How the Cryptocurrency Crash Changed the Regulatory Debate

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It’s harder to argue that your parents should leave you alone when you’ve just wrecked your car. As digital assets lost more than $2 trillion in value and a number of high-profile ventures exploded in 2022, most notably the FTX exchange, the debate over cryptocurrency regulation shifted sharply. The turmoil also raised the stakes in a battle already brewing in Congress over which of the state’s main market regulators, the Securities and Exchange Commission or the Commodity Trading Commission, should take the lead in overseeing crypto. Separately, the SEC has made it clear that it considers most digital assets to be securities, a designation that carries with it an extensive set of requirements, while major US bank regulators have issued a comprehensive statement on the dangers of cryptocurrencies.

1. How has the debate changed?

The collapse of FTX and criminal fraud charges brought against its co-founder, Sam Bankman-Fried, led to widespread embarrassment in Congress and among regulators. He and several other top FTX executives have donated heavily to Democratic and Republican campaigns and taken a leading role in the effort to craft a new regulatory regime that reflects the priorities of some in the crypto community. While regulators have pointed to the fact that cryptocurrency problems have not destabilized traditional financial markets, they have faced criticism for not taking action to prevent the industry’s worst abuses.

2. What did crypto leaders stand for?

Crypto executives and financial titans like Citadel Securities have joined the industry push for a 2022 Senate bill that would give the CFTC, the U.S. futures and derivatives watchdog, more authority to regulate crypto assets. Currently, the CFTC primarily oversees crypto futures. Major crypto trading platforms have argued that the assets they list should be considered commodities — that is, things whose value rises and falls independently of the profitability of the venture that produces them. Even after FTX’s fall, CFTC Chairman Rostin Benham said its implosion is an example of why his agency needs more authority to oversee cryptocurrency trading.

3. What about the SEC?

Many opponents of the Senate bill said the SEC’s rules offer greater protections for retail investors. The SEC was established after the market crash of 1929 and sees its main mission as protecting investors by requiring extensive disclosures from financial entities. SEC Chairman Gary Gensler, the former head of the CFTC, responded to criticism that traditional regulations don’t match the reality of cryptocurrency by saying the agency could waive some of its rules to better suit digital assets while ensuring investor protection if exchanges operate with registration agency.

4. What was the SEC doing?

He made it clear that he thinks many digital assets look like the kind of investor-funded ventures that are considered securities and therefore fall under its rulebook. Concerns among crypto traders grew when the SEC took the unusual step of an insider trading case in mid-2022 by identifying nine crypto assets it considered securities.

5. What does it mean that something is a security?

For the SEC, the question is whether it resembles a stock that a company is selling to raise money. Specifically, the SEC asks whether the venture involves investing money in an enterprise whose profits will derive from the efforts of others — a four-pronged assessment known as the Howey test, from a 1946 Supreme Court ruling. For example, in 2020 the agency sued Ripple Labs Inc., claiming that the company financed its growth by issuing XRP digital tokens to investors who bet that its value would rise. If a token is designated as a security, those who create it are subject to the same set of rules that govern initial public offerings on an exchange, such as registration and reporting requirements. For crypto exchanges, the designation means they cannot offer for public sale any token that does not meet those requirements, as well as imposing strict investor protection requirements for the platforms.

6. Which coins are or are not considered securities?

There is a lot of ambiguity about this issue. US regulators agree that Bitcoin, by far the largest digital asset, is not a security. It was started by an unknown person or persons under the pseudonym Satoshi Nakamoto and does not exist as a way to raise money for a specific project. In 2018, Ether, the second-largest token, was also considered not a security: While the Ethereum Foundation initially issued Ether to raise money, it grew into something decentralized enough that it probably wasn’t a security, a senior SEC official said — a view that Gensler refused to support. And when Ethereum switched to a new system in September for recording transactions that depend on pooling or “staking” coins, Gensler questioned whether the interest offered on such deposits could make the staked coins a security.

7. What did the banking regulators say?

The main bank regulators in the USA – the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency – released a joint statement on January 3 expressing concern over the risks posed by digital assets, such as fraud, legal uncertainties around custody and misleading statements by crypto companies. In a warning to lenders, they said it was important not to allow uncontrollable risks to migrate into the banking system.

8. Is it a problem elsewhere?

That. Rules adopted by the European Union, which have not yet come into effect, will seek to regulate tokens that reference another type of asset or act like a digital version of fiat money, such as stablecoins. The UK’s Financial Conduct Authority also regulates digital assets which it considers to be investments that come with a right to a return or a share of profits. But “payment tokens” like Bitcoin or “utility tokens” that allow access to a service remain unregulated in both regions. Singapore regulates both types, but under different laws. It considers coins that are digital representations of other assets, such as unlisted stocks, to be securities provided they are offered by an approved exchange. In 2022, the Monetary Authority of Singapore announced proposals to tighten access to retail crypto-commerce following a downturn in the digital token market. In Brazil, a new law was passed in December that created the country’s first cryptocurrency framework, with basic rules for brokerages offering cryptocurrencies as well as the day-to-day use of the asset. Brazil’s Congress acted after the collapse of FTX increased interest in regulation.

• Report of the Ministry of Finance on issues related to crypto regulation.

• A look at the crypto industry’s push in Washington to avoid securities regulation.

• Gary Gensler’s first cryptocurrency interview since taking over as SEC chairman for Bloomberg Businessweek.

• BGOV OnPoint of cryptocurrency legislation being considered by Congress.

• A 2018 Bloomberg QuickTake shows how long these fights have been going on.

• Executive order on crypto regulation signed by Biden.

• Article on the SEC’s fight with Ripple.

• Division of UK FCA regulated and unregulated tokens.

— With help from Ben Bain.

More stories like this are available at bloomberg.com

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