The chairmen of the Securities and Exchange Commission and the Commodity Futures Trading Commission will testify before Congress Tuesday on one subject and one subject alone: cryptocurrencies.
Panic, hype, price swings and an inane rush to tokenize everything may be the impetus for this hearing, but the message we will likely get from the chairmen won’t be apocalyptic. Instead, expect a confident duet: “We got this.”
The fact is that federal regulators have been thoughtfully on top of cryptocurrency issues for years. And if more oversight is needed in new digital currency markets, that power would best rest with the federal authorities, rather than with the states.
The SEC has rightly shown that several public sales of new tokens inspired by bitcoin fit the definition of securities issuance and, therefore, should have been registered offerings. They started with a warning shot — a thoughtful investigative report last summer — rather than a fusillade of enforcement actions. They have since followed up with targeted enforcement actions. First against clear scammers, and later against naive entrepreneurs who had real products but a poor understanding of regulation, and with those more innocent cases they have not sought civil monetary penalties.
They have also begun an important process of drawing a distinction between “initial coin offerings” that are securities on the one hand, and decentralized cryptocurrencies on the other, which don’t fit the bill and are more suitably regulated as digital commodities such as digital gold (bitcoin), digital fuel (ether), or digital real estate (filecoin/storj).
The CFTC has already classified bitcoin and similar cryptocurrencies as commodities and it has, accordingly, been regulating derivative financial products, such as swaps and futures offerings from several exchanges, such as the CME, CBOE and LedgerX. The CFTC has also been clear that it has the authority to police cryptocurrency spot markets for fraud, market manipulation and insider trading — and investigations are underway.
If this all surprises you, maybe it’s because some on Twitter — or the cable news you’ve been barraged with — claim that bitcoin is unregulated. To be clear, it’s not unregulated. There is, however, one thing that distinguishes a bitcoin spot market from a securities or commodities futures exchange: marketplace supervision.
The SEC only supervises exchanges that trade in securities. The SEC has not, however, deemed all cryptocurrencies to be securities, and there are compelling legal and policy reasons why such sweeping classification is unreasonable. Who, after all, could be the issuer of bitcoin? Miners? Software developers? This is rather like asking if gold is a security and then trying to determine who in the gold industry is the issuer of gold. Gold, a valuable asset that exists in the world independent of any promises from a third party issuer or promoter, is rightly classified and regulated as a commodity, just like bitcoin and similar cryptocurrencies are and should be.
The CFTC, while it supervises commodities futures exchanges, only has after-the-fact enforcement authority over fraud in spot markets — it does not license and supervise those markets directly.
The supervisory regulators of digital currencies are, somewhat by historical accident, state-by-state money transmission regulators. This means that digital currency exchanges must acquire a license in each and every state in which it has customers, comply with each different state’s differing regulations and explain their business to over 50 different regulators. If that seems odd and inefficient to you, you're not alone. In a recent joint op-ed for the Wall Street Journal, Chairmen Clayton and Giancarlo said they “would support policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era.”
They’re right. State-by-state regulation of inherently global internet money transmitters is inefficient and hurts innovation, financial inclusion, consumer protection and American competitiveness.
The big problem with respect to investor protection, however, is that state money transmission licensing is focused pretty exclusively on solvency and custody risks, not markets. When a customer hands over funds to a money transmitter, they have to trust it to not lose, steal or misdirect their money. The relatively simple issue of ensuring the solvency of digital currency exchanges aside, state money transmission regulations were never intended to deal with emergent investor protection issues inherent in high-volume marketplaces facilitating trading of a variety of speculative new digital assets amongst hundreds of thousands or even millions of active traders.
All told, should investor protection issues in digital currency spot markets need to be addressed via a new supervisory regime, they would be best addressed through a new regime crafted in legislation and perhaps seated within the CFTC. Much of that regime would be focused on investor disclosures, market transparency and guardrails to prevent and police fraud, market manipulation and insider trading, but the legislation should also deal with the more straightforward issue of licensing for exchanges that play a role as custodians and payment providers. It makes no sense to have 53 states and territories offering conflicting regulations in that arena either.
The public policy goals of state money transmission regulators could be subsumed within a larger, CFTC-administered investor protection regime, and state money transmission laws could be fully preempted for newly CFTC-regulated digital currency exchanges.
We’ve yet to see whether there’s any real appetite for that new federal supervisory regime, and it would have to be done through an act of Congress, no small feat. For now, though, it's good to know that the preeminent investor protection regulators here in the U.S., the CFTC and SEC, have got the early policy issues in these new and exciting markets covered.