SEC Under Gensler: Crypto Power Grab or Effective Protection?

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The US Securities and Exchange Commission (SEC) has long been a thorn in the side of the crypto ecosystem — and chairman Gary Gensler represents the very tip.

Securities regulations and the token economy don’t exactly mix. SEC watchdogs still map digital assets to the 76-year-old Howey Test with varying success: small-time operators are often stung while major cases tend to end in settlement.

The SEC issued guidance on how it squares digital assets with Howey back in 2019. Gensler has previously stated that most tokens on the market could be securities or investment contracts, bar bitcoin and potentially ether — toeing the line etched by his predecessor Jay Clayton.

“Nothing about the crypto markets is incompatible with the securities laws,” says Gensler. But until the SEC builds a clear and novel framework in which to operate, tailored specifically for the crypto space, startups and their legal teams must read between the lines before launching in US jurisdictions.

Many firms nix the US altogether (and New York especially so) to avoid sudden SEC strikes. Crypto exchanges too are also unsure which tokens are indeed securities. This leads to fewer listings on US platforms compared to offshore counterparts operating in comparatively lax jurisdictions. 

Clear regulations have rarely felt so important, now, some three weeks after the FTX calamity. But what does Gensler’s SEC career thus far reveal about what’s in store for the digital asset space?

2021: Gensler pushes for broader SEC powers to police crypto

President Joe Biden first nominated Gensler to the role of SEC chair in Feb. 2021, a move ratified by the Senate two months later. Years earlier, Gensler was teaching blockchain and crypto topics at the Massachusetts Institute of Technology, with his lectures still available online.

“I would be surprised if 10 years from now [blockchain] isn’t somewhere in the financial system in a meaningful way,” Gensler said in 2018. Gensler previously served as chairman of the Commodity Futures Trading Commission (CFTC) for nearly five years, between 2009 and 2014.

His resume, combined with a working understanding of blockchains and cryptocurrencies, had some hopeful of a more nuanced SEC.

If crypto is going to be widely adopted, it needs some rules of the road & a cop on the beat to enforce them.

To be clear, I am technology-neutral.

What I’m not neutral about: Investor protection.

— Gary Gensler (@GaryGensler) August 3, 2021

SEC chair Gary Gensler appeared in a number of short clips detailing the SEC’s view on crypto last year.

But the veteran regulator still inherited the Ripple Labs case, arguably the most significant SEC action since Block dot one back in 2019. The matter, which declares XRP a security, was pushed by former chair Clayton some 16 months prior to Gensler’s appointment.

The Ripple case could be headed for summary judgment after nearly two years of legal squabbling, with the outcome set to impact the crypto industry more than the Block dot one settlement.

In fact, there were only a handful of crypto-related SEC actions under Gensler in 2021, including charging promoters of BitConnect, a fraudulent crypto scheme from 2018, and operators of a phony investment firm promising outsized returns through digital asset trading.

Gensler’s first year at the SEC is more appropriately surmised as a push for a wider purview. The SEC had historically focused on token-related cases involving fraud or harm to investors, but Gensler made his case to Senator Elizabeth Warren last August for Congressional authority to police crypto exchanges, DeFi protocols and centralized lenders, claiming that many deal in unregistered securities. 

Patrick McHenry, top Republican on the House Financial Services Committee, quickly labeled the move a “blatant power grab.”

One month later, top US crypto exchange Coinbase announced it would cancel plans to launch a crypto lending product after the SEC threatened legal action. 

7/ Look….we’re committed to following the law. Sometimes the law is unclear. So if the SEC wants to publish guidance, we are also happy to follow that (it’s nice if you actually enforce it evenly across the industry equally btw).

— Brian Armstrong (@brian_armstrong) September 8, 2021

Coinbase CEO Brian Armstrong remained defiant in the face of SEC’s legal threats

Coinbase Lend accounts would’ve offered users up to 4% interest on USDC deposits, but Gensler’s SEC deemed the products securities, a view emphatically denied by Coinbase. 

The SEC’s action against Coinbase over Lend only ever amounted to a Well’s Notice — basically written intention to sue if the product was launched — with no case actually filed.

2022: Coinbase case a Trojan horse for securities suits

Gensler’s SEC has been more prolific in its crypto cases this year. In January, Gensler directed staff to figure out how to get “these platforms inside the investor protection remit,” amid emerging hints of probes into crypto lending products offered by Celsius, Voyager and Gemini.

One month later, the agency fined crypto lender BlockFi $100 million for failing to register its own retail crypto lending product as a security. The case marks the first of its kind against crypto lenders, fulfilling in part Gensler’s intent outlined in his letter to Warren. 

Gensler again pushed the idea of greater crypto exchange oversight in Apr. 2022. He raised compelling trading platforms to register with the regulator while requiring segregation of asset custody to minimize risk of losses.

“There’s no reason to treat the crypto market differently just because different technology is used,” Gensler said at the Penn Law Capital Markets Association’s annual conference at the time. “These crypto platforms play roles similar to those of traditional regulated exchanges. Thus, investors should be protected in the same way.”

Of the 1,300 people working at the agency, roughly 30 were dedicated full-time to crypto enforcement. The SEC in May pledged to bolster its crypto headcount to 50, while Gensler criticized crypto exchanges for offering multiple services — custody, trading and market making — which is frowned upon in traditional markets. 

Reports have indicated that the SEC is investigating failed projects including Terra and the bankrupt crypto lenders, but the agency is yet to disclose enforcement actions against any of them.

The SEC claims to be a “cop on the beat” for crypto. It should be!

But unfortunately, as Jim Chanos puts it, they’re more archaeologists than detectives: they wait until things go wrong & then show up to dig for details.

Case in point: ignoring Celsius, but going after BlockFi.

— Jake Chervinsky (@jchervinsky) August 25, 2022

SEC cases against big name failed projects could be on the horizon

Instead, the SEC has brought seven cases related to cryptocurrency in 2022, aside from BlockFi. Some are on brand for the SEC and cover overt fraud, such as a $300 million pyramid scheme and a dodgy profit-sharing scam that reaped investments worth $124 million.

There’s also the charges against apex influencer Kim Kardashian for touting SafeMoon clone EthereumMax to her Instagram followers, echoing cases against Steven Seagal, Floyd Mayweather and DJ Khalid in years past. Both case genres are worthy pursuits.

The SEC’s action against a former Coinbase product manager over alleged insider trading appears more significant. For one, it’s a crypto exchange matter, which Gensler flagged intent to police. But the case could ultimately deem a string of tokens as securities, providing a springboard for future SEC enforcement — especially if the Ripple Labs case ends in anticlimactic settlement.

It’s this kind of regulation by enforcement that has much of the crypto industry at arms with Gensler’s SEC, with neither side appearing eager to meet in the middle any time soon.

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