Why does everyone want to regulate Crypto?
Why regulate Crypto?
Within a week, the two largest cryptocurrency trading platforms in the world were sued by the SEC, and more than ten mainstream cryptocurrencies were designated as securities and included in the SEC’s regulatory scope. The SEC’s “power move” against the cryptocurrency industry has shocked everyone, and Gary Gensler, the current chairman of the SEC who is actually in charge, has become a veritable “extermination teacher” in the cryptocurrency field.
In 2021, Gary Gensler’s appointment was widely welcomed in the cryptocurrency industry. The new SEC chairman, who once taught blockchain courses at MIT, is generally considered an ally of the cryptocurrency world in high places. However, after taking office, Gensler reversed his position and issued a series of strong regulatory signals against cryptocurrencies, and has now become the “culprit” in the sweep of the cryptocurrency circle.
Why did Gensler have such a big contrast before and after taking office? Speculations such as “lost money speculating on coins” and “has a private grudge with Binance” often appear in chat conversations among practitioners. On Wednesday night, a hearing in the US House of Representatives caught BlockBeats’ attention. This was originally a hunt by regulatory agencies for cryptocurrency platforms, but unexpectedly turned into a denunciation of the SEC. It turns out that even in the “strictest” regulatory environment, there are obvious differences between regulatory agencies.
Looking back at the history of cryptocurrency regulation, we will find that behind Gensler’s relentless attack on the currency circle is the intensifying power struggle and endless infighting among US regulatory agencies. As a sacrificial product of the struggle between the two sides, Crypto is falling into unprecedented uncertainty and facing four-sided encirclement.
The Hunt Has Turned Bad
After suing Binance, the world’s largest cryptocurrency trading platform, on June 5th, the SEC did not leave the industry even a day to catch its breath, and sued Nasdaq-listed Coinbase the next day, while classifying more than ten mainstream cryptocurrencies such as SOL, ADA, and MATIC as securities. From any angle of interpretation, this lightning attack on the cryptocurrency industry is a “power move” that the SEC has shown to the world.
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In terms of its effectiveness, this attack undoubtedly satisfied the SEC. Under regulatory threats, Robinhood immediately stated that it would delist tokens defined as securities within a week. And Binance.US, which faces additional SEC asset freeze applications, delisted hundreds of token trading pairs in one night. However, the two lawsuits themselves are unlikely to achieve any substantive results in the short term. This, I believe, the SEC itself is very clear, after all, even the Ripple case has been dragging on for several years, let alone this time it is a one-on-two battle in the industry.
Interestingly, it wasn’t just practitioners in the cryptocurrency industry who were panicked after the SEC’s heavy-handed approach, but also “colleagues” from regulators. Perhaps the SEC is very aware that its target for this attack is actually someone else.
A few hours after the SEC accused Coinbase of violating securities laws, the U.S. House Agriculture Committee held a dual-subcommittee hearing to discuss regulation of the cryptocurrency spot market. Rostin Behnam, chairman of the Commodity Futures Trading Commission (CFTC), Coinbase’s Chief Legal Officer, Blockingul Grewal, and Robinhood’s Chief Legal and Compliance Officer, Dan Gallagher, were all present at the meeting. And at this hearing, the SEC became the target of everyone’s condemnation.
The committee asked CFTC Chairman directly whether the SEC should have complete control over digital assets. Behnam’s answer was very intriguing.
“This is not a zero-sum game, the legislative or legal authority that the CFTC may gain is not taken away from me by others. But there is a regulatory vacuum here, and there is a gap in regulating digital commodity assets,” Behnam said. “The SEC has authority over assets classified as securities. But in fact, the largest token, Bitcoin, is a commodity, as determined by U.S. courts. And under U.S. law, it is unregulated… And given that most of the encrypted commodity assets listed by most trading platforms are rarely formally classified as commodities, there is an urgent need to give regulators extra power over the encrypted commodity field.”
