The battle royale for crypto oversight begins

A hearing today in the Senate Agriculture Committee will likely set the future for cryptocurrency regulation. The hearing will review a two-part bill from committee chairman Sen. Debbie Stabenow (D-MI) and ranking member Sen. John Boozman (R-AR), who will give oversight of so-called “digital commodities” to the Commodity Futures Trading Commission (CFTC). Oversight of assets considered securities remains with the Securities and Exchange Commission (SEC).

Right now, tokens like Bitcoin or Ether are traded on platforms without regulatory oversight. Hacks, pump-and-dumps, carpet pulling and other scams are widespread and deeply damaging. Many financial reformers have wanted regulation to go entirely through the SEC, which is better resourced and has an explicit mandate for investor protection.

But legislation to that effect has not been introduced, and the Stabenow-Boozman bill, known as the Digital Commodities Consumer Protection Act (DCCPA), gets first-mover advantage. A separate bill from Sens. Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) are widely seen as an industry wish list; on the other end of the spectrum, members like Rep. Brad Sherman (D-CA) just want to see crypto banned.

DCCPA fits in as the attractive to Washington reasonable compromise, with support from both sides of the aisle. Stabenow spokesperson Elizabeth Rivera said Prospectus that the chairman is still working with Republicans on when to make a markup for the bill.

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Even individuals sympathetic to strong financial regulation have joined the DCCPA. Todd Phillips of the Center for American Progress, who has argued vehemently to protect crypto buyers, will testify at the hearing and argue that the bill is the best option available to close critical regulatory loopholes in a targeted manner.

But the finreg community is not universal on board. A new letter out today from two academics and Americans for Financial Reform senior policy analyst Mark Hays highlights several issues. The CFTC, they say, is understaffed and has little experience crafting rules to protect retail investors. Additionally, it has not performed adeptly in early attempts to handle new offerings such as Bitcoin futures. “Overall, the CFTC has thus far adopted a permissive approach to cryptocurrency oversight that has undermined market integrity and exposed consumers to potential harm,” the letter said.

At the heart of the battle is the question of which federal agency will get to regulate crypto — and which members of Congress will get jurisdiction. Although the CFTC and the SEC sit in the same broad category of financial market oversight, because commodity futures grew out of farmers hedging futures prices for grain and other crops, the CFTC is subject to the House and Senate Agriculture Committees. The SEC goes through the more typical banking and finance committees.

This matters because the crypto industry has lost an incredible amount of money this election cycle. Members of the Banking and Agriculture Committees both benefit from having part of the financial system interested in their work, and if crypto regulation goes to one agency or the other, one of those committees will be deprived of the opportunity for campaign money. “The empathetic view is that this is how committees work and that they can still carry out effective oversight. The cynical view is that that’s what’s wrong with Washington, Hays said.

At the heart of the battle is the question of which federal agency will get to regulate crypto — and which members of Congress will get jurisdiction.

But by keeping regulatory oversight in both agencies, critics fear, the industry could simply forum-shop for whichever agency offers the lightest touch, contouring their offerings to fit the definition of a digital good or security. It will lead to interagency turf battles over who should regulate what, which could ultimately damage the overall regime. “The industry is saying, ‘Get us regulations,'” said Lee Reiners, policy director at the Duke Financial Economics Center. “Once they get those rules, they’ll know how to play them.”

THE HEARING TODAY has two parts. CFTC Chairman Rostin Behnam, himself a former senior adviser to Stabenow, will testify in the first session, which coincidentally will take place while SEC Chairman Gary Gensler is testifying before the Senate Banking Committee. Gensler has been a sharp critic of the crypto industry. The Wall Street Journal ran a piece last week that suggested Gensler would support Congress handing authority over digital goods oversight to the CFTC, though it seemed to take his words out of context. Behnam, meanwhile, has called for more regulatory authority over crypto assets.

The second panel consists mainly of industry groups, including representatives of Coinbase, Citadel Securities and the Crypto Council for Innovation, along with Phillips. In an interview, Phillips told Prospectus that there is simply no current regulatory regime that is sufficient to deal with the damage from digital goods. “This is the only bill that has been introduced to do that,” he said.

The DCCPA will require all entities that allow trading in digital goods—platforms, brokers, dealers, and the like—to register with the CFTC. These entities will be held to the standards of traditional financial institutions, required to hold adequate capital, report suspicious transactions and abusive practices, and ensure investor custody of their assets. There are also disclosure requirements regarding risks and conflicts of interest. “This gives the CFTC the ability to investigate every transaction on these platforms,” ​​Phillips said.

