Many are speculating what the change in presidential administrations may bring for the crypto space. In particular, the imminent installment of Gary Gensler as SEC chairman has captured the attention of many, as, to date, the SEC has been one of the most active regulators in the space. Not to be left out of the discussion, this article looks at how Gary Gensler’s SEC might approach the crypto space. From a high level, it is pretty instructive that Gensler views the space through a public policy lens and has cited the need for more of a public policy framework. If we then back up to the SEC’s three-part mission: to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, Gensler will be balancing these interests as he guides the SEC’s policy-based approach to the space (with the caveat that any coordinated SEC action would need buy-in from a majority of SEC commissioners).
Background and Thoughts on Gensler’s Approach
For some background, I had previously watched Gensler’s MIT blockchain course and it gives a great snapshot of his views. Namely it showcases his understanding of distributed ledger technology at a deep level, including the underpinnings behind it, implications of its use and potential applications. He also knows the market landscape, including the players, and has been thinking and talking about a policy approach to the space for years. Gensler has stated that when he looks at technology, he believes it needs to live within public policy norms and frameworks, including guarding against illicit activities and, where in the SEC’s domain, investor protection frameworks.
A couple of notable takeaways from his course and past public engagements:
- When referencing blockchain, he has made analogies to the internet era. He has expressed that he doesn’t have a vested interest in whether blockchain tech takes off or not, he sees some potential in the tech and is certainly academically interested in the intersection of tech, finance, and public policy.
- He views the top factor hindering blockchain adoption as a lack of use cases. So far, the killer app has been crowdfunding (non-compliant with law) but if that could be tamed and funneled into an investor protection compliant vehicle, he believes there is something there. He views speculation as a use case as well, but it is yet to be determined whether it could change the world of payments. Market infrastructure in securities settlement could benefit from the tech as can payments processing.
- He frequently uses the analogy of the blockchain duck test and if it quacks like a duck, it’s a duck - even if it is a robotic duck. For public policies purposes, if it acts like a duck you are going to use common sense to regulate it like a duck.
- Gensler seems to agree with the SEC stance that most token projects are securities offerings and he doesn’t necessarily buy that token projects are decentralized.
While he has offered his fair share of critiques, Gensler is not a blockchain skeptic. He has in the past at congressional hearings pushed back at assertions that crypto is some sort of a Ponzi scheme based on the fact that it isn’t backed by anything. Gensler has proffered counterpoints to this line of thinking by stating that “there’s really nothing behind gold either … what’s behind it is a cultural norm, for thousands of years we liked gold. We do it as a store of value, so bitcoin is a modern form of digital gold. It’s a social construct.” In this sense, he may be at odds with the stance Yellen seems to be taking, which seems more skeptical and hostile. While he isn’t likely to be more permissive, he doesn’t believe the goal should be to regulate blockchain. He believes regulators should be technology neutral and appropriately regulate its applications, regulating so that investors are protected against fraud and any manipulation in the markets to strengthen and promote confidence in the markets.
As a regulator, you have to walk a tightrope of balancing between competing interests—this includes encouraging capital formation while protecting investors. In doing so, lines need to be drawn and as with any compromise, no one is ever going to be completely happy with where those lines end up. For instance, there are some core beliefs in the space around privacy rights, personal autonomy, and freedom. I would predict that Gensler would not put those interests above investor protection concerns.
Prefacing this that I am not exactly Miss Cleo, below are some thoughts around Gensler’s possible priorities in the crypto space. No refunds for these if they don’t come to fruition so don’t ask.
Prediction 1 - More Regulations, a Policy Framework
So just like to a surgeon, everything requires surgery—regulators are going to want to regulate. Hence, I do think we can make some predictions based on Gensler’s background as a regulator and the former head of the Commodity Futures Trading Commission (“CFTC”). Again, he is public policy oriented so my unsurprising prediction is that I think we will see more regulation but more regulatory coordination and the build out of more coherent policy frameworks. If there is a will among the commissioners to pass guidance, he is probably less inclined to lead by enforcement as others. That isn’t to say there won’t be enforcement, I think he will vigorously pursue fraud but I do think there will be a shift in enforcement from solely picking off the little guy (and big guy) token projects to regulating the market behaviors of the crypto institutional actors and the incumbent actors in the crypto space.
To be clear, I don’t think Gensler will be putting undue focus on crypto and will instead focus on regulating Wall Street to a great degree. At the same time, the line between crypto and traditional finance is increasingly blurred. Historically, there was a tension because market incumbents wanted to be in the space because volatility is their friend but there was reputational risk being in the space. However, over the past few years, market incumbents have really stepped into the space and crypto native companies have become institutional players (i.e., Coinbase, Gemini, etc.), with both shifts to the mainstream serving the interest of market participants through an increased professionalization of the crypto market, which could be further bolstered by coordinated regulatory oversight to ensure market stability and integrity.
