How the Crypto Meltdown Changed the Regulatory Debate

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It’s harder to argue that your parents should leave you alone when you’ve just wrecked your car. As digital assets have lost more than $2 trillion in value and a number of major ventures have exploded in 2022, most notably the FTX exchange, the cryptocurrency regulation debate has changed abruptly. The turmoil has also raised the stakes in a battle that was already underway in Congress over which of the nation’s top market regulators, the Securities and Exchange Commission or the Commodity Futures Trading Commission, should take the lead over cryptocurrency oversight. Separately, the SEC has clarified that it regards most digital assets as securities, a designation that carries with it a broad set of requirements, while top US banking regulators have issued a sweeping statement about the dangers of cryptocurrencies.

1. How has the debate changed?

The collapse of FTX and the criminal fraud charges filed against its co-founder, Sam Bankman-Fried, led to widespread embarrassment in Congress and among regulators. He and several other top FTX executives had donated heavily to Democratic and Republican campaigns and had taken a leading role in trying to create a new regulatory regime that reflected the priorities of some in the cryptocurrency community. While regulators stressed the fact that cryptocurrency woes hadn’t destabilized traditional financial markets, they were criticized for failing to take action to avert the industry’s worst abuses.

2. What Were Cryptocurrency Leaders Pushing For?

Crypto executives and financial titans like Citadel Securities had joined a 2022 industry push for a Senate bill that would have given the CFTC, the US watchdog on futures and derivatives trading, more power to regulate cryptocurrencies . Currently, the CFTC mainly oversees cryptocurrency futures. The largest cryptocurrency trading platforms have argued that the assets they list should be considered commodities, i.e. items whose values ​​rise and fall separate from the profitability of the company that produces them. After FTX’s fall, CFTC chairman Rostin Behnam said his implosion was an example of why his agency needs more power to oversee cryptocurrency trading.

3. What is the case with the SEC?

Many opponents of the Senate bill said SEC rules offer better protections for small investors. The SEC was formed in the wake of the 1929 market crash and sees its primary mission as protecting investors by soliciting copious disclosures from financial entities. SEC Chairman Gary Gensler, former head of the CFTC, has responded to criticism that traditional regulations don’t match the realities of cryptocurrency by saying the agency could waive some of its rules to better accommodate digital assets, while ensuring the investor protection, if the exchanges cooperate with the agency for registration.

4. What did the SEC do?

He’s making it clear that he thinks many digital assets look like the type of investor-funded ventures that are considered securities and therefore fall under his rule book. Anxieties among crypto traders heightened when the SEC took the unusual step in a mid-2022 insider trading case of identifying nine cryptocurrencies it considered securities. In January, the agency sued cryptocurrency brokers Genesis Global Capital and Gemini Trust Co., over a program they had used to raise billions by allowing customers to lend deposits in exchange for interest payments, something the SEC said it amounted to a certainty.

5. What does it mean that something is a security?

For the SEC, the question is whether anything resembles a stock sold by a company to raise money. Specifically, the SEC asks whether a business involves investing money in a business whose profits will come from the efforts of others — a four-pronged assessment known as the Howey test, from a 1946 Supreme Court ruling. For example, in 2020 the agency sued Ripple Labs Inc., claiming the company was funding its growth by issuing XRP digital tokens to investors who bet its value would rise. If a token is designated as a security, those who create it are subject to the same set of rules that govern initial public offerings in the stock market, such as registration and reporting requirements. For cryptocurrency exchanges, the designation means they cannot offer for public sale any token that does not meet these requirements, as well as imposing strict investor protection requirements for the platforms.

6. What currencies are or are not considered securities?

There is a lot of ambiguity about this question. US regulators agree that Bitcoin, by far the largest digital asset, is not a security. It was started by an unknown person or persons under the pseudonym Satoshi Nakamoto and does not exist as a way to raise money for a specific project. In 2018, Ether, the second-largest token, was also not considered a security: While the Ethereum Foundation initially issued Ether to raise funds, it had grown into something sufficiently decentralized that it likely wasn’t a security, a senior SEC official said, a position Gensler declined to support. And when Ethereum moved in September to a new system for recording transactions that depends on staked coins, Gensler asked whether the interest offered on such deposits could make staking coins a security.

7. What did banking regulators say?

Top U.S. banking regulators – the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency – issued a joint statement on Jan. 3 raising concerns about the risks posed by digital assets, such as scams, uncertainties legal issues around custody and misleading claims by cryptographic companies. In a warning to lenders, they said it is important that risks that cannot be controlled cannot migrate to the banking system.

8. Is this a problem elsewhere?

Yes. Rules adopted by the European Union that have not yet gone into effect will seek to regulate tokens that reference another asset type or act as a digital version of fiat money, such as stablecoins. The UK’s Financial Conduct Authority also regulates digital assets that it considers to be investments carrying redemption rights or profit sharing. But “payment tokens” like Bitcoin, or “utility tokens” that provide access to a service, remain unregulated in both regions. Singapore regulates both types but under different laws. Treat coins that are digital representations of other assets, such as unlisted stocks, as securities provided they are offered by an authorized exchange. In 2022, the Monetary Authority of Singapore announced proposals to strengthen access to cryptocurrency trading for retail clients after the digital token market crashed. In Brazil, a new law was enacted in December that created the country’s first framework for cryptocurrencies, with ground rules for brokers offering cryptocurrencies and the day-to-day use of the assets. Brazil’s Congress took action after the FTX crash, increasing interest in passing regulations.

• A Treasury Department report on cryptocurrency regulatory issues.

• A look at the crypto industry’s push in Washington to avoid securities regulation.

• Gary Gensler’s first cryptocurrency interview after taking over as SEC chairman with Bloomberg Businessweek.

• A BGOV OnPoint of cryptocurrency legislation before Congress.

• A 2018 Bloomberg QuickTake shows how long these fights have been going on.

• The executive order on the regulation of cryptocurrencies signed by Biden.

• An article on the SEC’s fight with Ripple.

• The UK FCA split between regulated and unregulated tokens.

–With assistance from Ben Bain.

(An earlier version of this article corrected the name of CFTC chairman Rostin Behnam.)

More stories like this can be found at bloomberg.com

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