• L Misthos and M Bacina

Square peg round hole: Gensler urges registration of crypto-assets despite regulatory mismatch

The Chairman of the United States Securities and Exchange Commission (SEC), Gary Gensler, has reiterated his reductive approach to the regulation of cryptocurrency and digital assets in a speech titled 'Kennedy and Crypto'.

Presented as part of 'SEC Speaks', Gensler opened by recognising past leaders of the US and its landmark investor protection legislation: The Securities Act of 1933, the Investment Company Act of 1940 and the Securities Exchanges Act of 1934. Gensler repeated his previous views that he considers that almost all crypto-asset tokens are 'securities' (noting the speech does not purport to be official SEC policy) and that:

Nothing about the crypto markets is incompatible with the securities law. Investor protection is as relevant, regardless of underlying technologies.

Few could disagree with the second sentence, but the first sentence raises serious concerns. Despite instructing his SEC staff to encourage entrepreneurs to have their tokens registered and regulated under existing securities law, only a tiny 'handful' of crypto tokens have managed to be registered as securities, which suggests some incompatibility must exist. Indeed, in many cases, the nature of and rights attaching to crypto-assets are quite different from traditional securities. In the years since the SEC's Munchee Order, the DAO Report and other 'regulation by enforcement' actions have hit US crypto projects, standing in stark contrast to Gensler's invitation to projects to 'come in' and register.

Interestingly, Mr Gensler's approach is also at odds with a number of significant bipartisan reform proposals currently making their way through the US Congress, including the draft Responsible Innovation Act and the draft Digital Commodities Consumer Protection Act.

Despite the reality of crypto-asset regulation not being fit for purpose in the US becoming increasingly clear, Gensler remains steadfast in his view that:

Not liking the message is not the same as not receiving it

It appears that Mr Gensler, unlike other Commissioners, wants innovation in digital assets only to occur in the narrow ways that laws designed for a centralised financial system will permit. Commissioner Pierce has been praised for calling out the lack of regulatory fit in the US, and pressing for sensible reforms and Commissioner Uyeda in a recent speech also said:

Rulemaking can be challenging and time-consuming. It may be tempting to develop “new” interpretations of existing statutes and rules and apply them through enforcement action. This temptation should be avoided.

He continued in noting the two key issues are:

does the crypto asset constitute a security and, if so, how do market participants comply with the federal securities laws and the Commission’s rules. To date, the Commission’s views in this space have been more often expressed through enforcement action. This is an example of a situation where regulation through enforcement does not yield the outcomes achievable through a process that involves public comment.

(our emphasis)

Many jurisdictions face similar problems, with a substantial education gap meaning that often the suggestion is made that cryptocurrencies should be simply regulated like a "normal" financial product. The fundamental differences between centrally issued and controlled financial products with walled markets permitting trading only under strict rules with carefully admitted participants, and the freeflowing nature of global permissionless blockchains prevent an easy fit.

Few major regulators have set out for crypto projects a path by which they can comply with securities laws and overcome requirements which are entirely sensible for a centralised system but become illogical when applied to a decentralised system. The current approach of some is to suggest that there is only decentralised theatre at work, and in truth small groups of centralised individuals operate crypto projects. While that may be true for some projects (a great number in the early stages of a crypto project as they journey towards fully decentralised decision-making), it is not the case for many more established projects.

The SEC has a history of crypto 'regulation by enforcement', launching a range of investigations and lawsuits against crypto projects such as Coinbase and Uniswap Labs. This is despite concerns voiced by the industry as to the lack of clear guidance as to what features the SEC will or will not regard as indicative of whether a crypto-asset is a security and examples of how a crypto project can register under existing US securities laws. Coinbase's General Counsel recently called out the regulatory mismatch and suggested a proper fit for purpose regime be developed.

To date, there is no example provided by the SEC as to how a decentralised crypto project could comply with US securities laws, and projects are left with a choice to try and register their tokens as securities (and accept the significant costs, delays, practical limitations and uncertainty as to how or whether they can in fact comply), avoid the US market entirely, or risk being the next target of the SEC.

At some point, the "technologically neutral" approach taken by regulators in relation to crypto-assets may need to be revisited. Laws have had to address specific technologies of cars, radio, mobile phones, tv and the internet, and it seems increasingly likely that the activity based regulation of financial services will need to evolve to accommodate both investor and consumer protection and the technological innovations brought by decentralised technologies.