Crypto companies have been criticizing the U.S. for a lack of clarity in crypto regulation. But what if there is a clear answer, only they do not like it? VIXIO sat down with U.S.-based crypto experts to discuss the regulation conundrum.
When new innovations emerge that cannot fit in the traditional, established legal frameworks, they often face challenges about whether and to what extent they are subject to the existing regulations. The need for clarity becomes more pressing as a product grows and attracts more and more attention from regulators.
Although the cryptocurrency market has been growing steadily for years, since COVID-19 hit many crypto holders have generated spectacular gains. The market has seen a tenfold increase in market capitalisation within the last two years, exceeding $3trn in value by November 2021.
Such an uptick could not pass without catching the eyes of regulators and policymakers.
Depending on the type of business activity, cryptocurrencies in the U.S. fall under the jurisdiction of various federal financial regulators, which are increasingly stepping up to enforce their rules against crypto companies.
Recently, the Securities and Exchange Commission (SEC) has come out as the main cop on the beat for cryptocurrencies that are considered securities, while decentralized cryptocurrencies, such as Bitcoin, are subject to banking regulations and the jurisdiction of the Commodity Futures Trading Commission (CFTC).
It was in the context of a complex and multi-layered financial regulatory framework that last December the SEC initiated a court action against Ripple, arguing that the company was selling its XRP token as an unregistered security for seven years.
Since the Ripple case, other crypto companies and legislators have come forth, criticizing the regulators for a lack of clarity. Ripple’s Brad Garlinghouse was just one of those who claimed there is a lack of regulatory clarity for crypto in the U.S., and the SEC “has sat back and watched for years.”
Grey areas or regulators doing their job?
When speaking about cryptocurrencies, a distinction should be made between those crypto-assets that are sold as a security and those that operate as a currency.
When a new business launches an initial coin offering (ICO), selling a new token to fund their business, that clearly belongs under securities laws, Gene Grant, CEO of Texas-based crypto firm VRBex/Levelfield, told VIXIO.
“As soon as you take other people’s money, you are regulated, and raising money is one of the most highly regulated activities in the U.S.,” Grant added.
“If you are raising money for an activity that has not commenced yet, that is a security and there is very little grey area there.”
On the other side of the scale are those crypto-assets, such as Bitcoin, which function as a currency in a decentralized way with no controlling body issuing and managing the currency.
Bitcoin derivatives fall under the jurisdiction of the CFTC, which oversees derivatives on commodities, while Bitcoin as a currency must comply with banking regulations.
“Now, we have the two extremes — cryptocurrencies that are securities, and Bitcoin, which is a distinct class from other cryptocurrencies. Then, there are those products that fall in the middle where there is a little bit of confusion on where it belongs,” Grant explained.
For instance, when Ether was first sold, it was issued to fund the company, meaning that it clearly belonged under the jurisdiction of the SEC. However, since its launch, the company has moved away from the initial model to become more like Bitcoin. Now it is a decentralized ecosystem with no controlling body and has been determined to be a commodity under the jurisdiction of the CFTC and the banking regulators, Grant added.
According to Grant, while Ripple may claim it is a currency rather than a security class, it is still at an early stage.
The SEC did not catch Ether soon enough so it is trying not to make the same mistake with Ripple.
“There is clarity, but the participants do not like the answers they receive when they ask the questions,” Grant said.
“That is not a lack of clarity, that is the regulator not paying attention early on and letting Ether through the net. Now the SEC is catching up and all the other crypto companies are not able to do the same,” he added.
“What we see today that people are claiming there is a lack of clarity is that middle ground where they do not have the ecosystem built yet, they want to, but they are not there yet.”
Critics of the increased crypto regulatory enforcement efforts argue that the uncertainty in the U.S. regulatory landscape discourages innovation. Senator Pat Toomey has warned Congress on several occasions that further regulation and enforcement would stifle innovation and push innovative fintechs away from the U.S.
However, when looking at crypto companies, these technological innovations are using the same old schemes to defraud people.
“Every possible scam and evil way of taking people’s money had already been invented by the time the U.S. adopted its securities laws in the 1930s,” Grant said.
“We have literally seen every scam that’s been tried in the traditional capital market being repackaged in the crypto markets,” Jim Preissler, managing partner at Tritaurian Capital, agreed.
What the regulators are now worried about is that nobody has been watching this space until very recently when the SEC started to strengthen enforcement, Preissler noted.
There is a reason why people have so much confidence in the U.S. stock market, and it is regulation, according to Preissler.
One of the three key missions of the SEC is to facilitate capital formation and it does so by requiring disclosures from companies to reduce the information asymmetry between issuers and buyers.
The U.S. has the single largest capital market in the world and that is because of its well-established regulatory framework, Grant stressed.
So what of the complaint from some cryptocurrency businesses that disclosure requirements are holding back innovation and preventing them from doing business?
According to Grant, this is a lot of nonsense: “It only means that it is slightly more difficult to start the business, but that was the intention, to make sure retail customers are protected from scams.”
“The claim that regulation stifles innovation and success is really an excuse because we do not see that in the U.S. stock market. In fact, quite the opposite,” Preissler added.
There is definitely a part of the crypto market that is interested in the unregulated, free-wheeling aspect of it because it brings in a lot of money and they can take advantage of and exploit this unregulated nature, he said.
On the other hand, there is also a camp that understands and tries to embrace regulation because they recognize that ultimately regulation will give confidence in the crypto markets and allow that broader penetration and mass market appeal that everybody really wants, Preissler said.
Although at this stage it might be convenient for some businesses to blame the lack of regulation and the negative impact of enforcement actions, the noose is tightening around non-compliant businesses as it becomes harder to escape from the sight of regulators.