In this speech, the most noteworthy thing is Behnam’s wording about cryptocurrencies. He did not use the term “digital assets”, but “digital commodity assets”. Behnam acknowledged that the SEC has regulatory authority over all assets classified as securities, but he did not recognize that digital currencies should be classified as securities. In his speech, Behnam also repeatedly hinted that only by allowing the CFTC to regulate cryptocurrencies as commodities could the regulatory vacuum in the industry be resolved.
In addition to the dispute over the classification of encrypted assets, the SEC’s current regulatory enforcement model is also under fierce attack. Glenn Thompson, chairman of the U.S. House Agriculture Committee, stood with the CFTC and explicitly stated: “Enforcement is not an appropriate way to manage markets, fully protect consumers, or promote innovation.”
CFTC and SEC have been at odds over cryptocurrency regulation
In fact, this is not the first time that the CFTC and SEC have clashed over cryptocurrency regulation. In August 2021, when the SEC called for an expansion of regulatory oversight of the cryptocurrency industry, then-CFTC Chairman Brian Quintenz tweeted that cryptocurrencies are commodities and should therefore be subject to CFTC regulation rather than SEC regulation. He wrote, “The SEC has no jurisdiction over pure commodities or their trading venues, whether they are wheat, gold, oil, or crypto assets.” The House Agriculture Committee immediately came to the defense of the CFTC, saying that cryptocurrencies are beyond the SEC’s jurisdiction.
Christopher Giancarlo, former CFTC chairman, also tweeted earlier that the CFTC has more experience in regulating Bitcoin and crypto markets than the SEC. Giancarlo wrote, “If the Biden administration really wants to regulate the cryptocurrency industry reasonably, it needs to nominate a CFTC chairman.”
To some extent, Giancarlo’s comments are not wrong. On the issue of jurisdiction over cryptocurrencies, the CFTC’s legal basis is indeed much clearer than the SEC’s. The CFTC has always believed that cryptocurrencies are commodities under Section 1(a)(9) of the Commodity Exchange Act (CEA) and fall within its regulatory purview. This interpretation has also been recognized by federal courts, allowing the CFTC to exercise its authority over cryptocurrency derivatives and to enforce anti-fraud and anti-manipulation laws over spot cryptocurrency trading. Since 2016, many cryptocurrency giants, including Bitfinex, Tether, BitMEX, and Binance, have received fines from the CFTC. From this perspective, the CFTC does have more experience in regulating cryptocurrency platforms. (BlockBeats Note: For more information on CFTC fine records against cryptocurrency companies, please read “The fines CFTC has imposed on cryptocurrency companies over the years.”)
In contrast, the SEC’s regulatory consistency on cryptocurrencies is much lower. Before Gary Gensler took office, the SEC seemed uninterested in cryptocurrencies. The only clear action taken was against projects engaged in initial coin offerings (ICOs), which were clearly unregistered securities offerings. However, the SEC has been evasive on broader attempts to regulate cryptocurrencies. Therefore, although the SEC’s total amount of fines against the cryptocurrency industry exceeds $100 million, the fines have only been imposed on projects such as Tezos, Block one (EOS), and Ripple, which have conducted token financing, and are seemingly powerless in the eyes of the crypto community.
After Gensler took over the SEC, there was a clear change in the situation, and the SEC’s regulation of cryptocurrencies became more and more aggressive. In August 2021, Gensler spoke as the chairman of the SEC at the Aspen Security Forum, stating that many areas of cryptocurrency involve securities laws and need to be regulated by the SEC. This remark immediately provoked a strong reaction from the CFTC, leading to the scene of the two sides confronting each other as described earlier. However, Gensler did not back down, and subsequently stated on multiple public occasions that the vast majority of tokens are securities and need to be placed under the SEC’s regulatory authority.
