Coinbase has been tussling with the United States Securities and Exchange Commission (SEC) for over a year, trying to force the agency to provide clear digital asset rules.
When Coinbase’s original petition, filed in July 2022, received no answer, it filed another in the U.S. Court of Appeals for the Third Circuit in April, complaining about the “unreasonable agency delay.” This latest writ of mandamus petition has drawn significant industry support, including from the U.S. Chamber of Commerce (USCC), the largest lobbying group in the United States.
In its May 9, 2023, amicus curiae (friend of the court) brief, the USCC stated that as things stand today, “nobody knows for certain which digital assets, if any, are ‘securities’ under federal law.”
This is no small question because the crypto sector has ballooned up to become a $1 trillion industry, and many of the USCC’s members are companies subject to U.S. securities laws. Those firms have “a strong interest in regulatory clarity,” said the USCC. Meanwhile, the SEC, while proclaiming itself the primary regulator of digital assets, “has refused to answer this threshold question.” The brief continued:
“The Commission has instead offered a series of one-off enforcement actions, supplemented by public speeches and other statements that one commissioner broadly described as ‘confusing, unhelpful, and inconsistent.’”
The Crypto Council also weighed in with an amicus brief in May, blasting the SEC for engaging in “regulation-by-enforcement,” in which it cracks down on individual firms rather than promulgating clear rules about what is or is not acceptable behavior. Regulation by enforcement, according to the Crypto Council, “thwarts meaningful participation in agency decision-making, deprives market participants of fair notice as to what is permissible, and chills innovation and investment in digital assets.”
Will crypto firms flee the United States?
Maybe it’s time to ask: Is U.S. reluctance or inability to provide regulatory clarity concerning digital assets going to drive crypto innovation overseas? Perhaps the U.S. should pay more attention to how the European Union or Switzerland manages matters around the classification of digital tokens. And is the SEC really the culprit here? It’s often cast as a villain of the crypto world, but maybe the agency’s hands are tied, or it’s just struggling to fill a regulatory vacuum in lieu of Congress’ inability to prove a comprehensive cryptocurrency framework.
“The lack of clarity and certainty in figuring out which assets are securities and in trying to figure out a path to compliance for those assets that are securities definitely drives some businesses away from the U.S.,” Carol Goforth, distinguished professor and Clayton N. Little professor of law at the University of Arkansas Fayetteville, told Cointelegraph.
Still, Congress has thus far failed to act on the matter of digital assets, and with no federal legislation on the books, the SEC may indeed be hamstrung to a certain extent. According to Goforth:
“There clearly is some fraud in the crypto space, and the SEC naturally wants to address it. There is no other authority with clear authority, so this desire is not unreasonable. Thus, there is a method to the SEC’s decision to attempt to apply precedents from the 1940s to these modern developments.”
Others take a dimmer view of the agency. “The SEC’s approach is indeed discouraging investments in innovative technology companies in the United States,” Jason Gottlieb, partner and chair of white collar and regulatory enforcement at law firm Morrison Cohen, told Cointelegraph. “As a result, responsible, law-abiding companies are simply looking elsewhere.”
Moreover, at least some laws and regulations are already on the books, with which most U.S.-based crypto firms are already complying.
“SEC chair Gensler has characterized the crypto asset industry as being one of the most noncompliant he has ever seen,” Michael Selig, counsel in the asset management department at law firm Willkie Farr & Gallagher, told Cointelegraph. “But if you trace the development of the industry within the U.S., you’ll find that it has generally evolved in compliance with clearly applicable laws and regulations.”
The U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN), along with state financial services agencies, were the first regulators to offer guidance for crypto participants, making it clear that certain crypto asset intermediaries, like exchanges and custodians, had to register or obtain a license with the regulator.
Selig further explained, “Today, the vast majority of crypto asset exchanges and custodians, among other intermediaries, are registered with FinCEN as a money services business and maintain money transmitter licenses in multiple states. The U.S. Commodity Futures Trading Commission (CFTC) followed these agencies by releasing guidance with regard to the offering of margined crypto asset transactions to retail customers, leading exchanges to make adjustments to their margin programs.”
