July 27, 2022
To say that federal securities regulators are expanding oversight of cryptocurrencies at an opportune time would be an understatement. In fact, some industry experts say the increased attention is overdue.
Crypto assets have gone mainstream. Over the last year, several large pension funds have announced allocations to crypto or its underlying blockchain technology, while asset managers like Fidelity Investments have enabled 401(k) retirement savings plan participants to invest directly in Bitcoin1 and celebrities like Tom Brady and Larry David pitch crypto on TV to retail investors. Meanwhile, cryptocurrencies have been hit particularly hard during Wall Street’s recent downturn, losing two-thirds of their value since their November 2021 peak market capitalization of $3 trillion.2
Enter the U.S. Securities and Exchange Commission’s (SEC). On May 3, 2022, the SEC’s Division of Enforcement announced the expansion of its crypto group from 30 to 50 people and renamed it the Crypto Assets and Cyber Unit. “By nearly doubling the size of this key unit, the SEC will be better equipped to police wrongdoing in the crypto markets,” SEC Chair Gary Gensler said in a statement accompanying the announcement. The SEC said the Crypto Assets and Cyber Unit would focus on investigating securities fraud violations related to crypto asset offerings, crypto asset exchanges, crypto asset lending and staking products, decentralized finance (DeFi) platforms, non-fungible tokens (NFTs), and stablecoins. Division of Enforcement Director Gurbir S. Grewal added that the unit “will be at the forefront of protecting investors and ensuring fair and orderly markets in the face of these critical challenges.”
Formerly known as the Cyber Unit, the group began investigating crypto in 2017, around the time Bitcoin reached $10,000 per coin and several new cryptocurrencies launched Initial Coin Offerings (ICOs)3. At the time, the SEC warned investors that, due to the limited oversight, “ICOs could easily be scams or ponzi [sic] schemes disguised as legitimate investments.”4 In the past five years, the unit has brought more than 80 enforcement actions related to fraudulent and unregistered crypto asset offerings and platforms, leading the SEC to recover more than $2 billion for swindled investors.
The SEC’s enforcement expansion comes amid other proposed SEC initiatives to regulate the crypto markets and legislative activity in the U.S. Congress focusing on the best way to regulate issuers of stablecoins, which are cryptocurrencies pegged to a fiat currency like the U.S. dollar.5 The SEC’s regulatory initiatives to broaden investor protections in the crypto markets, announced on April 4, 2022 by Chair Gensler, included registering and regulating crypto exchanges, potentially separating out asset custody to minimize investor risk, and partnering with the Commodity Futures Trading Commission (CFTC) to address trading platforms for crypto-based security tokens and commodity tokens.6 The SEC’s proposed initiatives are in line with President Biden’s March 2022 Executive Order, which directed federal agencies to implement a strategy for policies and regulations on digital assets, including cryptocurrencies.7 Although Biden’s Executive Order was well received by crypto market experts —they described it as “extremely positive,” “long overdue,” and an “acknowledgment that cryptocurrency is here to stay” —it did nothing to quell the uncertainty as to which federal agency will serve as the primary regulatory of the crypto markets.8
Judging from its expansion of the Crypto Assets and Cyber Unit and proposed regulatory initiatives, the SEC views itself as the primary regulator of the crypto markets. But a bipartisan bill introduced on June 7, 2022 by U.S. Senators Cynthia Lummis (R-Wyoming) and Kirsten Gillibrand (D-New York) allocates primary oversight to the CFTC, reasoning that crypto products operate more like commodities than securities.9 Senators Lummis and Gillibrand’s bill has received a fair amount of criticism from investor protection and consumer advocacy groups, who say it indulges cryptoindustry-led efforts to marginalize the SEC.10 That criticism aside, U.S. Senators Debbie Stabenow (D-Michigan) and John Boozman (R-Arkansas) are in the process of drafting crypto legislation that also designates the CFTC as the primary regulator of the crypto markets.11
Congress will likely not act until after the midterm elections and there is no indication whether it will agree with Chair Gensler that the SEC already has the tools to properly and effectively police crypto markets. “We already have robust ways to protect investors trading on platforms. And we have robust ways to protect investors when entrepreneurs want to raise money from the public. We ought to apply these same protections in the crypto markets,” Chair Gensler said. “Let’s not risk undermining 90 years of securities laws and create some regulatory arbitrage or loopholes.”
On July 8, 2022, Federal Reserve Vice Chair Lael Brainard echoed Gensler’s comments while reflecting on the recent crypto turbulence and massive losses. “It is important that the foundations for sound regulation of the crypto financial system be established now before the crypto ecosystem becomes so large or interconnected that it might pose risks to the stability of the broader financial system,” she said.12