It has been more than a decade since Satoshi introduced the world to the peer-to-peer electronic cash system called Bitcoin, and yet the regulatory landscape for crypto-assets remains a dark forest. After one of the most eventful years in crypto to date, what can we expect from the Securities and Exchange Commission and Commodity Futures Trading Commission (crypto’s primary U.S. market regulators) in 2023?
Securities and Exchange Commission
The SEC nearly doubled the size of its crypto-asset enforcement team in early 2022 and will likely continue to regulate by enforcement in 2023.
Michael Selig is counsel at Willkie Farr & Gallagher. This op-ed is part of CoinDesk's Crypto 2023.
SEC Chair Gary Gensler believes that the “vast majority” of crypto assets are securities. He said “probably only a few” may not be securities. While he might “think CryptoKitties is not a security,” the SEC is also reportedly investigating non-fungible tokens.
The SEC regards many crypto assets as a type of security called an “investment contract.” In SEC v. W.J. Howey & Co., the U.S. Supreme Court defined an investment contract as a contract, transaction or scheme whereby an investor invests money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
During his prior tenure as chairman of the Commodity Futures Trading Commission, Gensler oversaw the implementation of new swap market regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in the wake of the 2008 financial crisis. As SEC chair his approach to regulating crypto assets resembles his CFTC approach to regulating swaps. The Gensler-era CFTC disregarded industry opposition and leveraged the existing futures regulatory framework to hurriedly adopt a swaps regulatory framework that did not work for much of the market.
Read more: Adam Miller - 2023: The Year DAOs Follow the Law?
In the case of crypto assets, Gensler has “asked the SEC staff to work directly with entrepreneurs to get their tokens registered and regulated, where appropriate, as securities.” However, it appears unlikely that rules specifically tailored to crypto assets will be proposed during 2023. Gensler’s view is that most crypto assets are securities and therefore most crypto-asset issuers and intermediaries are subject to the same laws and regulations as other securities issuers and intermediaries. Gensler may face pushback from the Republican-controlled House Financial Services Committee in 2023, but is not likely to reverse course.
The regulatory narrative will continue to be shaped by the SEC’s enforcement actions. Since 2017 the SEC has brought dozens of actions for failing to register offers and sales of crypto assets as securities. These actions have mostly involved “utility tokens” sold in the days of initial coin offerings. The legal theory advanced by the defendants in many of these cases has been that the crypto assets were not part of an investment contract because the assets had consumptive use and therefore purchasers should not have reasonably expected profits. But lower courts have thus far rejected this argument, concluding that a crypto asset may be sold as part of an investment contract even if it has consumptive use.
More recently, crypto projects have shifted their focus to decentralization and community ownership. It is common for projects to issue crypto assets as a means of distributing governance and control over a network, protocol or organization to a broad and dispersed community. The legal theory likely to be advanced by these projects under the Howey Test is that such crypto assets are not securities because there is no “other” upon which holders of the crypto asset rely to earn profits.
As certain of the SEC’s more longstanding lawsuits against crypto-asset issuers conclude next year, the SEC may announce novel enforcement actions involving crypto assets associated with more decentralized crypto networks, protocols and organizations. The CFTC brought its first enforcement action against a decentralized autonomous organization this year and it may not be long before the SEC follows suit.
Gensler has emphasized that crypto market intermediaries (“whether they call themselves centralized or decentralized”) must register with the SEC. This signals that the agency may prioritize actions against intermediaries in 2023. These actions could test the theory that a crypto asset initially offered or sold as part of an investment contract remains an investment contract even when it is traded in secondary markets. In this regard, SEC v. Wahi, where the SEC alleges a crypto-asset exchange (Coinbase) employee engaged in insider trading, is a case to watch.
Commodity Futures Trading Commission
The CFTC has limited authority over crypto assets. It has exclusive jurisdiction over commodity derivatives, but only holds anti-manipulation and anti-fraud jurisdiction over commodity spot transactions. Its jurisdiction over crypto assets is based upon its position that bitcoin, ether, tether and other crypto assets are commodities.
CFTC Chair Rostin Behnam has requested “clear authority to impose [the CFTC’s] traditional regulatory regime over the digital asset commodity market.” Earlier this year, bipartisan legislators in the U.S. Congress introduced competing bills that would each establish a crypto market intermediary registration regime overseen by the CFTC. These bills are likely to be reintroduced in 2023. After recent crypto market events, a comprehensive crypto bill that expands the CFTC’s jurisdiction may see broad support. However, neither bill would establish a bright line between SEC and CFTC jurisdiction over crypto assets. Gensler believes that most crypto assets are securities and Behnam has not challenged this view. In fact, he has advocated for “shared responsibility” between the agencies. Regardless of what happens on Capitol Hill in 2023, the CFTC is unlikely to win jurisdiction over all crypto assets.
The CFTC has been active in regulating by enforcement. More than 20% of the agency’s enforcement actions in 2022 involved crypto assets, and it is not likely to let up in 2023. Although the agency does not comprehensively regulate crypto-asset spot markets, the CFTC has recently begun to seek crypto-asset trading bans against defendants. This signals that the agency regards itself as the cop on the beat for non-security crypto asset markets. The CFTC’s lawsuit against the Ooki DAO made headlines this year because it raised novel legal questions. One question: Are decentralized autonomous organizations (DAO) “unincorporated associations” and can they be served with notice of the lawsuit through an online chatbot and forum? This is a case to continue to watch in 2023.
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The crypto-asset regulatory landscape will likely remain a dark forest in 2023. SEC Chair Gensler believes the majority of crypto assets are securities but is not in favor of new crypto market rules or guidance. On the other hand, CFTC Chair Behnam seeks additional CFTC authority over crypto assets but the agency is currently limited in its ability to issue rules or guidance for these markets. While crypto projects continue to push the boundaries of decentralization and community governance, the SEC and CFTC will likely push the boundaries of their existing authorities through novel enforcement actions. With neither agency poised to issue new crypto rules, 2023 will be the year of regulation versus decentralization.