Why the SEC is unlikely to pursue its announced crypto regulations
The news stands to shutter US based exchanges, but the most likely outcome is something else entirely.
"If a platform offers trading of digital assets that are securities and operates as an 'exchange,' as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration," reads the Securities and Exchange Commission's (SEC's) public statement on cryptocurrencies and exchanges.
If cryptocurrencies are securities then cryptocurrency exchanges are securities exchanges. This news as it stands might threaten to shut down all USA based cryptocurrency exchanges. This is understandably alarming news for cryptocurrency speculators, and prices have already tumbled across the board.
Which cryptocurrencies are classified as securities?
It's a grey area, but a cryptocurrency might be classified as a security if:
- It's an ICO.
- It's linked to a financial product.
- It pays dividends.
- It's a purely speculative asset whose value depends on the labour of others.
Arguably, this is just about all cryptocurrencies in existence.
Previously only a handful of coins have ended up sporadically lumped into the official securities category, such as those which pay dividends. And select exchanges such as Bitfinex have barred these from US buyers on a case by case basis. This new announcement threatens to bring the same restrictions to many more tokens and all ICOs at all exchanges around the USA.
As it stands, there are zero appropriately registered cryptocurrency exchanges. Instead each prominent service has brought out its own patchwork and improvised regulatory measures. For example:
- Coinbase's GDAX is working with a scattershot of money transmission licences across different states.
- The Gemini exchange operates as a trust company and a fiduciary.
- The most up to date exchange at the moment might be Poloniex, which became the first exchange to actually approach the SEC and try to become a national securities exchange following its acquisition by Circle, but isn't there yet.
The most extreme possibility is that US exchanges will be shuttering, or at least delisting, many of their tokens. But these possibilities are the most extreme interpretations. Ripple CEO Brad Garlinghouse suggested on Twitter that the current market reaction is outsized, and that there are three ways forward.
As it stands getting registered with the SEC as a national securities exchange might be one of the most promising ways forward. This might be a very expensive and unpleasant process, exacerbated by the fact that the SEC probably doesn't have the manpower to deal with a sudden wave of registration, and that the current regulatory framework simply wasn't meant to handle cryptocurrencies.
This is fairly obvious right in the introduction of the current rules, written in 1998 after a three year investigation into the revolutionary trading technology of the '90s.
"During the past three years, the Commission has undertaken a reevaluation of its regulatory framework for markets because of substantial changes in the way securities are traded. Market participants have incorporated technology into their businesses to provide investors with an increasing array of services... The current regulatory framework, however, designed more than six decades ago, did not envision many of these trading and business functions. The current regulatory framework, however, designed more than six decades ago, did not envision many of these trading and business functions." - SEC Regulation Final Rules, 1998
Plastering 1998 securities legislation on top of cryptocurrency exchanges would leave it hanging like ill-fitting wallpaper. But the SEC still has an obligation to enforce existing regulations and protect consumers, which leaves everyone in an uncomfortable spot.
The fourth option might be better for all involved.
The fourth option
The fourth option might be for cryptocurrency exchanges to just start calling themselves cryptocurrency marketplaces instead.
OECD think tank advisor and Shyft CEO Joseph Weinberg points out that cryptocurrency exchanges are functionally just marketplaces, and are completely different to the types of exchanges that the SEC is meant to regulate.
"Our ecosystem has never been good at branding - bitcoin isn’t actually a coin, ICOs aren’t actually coin offerings and exchanges aren’t actually exchanges," he said.
"Crypto exchanges are actually marketplaces where buyers and sellers come to transaction between two or more parties. The majority of technology professionals building these exchanges aren’t familiar with securities law where terminology is very important."
He suggests that a measured approach would be a lot more beneficial to everyone.
"To use the terminology of an exchange implies securities dealings and securities markets. The SEC is doing their jobs in protecting consumers from market risks [and] any terminology that may mislead and put investors and consumers at risk. It would be correct for the SEC to issue a courtesy to these new companies that if they continue to use terminology like this, they will be scrutinized under securities law. The SEC could bring about a lot of clarity if it would issue a definition of what an exchange is and the laws that govern this to the crypto community."
He also points out that a truly global asset class like cryptocurrency might be better served in the long term, as well as the short term it seems, by better international cooperation on legislation.
"In order to properly address these issues globally, there needs to be collaboration and coordination between intergovernmental agencies and organizations to focus on policy for the industry. We need to put this in motion now before we have a runaway effect where policy is fractured, like we saw with the internet and starting to see in the crypto space. The problem comes when you have one country like Japan overseeing bitcoin as a currency, therefore regulated by the central bank, and another country saying that it is a commodity and regulated by government agencies like the CFTC."
"Cryptocurrencies is a completely new asset class, which requires new formulas of thinking and new approaches. While the SEC acting proactively is in the right direction, they also need to work with the ecosystem on these issues. We need policy and standards for the global community on how to approach these issues together."
What are the odds of this happening?
It's impossible to say with certainty, but judging by the current cryptocurrency bloodbath it's probably more likely than most people think.
Firstly, this screw-tightening stands to be just as painful and expensive for the SEC as the exchanges. Securities exchange registration is rigorous on both sides of the table, and it's reasonable to assume that the SEC will be open to sensible alternatives.
Secondly, SEC chairman Jay Clayton has previously made it clear that the SEC's mission is to protect market participants, but he doesn't want to stifle innovation and is overall very optimistic about how blockchain and cryptocurrency systems can help the SEC fulfill its mission.
"To be clear, I am very optimistic that developments in financial technology will help facilitate capital formation, providing promising investment opportunities for institutional and Main Street investors alike. From a financial regulatory perspective, these developments may enable us to better monitor transactions, holdings and obligations (including credit exposures) and other activities and characteristics of our markets, thereby facilitating our regulatory mission, including, importantly, investor protection." - Jay Clayton, SEC Chairman
You don't have to look very far to find these kinds of developments. Weinberg's Shyft venture is one of the nearer-to-hand examples, while others include Polymath, whose price incidentally rose 25% as news of the SEC announcement broke.
And thirdly, you similarly don't have to look very far to find compelling evidence of the SEC's willingness to find sensible and innovative ways forward wherever possible.
If nothing else, it might be worth taking a look at the actual announcement for yourself and noting that it simply lays out the existing law of the land in broad terms, and remembering that this wouldn't be the first time legislative ambiguities have triggered overreactions.
Disclosure: At the time of writing the author holds ETH, IOTA, ICX, VEN, XLM, SALT, BTC, NANO