It's a simple question, but the answer may not be: How clear does the government need to be about defining what’s legal — and what's not — in the crypto space?
U.S. Securities and Exchange Commission Chair Gary Gensler has said the vast majority of crypto tokens, more than 10,000 at present, are likely securities. For this reason, apparently, he has sometimes portrayed the industry’s demands for regulatory clarity as much ado about nothing.
In a Sept. 8th speech, Gensler said that the SEC’s enforcement actions and speeches over the past five years have made it “pretty clear” how securities laws apply to the crypto industry.
“Not liking the message isn’t the same thing as not receiving it,” he said.
But SEC messaging is not a substitute for clear, actual rules, the crypto industry and its supporters argue. They point to a dearth of guidance and a patchwork of regulatory agencies that are engaging, they say, in the equivalent of "regulation by enforcement." Meaning: regulators aren't spelling out what’s allowed. Instead, they're using enforcement actions to broadly indicate which activities they regard as illegal. The way the crypto industry sees it, if the government's behavior doesn't change, it could dampen innovation.
In September, the White House published a framework for regulating digital assets. The document — the result of a March executive order from President Joseph Biden -- calls for regulations to safeguard crypto investors. The order also proposes a number of measures that would, in the view of the Administration, help foster responsible innovation across the crypto world.
Some lawmakers say regulatory clarity can’t come soon enough.
“I recognize these questions are complicated, but it is time for the SEC to engage,” Sen. John Hickenlooper (D-CO) said in a letter to SEC Chairman Gensler. In the letter, dated Oct. 13, he urged the agency to issue regulations for digital asset securities through a “transparent” notice-and-comment regulatory process.
Regulators have filed a flurry of enforcement actions against crypto players to curb perceived abuses in the last few years. But that didn't prevent the industry's most recent meltdown, which wiped out billions of dollars in market value. The Luna-Terra algorithmic stablecoin ecosystem collapsed in May; the bankruptcies of crypto lender Celsius Network and hedge fund Three Arrows Capital followed.
The SEC’s high-profile lawsuit against Ripple Labs, a prominent payments company, could shed light on when, and under what circumstances, the agency regards tokens as securities. In July, the SEC also filed insider-trading charges against a former Coinbase employee, the former employee’s brother and his friend. The SEC asserted that nine of the tokens traded by the defendants were securities. Both cases are being watched closely.
The SEC's buckshot approach does not sit well with some legal experts: “What I disagree with about the SEC’s (overall) approach is their prima facie assumption that tokens are securities,” said Jason Seibert, a Houston-based securities lawyer who has defended crypto companies in SEC actions. Each company’s efforts “need to be looked at individually.”
David T. Ackerman, head of compliance for MobileCoin, a crypto payments company, agrees: "Logically speaking, if most tokens are securities in the chairman's eyes, then the most valuable data to the industry would be which tokens are not," he said. Ackerman noted that these sorts of details would give the industry "a very good barometer" of how to judge digital assets.
The Commodity Futures Trading Commission (CFTC), generally regarded by the crypto industry as a more lenient regulator, riveted heads in September when it filed a lawsuit against the Ooki DAO, a decentralized autonomous organization. The CFTC assertion that the Ooki DAO violated the law by offering off-exchange trading of digital assets was not particularly surprising, legal experts say. But its claim that any member who voted on the DAO’s proposals could be held liable for its actions was shocking, and could also set a dangerous precedent if the courts uphold it, some lawyers say.
The CFTC's enforcement action may be the “most egregious example of regulation by enforcement in the history of crypto,” Jake Chervinsky, head of policy for the Blockchain Association, tweeted on Sept. 22, after the action was announced. “We've complained at length about the SEC abusing this tactic, but the CFTC has put them to shame.”
CFTC Commissioner Summer Mersinger, in a dissent, wrote that she “cannot agree with the Commission’s approach of determining liability for DAO token holders based on their participation in governance voting.”
Reached by TruthDAO, the SEC and the CFTC declined to comment beyond their regulatory filings.
With no clear rules of the road available, the crypto industry, at times, has tried to take matter into its own hands.
Four years ago, Patrick Daugherty, a partner at Foley & Lardner law firm, said he approached Shelley Parratt, the deputy director of the SEC's Division of Corporation Finance. Daugherty's message to Parratt: the legal community needed guidance about when digital assets were considered securities. According to Daugherty, Paratt told him that an upcoming speech by the SEC’s division director, William Hinman, would shed light on that very topic. A few months later, Hinman’s speech made a splash: Aside from the fundraising that occurred early on with Ethereum, Hinman told the audience that the crypto ecosystem had become decentralized enough that it was not considered a security.
Paratt and Hinman couldn’t be reached for comment. The SEC declined to comment on the officials’ statements.
Hinman’s speech — which he prefaced by saying it was his personal opinion, not the SEC's official stance — nevertheless gave the industry “pretty good guidance of what to look for in trying to classify a token as a commodity or a security,” Daugherty said.
Hinman’s comments have become a key point of contention in the SEC’s lawsuit against Ripple. Filed in December 2020, the lawsuit charged Ripple with raising $1.3 billion through the sale of XRP, a token that the agency contends is an unregistered security. In late September, U.S. District Court Judge Analisa Torres, in a move viewed as a win for Ripple, ordered the SEC to release drafts and emails related to Hinman’s speech.
The SEC complied and turned over the documents "over 18 months and six court orders later," tweeted Ripple general counsel Stuart Alderoty Oct. 20 on his verified Twitter account. "While they remain confidential for now (at the SEC insistence), I can say that it was well worth the fight to get them," Alderoty wrote.
John Deaton, an attorney who represents 74,000 XRP holders, believes that there’s a “strong likelihood” that the Hinman documents referred to XRP and Ethereum, since the two were vying in 2018 to be the second largest cryptocurrency behind Bitcoin.
“What we’re saying is that, look, if Ethereum is not subject to securities regulation, then XRP is not either,” said Deaton.