‘Our rules must evolve’: The crypto industry is caught in regulatory purgatory

“As the markets have evolved, so must our rules,” said US Securities and Exchange Commission Chairman Gary Gensler, speaking about his approach to financial regulation before the Senate Banking, Housing and Urban Affairs Committee on Thursday.

While Gensler’s comments to the Senate seemed to signal modernization, he has argued that existing rules are sufficient for crypto, especially when it comes to whether the vast majority of the nearly 10,000 tokens available are securities.

“Nothing about the crypto markets is inconsistent with securities law,” he said on September 8 in a speech to the Practicing Law Institute.

As various agencies and departments recognize crypto’s growing influence, intergovernmental jockeying and a lack of clear regulation is creating confusion among companies and investors, legal and compliance experts said. Fortune. Even with the White House and the Treasury Department releasing frames and reports on digital asset development on Friday, experts say there has been little practical progress.

“There was a very steep learning curve for digital asset technology and traditional regulators really had a tough time,” said Tracy Angulo, director of financial services at consultancy Guidehouse. “Each agency took its own perspective on this, and there was no connection.”

“Tell Us Why”

One of the most important regulatory debates is which US agency will oversee various crypto instruments. A lot of this comes down to whether a particular cryptocurrency or token is a security under securities law, said Daniel Davis, partner at law firm Katten and former general counsel at the Commodity Futures Trading Commission.

If a cryptocurrency or token is a security, jurisdiction will lie with the SEC – if not, then the CTFC, with some exceptions.

The distinction dates back to a 1940s Supreme Court case that established the Howey test, which determines whether a contract or transaction is subject to securities laws.

Something qualifies as an “investment contract” if there is an expectation that profit in an investment may come from the efforts of others. As Davis explained, a classic example is buying stock in a company. This money will be combined with money from other share sales, and the company’s board and senior staff will try to manage these funds towards increasing the value of the shares.

Under this test, the two largest cryptocurrencies by market capitalization, Bitcoin and Ether, are probably not securities because there is no centralized group working to create additional returns. Likewise, if someone buys a digital asset that seeks access to a particular blockchain, it can be considered a sort of arcade token with consumptive use, rather than an investment tool.

While Bitcoin and Ether have generally been considered commodities rather than securities—and therefore regulated under the CFTC—Gensler has taken a more aggressive approach to the rest of the market. As he reiterated before the Senate, “Of the nearly 10,000 tokens in the crypto market, I think the vast majority are securities.”

Industry advocates such as Davis said they are still seeking clarification in lieu of what they have described as ad hoc statements that do not necessarily represent actual policy. For example, Davis said he wants more guidance on the small number of tokens that Gensler consistently describes as not securities.

“It would be great for the crypto industry if [he] would tell us why,” Davis said Fortune. “It would provide some more specific, concrete notions of what is and is not a security.”

That uncertainty only intensified after Gensler’s testimony on Thursday, when he told reporters that the new staking system implemented in Ethereum’s merger last week could fall under securities rules.

Furthermore, Gensler has argued that because most tokens are securities, it means that crypto intermediaries, such as exchanges, trade in securities and should register with the SEC. This, in turn, may require them to break down their various services, for example brokerage and custody functions, into separate legal entities.

Jonathan Shapiro, a partner at the law firm Goodwin, said SEC filings create new challenges for companies and investors, particularly because they have not been given explicit guidance. “There’s no way to necessarily have confidence that even if you solve one set of exposures, you’re not going to get slaughtered under a number of other spheres,” he said Fortune.

‘Patchwork’

Nick Losurdo, a partner at Goodwin and former SEC counsel, described the agency’s approach as “broad-brushing without following through with any articulation.”

“We all learned in fourth and fifth grade, you can’t just show your math conclusion — you have to show the math,” he said.

While Gensler continues to argue that existing laws are sufficient, many industry advocates say more clarification is important, especially as Gensler argues for updating other rules.

“It certainly appears that the SEC, given [amount] of rulemaking they’ve done over the last year, they certainly don’t seem to hesitate to reach for the rulemaking when they want to explore and address an issue,” added Davis, the former CFTC attorney.

In a recent interview with CoinDeskGensler pointed to two SEC cases from 2017 that laid out when tokens are securities.

Amy Jane Longo, a partner at the law firm Ropes & Gray, said settled cases don’t provide much clarity because they aren’t litigated with potential defenses and lines of argument. “What we really end up with is a patchwork of articulations,” she said Fortune.

Shapiro said this is compounded by the fact that the SEC serves as both an enforcement officer and regulatory agency. As a result, it is more pragmatic for defendants to settle rather than go to trial. A notable exception to this is the payment services company Ripple, which decided to challenge the SEC’s accusation that it raised money through an unregistered securities offering of digital asset XRP. The case is ongoing.

“It’s easier to initiate enforcement than it is to engage in regulation,” Davis said. “Despite that, there are huge benefits to making rules and giving the public a better idea of ​​what the rules of the road are.”

Beyond the SEC

Of course, the SEC is not the only government body that can oversee crypto. There are various proposals floating around Congress, including a bipartisan proposal from early August that would give regulatory authority over Bitcoin and Ether to the CFTC, which many see as more industry-friendly than the SEC.

Friday’s flurry of activity from the White House and the Treasury Department — spurred by President Joe Biden’s March 9 executive order for further research into digital assets — simply didn’t provide much clarity, experts say.

The White House guidance called on both the SEC and the CFTC to “aggressively pursue investigations and enforcement actions,” as well as to “issue guidance and address current and emerging risks in the digital asset ecosystem,” although it did not separate responsibilities between the two agencies.

Similarly, the Treasury Department, titled “Crypto-assets: Implications for consumers, investors and businesses,” asked US regulatory and law enforcement agencies to “aggressively pursue investigations” and “issue guidance and rules for oversight.”

Losurdo described the White House guidance as “kind of a nothing burger,” adding that Congress should step up.

Angulo said the agencies are likely negotiating behind the scenes to determine where regulatory authority lies. Meanwhile, there appears to be increased jockeying between the agencies, such as a July CTFC statement that described a crypto-related SEC case as “regulation by enforcement” and called for more transparency, adding that “regulatory clarity comes from be out” in the open, not in the dark.”