The Financial Services Committee of the U.S. House of Representatives met earlier this week to conduct an oversight hearing on the Securities & Exchange Commission (SEC). While many topics were covered in this marathon session, by far the most important, and the impetus for the hearing, was a growing concern by both Republican and Democrat members of the committee that the SEC is weaponizing its enforcement powers to attack and undermine the developing market for digital assets, also known as cryptocurrencies or tokens. The SEC’s declaration of war against cryptocurrencies is producing a massive chilling effect on the industry, potentially harming the competitive interests of the U.S. in one of the most promising technological and financial innovations of the century.
The central characters in this drama included committee chair Rep. Patrick McHenry (R-NC), Gary Gensler, the chair of the Securities & Exchange Commission, and Rep. Maxine Waters (D-CA), the former chair of the Financial Services Committee who has come under fire for her close relationship with Sam Bankman-Fried, the disgraced founder of now bankrupt crypto exchange FTX. In what appears to be a regulatory landgrab, Gensler is positioning the SEC as the primary enforcer of crypto regulation in the absence of clear legislative guidance from Congress. Indeed, under Gensler’s leadership, the SEC has brought around 50 separate enforcement actions against crypto related entities and individuals.
In his testimony, Gensler repeatedly referred to the SEC as the “cop on the beat,” telling the committee that he was “watching out for your constituents.” If the SEC is the cop on the beat, then the officer has been dozing off for most of it. Indeed, the SEC was asleep at the wheel for many of the major crypto disasters and frauds over the course of 2022, including most notably the massive corruption at FTX. Gensler and his staff met in consultation with FTX’s founder on multiple occasions over the year before FTX’s collapse to discuss how to bring digital assets under SEC’s regulatory authority. FTX may have believed this would result in a quid pro quo in which FTX would receive special treatment that would position FTX ahead of its competitors.
In the absence of legislation, Gensler is practicing regulation by enforcement. This is akin to arresting someone for speeding when there are no speed limits posted, simply because the officer thinks the driver should have known better. That is not how laws are supposed to work in this country. The crypto industry has been appealing for regulatory and legislative guidance for years. Instead, its members, including Coinbase, the U.S. publicly-listed crypto exchange already under SEC oversight, have recently been handed Wells Notices from the SEC informing them they are being investigated and implying an indictment is likely to follow imminently. In Coinbase’s case, the CEO noted that the company met with the SEC over thirty times in the nine months before it received a Wells Notice, in the hopes of receiving regulatory clarity from the commission. Instead of providing guidance and rules that could be followed, Gensler now wants an additional $78 million in funding for enforcement.
Members of the committee criticized Gensler for not providing clear regulatory guidance on whether “digital assets offered as part of an investment contract are subject to securities laws.” Most importantly, Gensler refused to answer the fundamental question of whether he believes that Ethereum’s digital token (ETH) is a security. This is one of the most basic issues lawmakers and regulators must address to provide clarity to crypto entrepreneurs, exchanges, and investors alike. Ethereum has been around for ten years, has a market capitalization of nearly a quarter of a trillion dollars—representing twenty percent of the entire crypto market—, and is the second largest cryptocurrency after Bitcoin (BTC). While smaller today, Ethereum may matter more than Bitcoin over the long run because Ethereum is viewed as having a wider set of use cases and as a building block for numerous practical applications.
The SEC and Gensler himself have repeatedly affirmed that Bitcoin is not a security, but rather a commodity. If a digital asset is a commodity, then it would rightly be regulated by the Commodity Futures Trading Commission (CFTC), not the SEC. However, Ethereum remains in limbo, with some officials, including the New York Attorney General, asserting it is a security, while in contrast the chairman of the CFTC recently reaffirmed the commission’s view that Ethereum is a commodity. The heart of the matter derives from the so-called Howey Test, named for the case in which the U.S. Supreme Court determined something is a security when “there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Until this question is resolved, markets will remain in turmoil, and Ethereum related innovation and development activity will simply move offshore where the uncertainty doesn’t threaten entrepreneurs and market participants with regulatory peril and legal jeopardy.
In McHenry’s words, Gensler’s “approach is driving innovation oversees and endangering American competitiveness.” McHenry has it right. “Congress must provide clear rules of the road for the digital asset ecosystem because the regulators cannot agree. Regulation by enforcement is not sufficient or sustainable.”
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