On this basis, Gensler’s “enforcement team” began a series of investigations into different tokens and gave detailed explanations of “investment contracts” based on the Howey Test, trying to push the narrative that “cryptocurrencies are securities” into the mainstream. On November 8, 2022, the US District Court for the District of New Hampshire ruled in favor of the SEC in the case of accusing LBRY of issuing unregistered securities, recognizing that the cryptocurrency LBC issued by LBRY is a security. The SEC won an important victory in the “securitization of cryptocurrencies” battle, and added a new chip to its long-standing tug-of-war with Ripple (XRP).
The day after the LBRY case was won, FTX collapsed. A super unicorn worth billions of dollars disappeared in just 48 hours, leading to another regulatory battle between the CFTC and the SEC. Both agencies took enforcement action against SBF, accusing him of violating securities laws and commodity trading laws, respectively.
When accusing FTX executives Caroline Ellison and Gary Wang, the SEC believed that they manipulated the FTT token and specifically described FTT as a “crypto asset security.” The CFTC did not specify the legal status of FTT, but used Bitcoin, Ethereum, and Tether as examples of “digital commodity assets,” implying the asset attributes of FTT. The fight for the interpretation power of token attributes is unusually intense, and CFTC Commissioner Caroline D. Pham even directly issued a statement condemning the SEC’s actions as “an example of enforcement regulation” and encouraging the CFTC to use all feasible means to enforce commodity trading laws in the cryptocurrency field.
The Regulatory “Cash Cow”
Why are regulatory agencies making such a big fuss about cryptocurrencies?
Before the FTX crash, the consensus among the regulatory community seemed to be that Congress should establish a comprehensive regulatory framework for the cryptocurrency industry. For example, in October 2022, the Financial Stability Oversight Council (FSOC) recommended to Congress that legislation be passed to provide regulatory agencies with rule-making authority over “non-security crypto assets.” However, the committee did not give a clear directive as to whether it should be the CFTC or the SEC.
Meanwhile, the Digital Commodity Consumer Protection Act proposed by Senators Debbie Stabenow and John Boozman in August of the same year defined cryptocurrencies such as Bitcoin as commodities, but did not provide detailed guidance on which crypto assets should be classified as “securities.” This obviously gives the CFTC more jurisdiction over crypto. And the Financial Innovation Act later launched by Senators Cynthia Lummis and others specifically stated that most digital assets have much more in common with commodities than securities, further supporting the CFTC as the primary cryptocurrency regulator.
One very important commonality between the two bills is that both will allow the CFTC to self-fund by charging user fees to crypto companies. And the “fee-based fundraising” approach is the power that the SEC has long had in the securities market. It should be noted that the fees that the SEC charges for securities trading and other market activities are the main source of its budget.
Since Congress significantly expanded the CFTC’s responsibilities in 2009 by including swap trading in its jurisdiction, the CFTC’s budget has not kept pace with its expanding jurisdiction, and its budget still relies on appropriations from Congress. Therefore, compared to the SEC’s budget of about $20 billion, the CFTC’s budget of $300 million is an order of magnitude lower. For an underfunded agency, the ability to collect “protection fees” is an absolute game changer.
Take the SEC, for example, a large part of its annual budget comes from fees charged in the securities market. These fees include registration fees (paid by companies when they go public with stocks or bonds), trading fees (paid by securities exchanges and other market participants when they trade), and many other small fees. Of course, there are also all kinds of fines. So even though its budget must be approved by Congress, the SEC seems to rely little on appropriations from Congress.
There is no doubt that the ability to collect user fees will greatly ensure that the CFTC effectively fulfills its mission. Earlier, the CFTC’s fines against Bitfinex and Tether reached 1.5 million and 41 million US dollars, respectively. In 2021, the CFTC reached a settlement with BitMEX, which directly paid a fine of 100 million US dollars to the CFTC, accounting for one-third of the CFTC’s budget that year.
As CFTC Chairman Rostin Behnam said, the regulation of cryptocurrency assets is in a vacuum. Therefore, the regulatory agency that gains the upper hand can not only take the initiative, gain more power, but also obtain visible benefits. For regulatory agencies, it is increasingly important to find their own “cash cows” in the context of the United States’ serious fiscal deficits and nationwide discussions on debt ceilings.