All crypto eyes were on Washington this week as Gary Gensler drew a line in the sand on securities laws and a battle brewed over an infrastructure funding bill that would seek to tax cryptocurrency transactions. We take a look at the first of those stories in today’s main column and the second in “The Conversation.”
One remark the Securities and Exchange Commission chief made about a need for more international harmony and less “regulatory arbitrage” around crypto policymaking provides an interesting framing for this week’s “Money Reimagined” podcast episode, which focuses on Ireland, its tax laws, and how policy differentiation can help smaller countries catalyze ecosystems of innovation.
Have a listen after reading the newsletter.
Gensler dispels wishful thinking
The great disappointment that many in the crypto community felt from Gary Gensler’s speech this week reflected, more than anything, how wishful thinking can trump facts. His letter-of-the-law message that most tokens are subject to securities laws was entirely predictable.
That doesn’t mean people shouldn't be frustrated by the SEC chairman’s online address to the Aspen Institute’s Security Forum, described by crypto legal commentator Katherine Wu as the “the most aggressive and hostile stance re U.S. crypto regulation to date from the SEC.” In fact, it should motivate them to do more to mollify increasingly hostile policymakers in Washington.
The reality is that in sharing his predecessor Jay Clayton’s view that “every ICO I’ve seen is a security,” the new SEC Chief made no substantive departure from what he’d expressed before. I know this because I worked with Gensler at MIT’s Digital Currency Initiative, where he would frequently cite the “walks like a duck” test to argue that initial coin offerings seemed to meet the Howey Test for what constitutes a security.
When he was named to this position, Gensler’s experience teaching blockchain classes at MIT fueled excessive hope that the industry would now enjoy a friendlier SEC. But Gensler’s deep knowledge and interest in the technology – including an expressed belief that it holds potential to tackle unfair rent-seeking practices within the legacy financial system – never implied that this seasoned regulator would waiver from a strict interpretation of the facts before him.
You see, the professor-cum-SEC chair was right then, as he is now, that in terms of the SEC’s worldview, token projects involving issuances to investors almost always have the features of a security. Look at them with a regulator’s lens and you’ll see the three unmistakable Howey Test features: an “investment of money” in a “common enterprise” with an “expectation of profit derived from the efforts of others.”
I also believe he’s (mostly) right in arguing – as he did on Tuesday and always did at MIT – that for a new, innovative technology to be impactful at scale it needs to be brought within scope of public policy.
A need for leniency
Where Gensler and I tended to disagree during our time together was on the extent to which regulatory agencies should give latitude to cryptocurrency and blockchain developers for that innovation to thrive. However clear securities laws may be, I believe it’s important that financial innovators be given some time-bound degree of freedom from regulatory risk if they are to have the chance to disrupt the incumbents of the existing financial system.
So, I was especially disappointed on Tuesday that his speech gave zero hints of any compromise on this issue. Gensler made no mention, for example, of SEC Commissioner Hester Peirce’s proposal for a “safe harbor” provision that would give crypto startups a three-year grace period to build and launch their projects before they have to worry about federal securities laws.
Instead, the spirit of his message was punitive, focused predominantly on the risks posed by cryptocurrencies, both to investors and national security, and tapping broad, negative stereotypes to describe those risks. While he alluded to his belief in cryptocurrencies’ potential, Gensler seemed more intently focused on their dangers.
I believe he was motivated by a desire to set the legal record straight. Many startups were given flawed advice that their projects would be exempt from SEC filing requirements. Gensler’s speech brought home that point and made it harder for fee-seeking lawyers to opportunistically tell idealistic founders what they want to hear.
The bigger problem, though, is the second-round political effects of his tough-on-crypto stance. Generalizations without context – such as this one: “to the extent that [crypto] is used as [a medium of exchange], it’s often to skirt our laws with respect to anti-money laundering, sanctions, and tax collection” – pump oxygen into the crypto skepticism growing in Washington.
Gensler’s opinion carries weight in the U.S. capital. He held senior positions in the Treasury Department during the Clinton Administration and as the chairman of the Commodities and Futures Trading Commission under President Obama he oversaw some vital post-financial crisis reforms. His stance will empower the likes of Senators Elizabeth Warren (D-Mass.) and Sherrod Brown (D-Ohio), who are calling for draconian limits on the industry.
Giving bankers a free ride
Some might argue that Gensler’s statements on ICOs don’t matter. Clayton’s pronouncements and early SEC lawsuits were already instrumental in killing off the hype-filled ICO boom in 2018, which was mostly a good thing. And exchanges have put restrictions in place to prevent U.S. investors from buying many tokens that were deemed in breach.
But Gensler appeared to have a wider focus than those past ICOs. In citing a need to regulate decentralized exchanges, he made it clear the SEC has its sights on decentralized finance (DeFi) and on the various governance tokens that drive it. Whether they are described as “ICOs” or not is irrelevant. That could do a lot of harm to the sprawling, expanding DeFi ecosystem.
A crypto skeptic would say, “Why care about making it harder for crypto developers to get rich?” The answer: because this unique field of permissionless, breakneck innovation offers the greatest opportunity yet to reform an outdated, rent-seeking financial system that excludes billions from the chance to make something of their money. A crackdown on DeFi could kill off one of the most promising areas of financial innovation seen for decades.
It’s infuriating that advocates of stricter rules for cryptocurrencies often argue that startups in this space are “freeriding” because the banks and other institutions they compete with are already complying with strict laws. I say that not because I’m dead against crypto regulation – I subscribe to Gensler’s view that good policy can help the technology grow – but because the comparison grossly misrepresents the different starting positions that financial incumbents and their startup challengers occupy.
The reality is that because compliance is so expensive – many bankers now complain that it’s the biggest burden they face in providing affordable capital to non-high-net-worth clients – it functions as a “moat,” a barrier to entry that prevents smaller players that can’t afford it from taking on the bigger players that can. How is a fresh-out-of-college team of brilliant crypto developers going to come up with a less-onerous lending model, for example, if they can’t come up with the tens of millions of dollars needed to make their project compliant?
All hope is not lost. Much could be done at the legislative level to make it easier for crypto innovators to thrive while still imposing a regulatory framework that appropriately protects investors and maintains financial security. Among the multiple cryptocurrency bills in front of lawmakers right now, some make a decent stab at that.
Now that Gensler has made clear his thinking on the applicability of existing laws to this sector, maybe legislators can create carve outs from those laws that better achieve that innovation-versus-regulation balance.
Or maybe that, too, is wishful thinking.
Off the Charts: Bitcoin volumes surge. Why?
Well, that’s odd.
On-chain data show a huge surge in the dollar value of transactions over the Bitcoin network last Sunday, so much that the daily tally – coming in at a noteworthy $69.69 billion – was second only to May 28 of this year.
As Bitcoin Market Journal’s Mati Greenspan wrote in his newsletter on Monday, what’s strange is that these high on-chain volumes were out of sync with relatively thin summer trading on crypto exchanges, where most transactions take place, and with a “completely empty” mempool, which reflects outstanding bitcoin transactions awaiting confirmation. What’s more, the total number of on-chain transactions “was well below average, and the number of unique addresses used was the lowest it’s been since 2016!,” Greenspan wrote.
As Greenspan noted, there were clearly some bitcoin whales moving large amounts of funds around. Why? We don’t know. The question is whether it’s a precursor for greater volume in the market.