The definition of “digital goods” in the DCCPA is not entirely precise, but it specifically names Ether and Bitcoin, two of the largest cryptoassets, as the types that would qualify. Ethereum, the parent company of Ether, is undergoing a change in its security model, which some reformers believe makes it more akin to a security. “Unless the bill’s authors and the CFTC hammer out a clear understanding of where the SEC begins and ends, leaving it up to the CFTC’s rulemaking, we feel the bill could do more harm than good,” Hays said.

That puts a lot on the plate of an agency that has done little to convince critics of its regulatory value. “When it comes to crypto, the CFTC is a modern OTS, they just are,” Reiners said, referring to the now-defunct Office of Thrift Supervision, seen as such a weak regulator that banks would shape their institutions to come under its . area.

Phillips disputed that, noting that Gensler himself once ran the CFTC. “It’s not about one agency over the other, it’s who the president nominates and will Congress give them money to carry out the law.”

Still, early returns on the CFTC’s efforts in crypto haven’t been promising. Donald Trump’s pick to run the agency, Christopher Giancarlo, literally wrote a book with a title referring to himself as “CryptoDad.” (As Reiners noted, “Can you imagine if Alan Greenspan called himself SubprimeDad circa 2005?”) The letter notes, “Since 2014, the CFTC has filed just over 50 enforcement actions related to cryptocurrency, a surprisingly low number considering the widespread fraud and abuse in cryptocurrency markets.” The SEC has nearly doubled that number in a shorter time frame.

In June, the agency, now under Behnam’s leadership, filed a civil suit against Gemini, a crypto exchange, under its anti-fraud and anti-market manipulation powers. The suit alleges that Gemini’s Bitcoin futures product based its reference price on a thinly traded auction that could be easily manipulated, which Gemini knew and lied to the CFTC about. This means it took five years for the CFTC to recognize market manipulation and take action. “How is the effective regulation when you come in after the fact?” Reiners asked.

The problem, critics say, is that the CFTC typically regulates derivatives products, which large and sophisticated investors buy. Concerns for retail investors don’t matter, meaning the agency is untested when it comes to writing rules about things like deceptive marketing. The CFTC has also historically lacked the resources to even manage its derivatives oversight. In the DCCPA, the agency would be able to impose user fees on crypto platforms to fully fund oversight. That, along with additional funding, would be critical, Phillips said.

BUT THE CFTC STILL COULD end up behind the curve. Crypto tokens can be created immediately, through a “self-certification regime”, where a product can be listed as long as the entity selling it certifies that it complies with all rules and regulations. “This regime allows you to say, ‘We’re going to put this paper out, it’s got all the right stuff in it, we’re going, we’re going to start marketing,'” Hays explained. “And the CFTC has to decide whether to suspend it.” Since anyone can simply grab the source code from a token, modify it marginally, and produce a new one, new coins can be created in arbitrary quantities in minutes, creating a potential overload of the CFTC.

The Bitcoin futures market also relied on a self-certification process; that’s how Gemini’s allegedly manipulated futures lasted for five years before the CFTC filed a complaint. The CFTC has not halted trading in any self-certified commodity derivative since 2017, although it has said it engaged in “heightened review” with platforms to ensure compliance. But it is an unenforced, informal regime. The CFTC has also said it only looks at the derivative contract for exposure to fraud and not the underlying asset, as was the case with Gemini.

“This creates a fast lane,” Reiners said. “There is obviously a problem with fundamentally new products that should be subject to greater scrutiny by regulators.” He proposed a process where issuers would have to submit their product to the CFTC for approval, rather than self-certification.

Critics also worry that the DCCPA could hinder state efforts for strong regulation, such as in New York and California. Foreclosures were a problem during the housing bubble, when the Office of the Comptroller of the Currency overruled state predatory lending laws.

Supporters of the DCCPA say the importance of getting some oversight in place for these unregulated parts of the crypto market supersedes any concerns about forum shopping or turf wars. “There will always be Bitcoin assets that are not securities, we need some kind of regulatory oversight for them,” Phillips said. “I like this bill because for the things that are not securities, it does a good job.” Asked whether the SEC should handle these non-securities, Phillips said he didn’t really have a preference.

But other reformers, while recognizing that spot market surveillance is a major gap, worry that the legislation will not only stop the SEC but erode its jurisdiction. “I agree that this bill, should it pass, is an improvement over the status quo,” Reiners said. “But the status quo is pretty terrible. I just think we can do better.”