No “clear path to compliance”
By this measure, the SEC is an outlier. “Rather than issue similar guidance or rules for crypto asset securities, the SEC has adopted a regulation-by-enforcement approach,” said Selig. “In the absence of tailored rules or guidance for crypto asset securities offerings and crypto asset securities intermediaries, market participants do not have a clear path to compliance.”
Overseas is arguably a different story. Several nations and jurisdictions are already bringing clarity to the problem at hand. “The European Union, Switzerland, Singapore, the United Kingdom, Japan and the Caymans have all provided guidance for how to operate as a digital assets company,” said Gottlieb. “The United States, and in particular the SEC, has not. The SEC says ‘just follow the rules,’ but points to rules that literally cannot be followed because they were not written for digital assets.”
The European Union, for instance, has created a clear framework that distinguishes between payment tokens, security tokens and utility tokens. “Europe created legal certainty with this step, which is a great advantage for the region because it will attract startups from the industry,” Daniel Schoenberger, chief legal officer at the Web3 Foundation, told Cointelegraph.
“The EU acknowledged that tokens can have very different use cases, and it is important to evaluate how a token is used rather than treating all of them the same,” Schoenberger added. “When it comes to technology, there is no one size fits all solution.” In other words: Not everything is a financial use case.
Tokens can be reclassified over time
Within the EU framework, there is even room for a token to be reclassified over time. For instance, it can begin life as a security token, but later evolve into a utility token. As Schoenberger explained to Cointelegraph:
“A token can be used initially as a fundraising instrument. If a token is used for fundraising purposes, it should be subject to all applicable laws and regulations. However, over time that same token may serve a functional purpose devoid of speculative investment. This is part of the nature and innovation of blockchain technology.”
The Web3 Foundation, which launched the Polkadot network in 2020, announced in November 2022, for example, that “The Polkadot blockchain’s native token (DOT), initially offered, sold and delivered to purchasers as a security, has morphed and no longer is a security. It is software.”
The DOT token is merely used for participating in the network now, Schoenberger told Cointelegraph. “Therefore, we need statutory rules for regulators to reevaluate digital assets and a binding process of ‘desecuritization’ of a token.”
Asked whether U.S. regulators could learn some things from their European counterparts, Goforth answered, “Maybe, but we have a very different regulatory environment. We have multiple agencies with overlapping jurisdiction, plus state regulation on top of that. We also are already used to thinking about digital or crypto assets in somewhat different ways than they are categorized by the EU. On the other hand, we could definitely learn that new legislation is a better path forward.”
“The United States is out of step with the international financial regulatory community,” commented Morisson Cohen’s Gottlieb. It can continue down that path indefinitely if it chooses, “but the longer we allow the industry to incubate in other countries, the harder it will be to woo back when we finally realize what we’re missing,” he added.
Targeted legislation “might start the ball rolling”
If federal crypto legislation is the answer, as many believe, how far away is it? Can we expect it in 2023? “It may be a long time before we see a comprehensive regulatory framework for crypto assets in the U.S.,” said Willkie Farr & Gallagher’s Selig. “It is likely that we will ultimately see split authority between the SEC and CFTC, given the unlikelihood that all crypto assets are securities.”
After all, federal legislation can be an arduous process, with multiple committees in both houses of Congress further freighted with partisan politics, Selig said, adding, “We can expect to see a comprehensive market structure bill introduced in the coming months, but it is possible that the bill will be broken up into smaller pieces so that it can more easily make its way through the committee process.”
Goforth agreed that the greater likelihood is piecemeal crypto legislation. “I think it is exceedingly unlikely that we will have comprehensive legislation this year. If we are lucky, we will get targeted legislation on something like spot market regulation, or on stablecoin legislation, or on carve-outs from the tax code for ‘de minimis’ [i.e., very small] annual gains. And that kind of targeted legislation might start the ball rolling.”