Prediction 2 - Focus on Markets
As alluded to above, Gensler has indicated a focus on ensuring efficient markets and I expect he might switch the SEC’s focus from exclusively going after token projects to regulating secondary markets, focusing at least initially on the centralized exchanges, if there is buy in at the federal level that the SEC (as opposed to the CFTC or state regulators, as is currently the case) should play this role. That means, more of a focus on the exchanges and tamping down bad acts to shore up the stability of the market.
I think one of Gensler’s main focuses will be to regulate market infrastructure and exchanges, possibly with a push for a consolidated federal framework as opposed to state by state patchwork. To date, exchanges have been able to list and make money off transaction fees for tokens that may well be securities and just delist if the SEC goes after a project. This is a pretty nice position for crypto exchanges—taking all of the upside on these and not much in the way of downside. I do not believe that will continue. Many also used to think that because certain exchanges like Coinbase were closer to regulators and embraced things like the BitLicense, there was some sort of implicit regulatory consensus around the coins they listed. The Ripple enforcement proved that isn’t the case, which puts exchanges in the position of asking for forgiveness instead of permission on these assets that end up being securities. Combine that with the fact that retail investors end up losing their shirt when these assets get delisted, you can easily see how regulators would have an interest in quashing this behavior given that the exchanges are culpable and complicit in harming investors by giving the unregistered securities a market, access to retail investors and liquidity.
Gensler has indicated that he thinks all exchanges should be registered with the SEC or CFTC. He has expressed that he is regulator-neutral but holds the belief that either agency is well equipped to regulate them and there is not a need for a new regulator to oversee crypto markets. In his Libra testimony, he indicated that exchanges have been a honeypot for theft and cybersecurity issues and as a result, he thinks custody issues are a big problem in the space. He views the current state as untenable—that crypto market bad actors engage in market manipulation, wash trades, and other errant acts, and are not regulated. In terms of tailoring regulations, he has stated that he believes the exchanges could become alternative trading systems (“ATS”) and figure out what they can do under current regulations, what they cannot do, what is hard to do, and then request appropriate no-action letters.
Prediction 3 - Clarity on Current Regulatory Frontiers
Finally, and inevitably, I think there will be some sort of guidance on the current frontiers of the space; namely stablecoin products, NFTs, and the DeFi space. There may be additional enforcement of DeFi token issuers using a securities law analysis but also in line to the shift to focus on markets, there will be increased scrutiny on DEXes and NFT marketplaces.
With respect to stablecoins, the SEC recently spun out FinHub so there will be continuity in that respect and, to date, the SEC has said it’s a facts and circumstances determination whether a stablecoin is a security, indicating that algorithmic stablecoins look more like securities than other products in the space. Gensler has also weighed in on Libra, Facebook’s stablecoin, saying that it looks like an ETF in that they are taking your money and investing it in a basket of currencies. He proffered that if current law doesn’t put products like Libra into the purview of the SEC, Congress should fix that. While the lines in this area are yet to be drawn, what is clear, if you listen to Gensler’s Libra (now Diem) testimony, no one in the space is getting a pass. Gensler understands the tech intimately, which helps him understand the risk heat maps in the space. Calls for the SEC to take a hands-off approach to just let people innovate will not be convincing. I think he will extend SEC frameworks to cover novel instruments if the interest of investor protection is served.
However, as a general guidepost here, there is likely to be regulatory coordination on these fronts. Gensler does not believe the SEC needs jurisdiction over any, or all, of the space. However, Gensler does believe disclosure is important for all financial and investment products. He has stated that when you use other people’s money, you should expect some regulator would have an interest in that. For the crypto space, that could mean regulators (SEC, CFTC, banking regulators, and other agencies, as appropriate) confirming there are appropriate safeguards in place to ensure your custody is adequate and you aren’t engaging in malfeasance.
Overall, and this is biased as I am a lawyer that focuses on regulatory issues in the crypto space, I think Gary Gensler will be great for the space, not because he is a crypto apologist but because he is a technocrat. There is a lot of talk about the need for regulatory clarity—but it is a “careful what you wish for” scenario. I doubt there will be a widespread sense of relief when regulators start regulating as a lot of actors have benefited from the uncertainty and lack of clear lines—particularly crypto exchanges and VCs. However, as the space matures, more regulatory oversight is inevitable, and I am interested in smart, nuanced regulations. Gensler will focus on investor protection, make no mistake. In short, there is also probably a continuity of the SEC’s stance against “semantic gymnastics” and a focus on the facts and circumstances, but probably more clarity and bright lines through the use of public policy frameworks.
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