Division of Enforcement, increasing the number of dedicated positions to 50. The “Crypto Unit” is tasked with protecting investors in crypto markets and from cyber-related threats. With more personnel and resources available, the SEC believes the unit will be “better equipped to police wrongdoing in the crypto markets” while still staying involved in disclosure and controls issues with respect to cybersecurity.
According to the release, the 20 additional hires will include supervisors, investigative staff attorneys and fraud analysts, with a focus on investigating securities law violations in: crypto asset offerings, exchanges, and lending and staking products; decentralized finance (“DeFi”) platforms; non-fungible tokens (“NFTs”); and stablecoins.
As we stated in a recent post, statements and proposals by financial regulators suggest that providers should expect more scrutiny and additional compliance hurdles going forward.
In a speech given this week at Columbia University by Fabio Panetta, Member of the Executive Board of the European Central Bank (ECB), he decried the entire “crypto gamble,” seeing crypto-assets as “bringing about instability and insecurity – the exact opposite of what they promised” and calling for tighter regulation in the EU (and coordination with international partners) to curb the financial and associated risks from crypto-assets.
Panetta’s speech (entitled “For a few cryptos more: the Wild West of crypto finance”) evoked remarks made by SEC Chair Gary Gensler back in August 2021 that labeled crypto the “Wild West” and requested Congress give the Commission more authority “to write rules for and attach guardrails to crypto trading and lending” that would boost consumer trust and allow the industry to prosper. Panetta’s scathing broadside was lobbed against what he sees as the risky, seamier side of crypto – the speculative fervor and greed, the high volatility of crypto markets, the facilitation of criminal financial activity, the lack of adequate disclosures, the largely unregulated or “insufficiently supervised” cryptocurrency miners and service providers, and other un- or under-regulated aspects of the “crypto bubble” that, if left ignored, could pose risks to financial stability (citing the sub-prime mortgage market that triggered the last global financial crisis). While far more strident in tone than President Biden’s March 2022 executive order, Panetta’s speech similarly articulated a high-level strategy for regulating and fostering innovation in the burgeoning digital assets space and pushed for central banks to move more quickly to develop central bank digital currencies (CBDCs) and “respond to the people’s growing demand for digital assets and a digital currency by making sovereign money fit for the digital age” or else sit by as the private sector satisfies this demand.
Taking a wide view, Fabio Panetta’s remarks, coupled with the multiple crypto-related regulatory developments ongoing both in the EU and U.S., suggest that some changes are afoot for the crypto industry. While there has been some industry-friendly legislation at the state level in recent years to encourage innovation, at the federal level it seems that the honeymoon period of light touch or no regulation (or largely, regulation by agency enforcement) for the crypto industry is over. Innovation in this space continues at a furious pace at the same time as regulators are slowly gaining experience and expertise about the public policy and investor risks surrounding crypto-assets. Thus, providers should expect more scrutiny and additional compliance hurdles going forward, as multiple regulators have stated that the lasting innovations and societal benefits of cryptocurrencies and DeFi applications can only occur alongside responsible regulation. Panetta stated that pulling off such responsible oversight will not be easy, as there will be “complex trade-offs, balancing the goals of promoting innovation, preserving financial stability and ensuring consumer protection.”
On March 9, 2022, the President issued an Executive Order (the “E.O.”) that articulates a high-level, wide-ranging national strategy for regulating and fostering innovation in the burgeoning digital assets space. The strategy is intended to encourage innovation yet still provide adequate oversight to control systemic risks and the attendant investor, business, consumer and environmental concerns.
The E.O. is very broad in scope. It focuses on the myriad of issues associated with “digital assets,” a term defined in a way to capture a wide variety of existing and emerging “crypto” implementations. Specifically, the E.O. defines digital assets to include “all central bank digital currencies (CBDCs), regardless of the technology used, and to other representations of value, financial assets and instruments, or claims that are used to make payments or investments, or to transmit or exchange funds or the equivalent thereof, that are issued or represented in digital form through the use of distributed ledger technology.” Significantly, the E.O. does not make an attempt at defining the regulatory status of digital assets and notes a digital asset “may be, among other things, a security, a commodity, a derivative, or other financial product.”
While the E.O. itself doesn’t really set forth any new requirements, it puts into motion a process that may yield specific regulatory approaches to digital assets. Of course, this process is happening in parallel with other initiatives by the Securities and Exchange Commission (“SEC”) and Congress itself and thus, there is a possibility that the E.O will result in approaches that are in ways inconsistent with other ongoing regulatory developments. For example, in January 2022 the SEC released a proposal that would enhance investor protections and cybersecurity for alternative trading systems that trade Treasuries and other government securities. The proposal prompted a dissenting statement from SEC Commissioner Hester Peirce (often referred to as “Crypto Mom” for her advocacy of the industry), who objected to the speed and breadth of the January 2022 proposal. The E.O. sidesteps some of the controversial issues addressed in the SEC proposal, such as how “exchanges” should be defined, as well as the greater issue of how different digital assets should be classified (and therefore, which financial regulatory agencies have jurisdiction over various digital products and platforms). At the same time, there seems to be some amount of bipartisan interest in Congress to pass its own legislation regulating certain aspects of cryptocurrency and related technologies (e.g., in the stablecoin area), Whether or not that legislation would be consistent with the results of the E.O.-driven processes is also hard to tell.
The SEC’s push to regulate the next generation of blockchain-based applications will likely give rise to disputes and enforcement actions, particularly in the developing decentralized finance (DeFi) space. Although DeFi has the potential to enhance or replace traditional financial products by speeding execution and reducing transaction costs using blockchain technology,…
On January 10, 2022, the Securities and Exchange Commission (“SEC” or the “Commission”) announced it settled charges in In re tZERO ATS, LLC, No. 93938 (SEC Order Jan. 10, 2022) (“Order”). The Order details how the SEC fined blockchain-based trading platform tZERO ATS, LLC (“tZERO”), an alternative trading systems (“ATS”), for alleged violations of Regulation ATS, which requires certain disclosures to the Commission.
An ATS is a trading system that meets the definition of “exchange” under federal securities laws but is not required to register as a national securities exchange if the ATS operates under an exemption provided under regulations under the Securities Exchange Act of 1934 (“Exchange Act”). As stated in the Order, tZERO is an ATS that offers both “digitally enhanced securities” recorded on a blockchain and trading and settlement services for unique investments that may not be available through traditional brokerages.
In its first enforcement action of the year involving ICOs, the U.S. Securities and Exchange Commission (SEC) charged two companies and their founder for violations of antifraud and registration provisions of the federal securities laws in connection with an initial coin offering (ICO). On January 6, 2022, the SEC announced charges against Australian citizen Craig Sproule and two companies he founded, Crowd Machine, Inc. and Metavine, Inc. (collectively, the Defendants), for making materially false and misleading statements in connection with an unregistered offer and sale of digital asset securities in an ICO. (SEC v. Crowd Machine, Inc., No. 22-00076 (N.D. Cal. filed Jan. 6, 2022)).
These charges add to the SEC’s growing list of enforcement actions that target unregistered offerings of digital assets. ICO activity peaked in 2017, when hundreds of issuances raised an estimated $5 billion from investors. Since that time, scrutiny from the SEC has cooled this practice. However, the SEC remains vigilant in taking action against unregistered ICOs, based on its view that digital tokens are likely to be securities. In remarks last year, SEC Chairman Gary Gensler voiced agreement with former SEC Chairman Jay Clayton’s position on ICOs: “To the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.”