2024: The Year of Regulatory Compromises

After a year of conflict between crypto companies and agencies like the SEC and CFTC, we can expect to see greater dialogue and progress on regulation in 2024, says Michael Selig, of Willkie Farr & Gallagher.

AccessTimeIconDec 18, 2023 at 4:23 p.m. UTC
Updated Mar 8, 2024 at 6:49 p.m. UTC
AccessTimeIconDec 18, 2023 at 4:23 p.m. UTCUpdated Mar 8, 2024 at 6:49 p.m. UTC
AccessTimeIconDec 18, 2023 at 4:23 p.m. UTCUpdated Mar 8, 2024 at 6:49 p.m. UTC

In the wake of the implosion of multiple crypto operators in 2022, a phalanx of administrative agencies descended upon the industry, declaring it “rife with fraud, scams, bankruptcies, and money laundering.” In an effort to remedy these perceived defects, the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) collectively brought more than 200 enforcement actions against crypto industry participants over the course of 2023.

Like an autoimmune response that is unable to distinguish good from bad, the agencies filed lawsuits against both those that skirted the law and those that attempted to comply with it. Among those ensnared by the agencies’ enforcement dragnet were a distributor of uniquely-generated animated cat JPEGs, a decentralized autonomous organization and numerous celebrity “influencers,” including Kim Kardashian, Paul Pierce and Lindsay Lohan.

This post is part of CoinDesk's "Crypto 2024" predictions package.

The regulators deemed seemingly every industry participant to be running afoul of Depression-era laws with questionable applicability to crypto and dismissed petitions for more fulsome rulemaking. But, as the year winds down, the SEC is nursing two black eyes from losses against Ripple and Grayscale in federal court and the CFTC now seems more interested in settling actions with crypto exchanges than engaging in protracted litigation with them.

If 2023 has been the year of regulation versus decentralization (as I predicted last December), next year may very well be one of regulatory compromises. It is unlikely that Congress will pass comprehensive crypto legislation during an election year, but regulators may opt to pare back a failing regulation-by-enforcement strategy and instead work collaboratively with industry to develop an interim regulatory framework through a combination of notice and comment rulemaking and no-action relief.

Crypto industry participants and regulators have a common interest. Both were caught in the same rug-pull late last year (following FTX’s implosion) and should want to prevent bad actors from once again crippling the good despite the unlikelihood of an immediate legislative solution.

While it is unlikely SEC Chair Gary Gensler will let up on his crusade against the perceived “wide-ranging noncompliance” within the industry, the SEC and other crypto regulator hopefuls will need to make compromises next year. Grayscale’s legal challenge to the SEC’s rejection of its spot bitcoin exchange-traded fund (ETF) application resulted in a unanimous three-judge D.C. Circuit Court of Appeals panel holding that the SEC’s action was “arbitrary and capricious.” The U.S. Court of Appeals for the Third Circuit also required the SEC to respond to a petition for rulemaking on crypto asset securities.

This uprising against administrative agency overreach extends well beyond the crypto industry. In a lawsuit brought by the Chamber of Commerce against the SEC, the Fifth Circuit Court of Appeals ruled last month that the SEC acted arbitrarily and capriciously by failing to address industry comments and conduct a proper cost-benefit analysis with respect to a rulemaking related to share repurchase disclosures.

And the SEC must defend against a lawsuit brought by six industry groups alleging that the agency exceeded its statutory authority in adopting new private fund adviser regulations. Additionally, the Fifth Circuit Court of Appeals recently told the CFTC that the agency abused its discretion by withdrawing a no-action letter without providing any supporting reasoning and a CFTC-registered exchange is suing the agency for arbitrarily and capriciously rejecting its bid to list new event contracts on its platform.

These types of legal challenges to administrative actions are likely to continue to circumscribe and force the hand of the regulators next year. As a result of the Grayscale decision, the SEC recently authorized a futures-based ether ETF and it is rumored that the agency will approve a spot bitcoin ETF as soon as January.

After the U.S. Court of Appeals for the Third Circuit mandated that the SEC respond to an industry petition for rulemaking, the SEC opted to reject the petition. But Chair Gensler’s accompanying public remarks were a far cry from his prior statement that “probably only a few” crypto assets “may not be” securities. “Of course, . . . not every crypto asset is necessarily offered and sold as a security . . . [and] I look forward to working with crypto projects and intermediaries that wish to comply with the law,” he now says.

Although the SEC does not intend to propose a comprehensive regulatory framework for crypto, the agency has proposed a handful of new regulations subject to finalization next year that would impact crypto industry participants. SEC proposals to redefine the definition of an “exchange” to include “communication protocol systems” and require investment advisers to custody crypto assets with a qualified custodian, if adopted in current form, are likely to result in similar administrative law challenges. Multiple industry groups and crypto firms claim that the SEC has violated the so-called “major questions doctrine” by proposing these regulations without clear Congressional authorization to do so, among other complaints. The reality that these regulations may be held up by legal battles and then abandoned in the event of a change in administration may prompt the SEC to make significant concessions.

Crypto industry participants will also have reason to expand interactions with agency staff beyond those compelled by a subpoena next year. As institutional demand for crypto continues to increase, industry participants seek to offer a broad swath of products that will require collaboration with regulators.

For example, many types of tokenized real world assets (RWAs) are very clearly within the SEC’s jurisdictional ambit and will require SEC staff buy in. Exchanges that hope to offer crypto margin trading and perpetual futures within the U.S. will need CFTC approval. And prudentially-regulated financial institutions that seek to offer stablecoins and other crypto products will not be able to do so without the authorization of their supervising regulators.

After a long year of legal battles, in the new year we can expect the crypto industry and regulators to warm up to one another (if ever so slightly), and this will be a net positive for all.

Edited by Benjamin Schiller.

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Michael Selig

Michael Selig is Counsel at Willkie Farr & Gallagher.

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