Investors at risk in the absence of an adequate US crypto regulatory regime

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The author is professor emeritus at Harvard Law School and director of the Committee on Capital Markets Regulation

The failure of the FTX exchange has triggered a strong regulatory crackdown in the crypto world. The Securities and Exchange Commission has filed civil lawsuits against the world’s largest crypto exchanges, Binance and Coinbase, for allegedly failing to register with the regulator as stock exchanges.

But U.S. crypto investors remain at risk in the absence of an adequate crypto regulatory framework, particularly in the case of Binance, which has been accused by the SEC of commingling billions of dollars in client funds. The reality is that SEC Chairman Gary Gensler had the opportunity to establish one, but he did not act.

As recently as May 2021, Gensler admitted in congressional testimony that the problem was that there was no regulatory framework for crypto exchanges to register with the SEC. But in December 2022, immediately after FTX failed, Gensler reversed course, saying instead that crypto exchanges should come in and register with the SEC.

But can crypto exchanges actually register as securities exchanges? The answer is no. SEC-specific regulations made that impossible, according to a report by the nonprofit Capital Markets Regulatory Committee (CCMR).

More importantly, if a crypto exchange were to register as a securities exchange, it would have nothing to trade. This is because registered securities exchanges can only list and trade crypto assets that have been registered with the SEC as securities.

And only five of the existing 23,000 digital assets are actually registered with the SEC. These five digital assets constitute 0% of the $230 billion in daily crypto trading volume. They would not be able to trade digital assets such as bitcoin and ether, which are not registered securities and constitute the majority of digital asset trading. The SEC could easily solve this problem by using its exemption power to allow both securities and non-securities to trade side-by-side on a registered exchange.

Additionally, the SEC has not tailored its disclosure requirements to crypto. Issuers of registered equity and debt securities are reasonably required to provide ongoing information about their operations, but this would make no sense for digital assets such as bitcoin and ether that have no operations and whose value is based solely on supply and demand. Other jurisdictions, including the EU and Japan, have adopted disclosure regimes for the registration of crypto assets that address these issues.

Trading on registered stock exchanges is also limited by law to registered brokers, but none of them are registered to trade crypto assets. Again, the SEC has made it impossible for a broker to register to trade crypto assets, as its rules prohibit such parties from trading other assets such as stocks or bonds. It is impossible for established brokers to operate a business that exclusively trades crypto assets. On the contrary, all other major jurisdictions allow registered brokers to trade crypto assets with other financial assets.

One option left to exchanges is to exclusively trade digital assets that are not securities so that they do not have to register as securities exchanges. Indeed, a new crypto exchange EDX Markets, backed by Citadel Securities and Fidelity, appears to have done just that. This solution, however, does not allow crypto exchanges to trade registered securities and non-securities side-by-side. And it does not result in providing regulatory standards of investor protection from stock exchanges to crypto exchanges.

The SEC’s unnecessary failure to create a registration regime for crypto exchanges has not gone completely unnoticed. The House Financial Services Committee and the House Agriculture Committee have proposed legislation to create a workable registration regime for crypto exchanges, but it is still in its infancy.

It’s possible that the SEC’s strategy is to ban crypto entirely by forcing exchanges to do the impossible and then suing them for not doing it. But it is not the role of the SEC to determine whether crypto assets, or any other financial assets for that matter, are worthwhile investments.

Instead, it falls to the SEC to establish investor protections that allow investors to safely make that decision for themselves, as regulators in every other major jurisdiction have done for crypto. . And, at this primary mission, the SEC and Gensler have clearly failed, with the very likely result of increased investor losses in the future.

CCMR Research Director John Gulliver contributed to this article

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