After serving as the first boss of SEC’s Crypto Unit from 2017 to 2019, I often asked what kind of crypto enforcement we should expect to see from the new administration. My first answer is that I don’t know. My second answer is that I think it will be different, but it will not disappear.
To predict the future of crypto enforcement, we should start by undergoing the past.
The beginning
SEC’s Crypto Enforcement Unit was formed in 2017 during the first Trump administration. The early focus was on one, fraud and two, core capital collection events. Regulation of capital collection is the main purpose of the Securities Act of 1933. When an investor gives money to an entrepreneur who will use it in a company to generate profits, the investor has the right to certain information about the company. Early crypto studies were focused on this fundraising activity, which was usually in the form of an unregistered initial coin offer (“ICO”). The idea was that at that time many ICOs were not as different in substance than equity or debt offerings and should be regulated in a similar way.
The industry responded responsibly and now crypto entrepreneurs often collect money in accordance with the federal securities laws. In one of several options, some offers are exempt from SEC registration because they are limited to accredited investors. Entrepreneurs then use the capital to build a blockchain protocol or other crypto product. Once built, the sale of tokens is probably not a securities in the Tokens because people do not buy tokens as an investment in someone’s business. Even if there is hope of profits, this profit would come from the buyers and other participants, not the efforts of a central business manager.
The past four years
Over the past four years, SEC has focused more of its enforcement activity in secondary markets such as centralized trading platforms and decentralized protocols. It is less clear how the federal securities laws apply to these markets. These transactions generally do not involve a central entrepreneur who collects money from investors and uses them in a business. Instead, there are thousands or even millions of crypto participants who interact with each other sometimes anonymously via autonomous software. Token buyers may not know who sold them tokens and there may be no central actor who is the key to future success. The federal district courts have reached different conclusions and there are reports that SEC can drop one of these central cases.
More broadly, enforcement became the dominant focus of SEC regulation. SEC doubled the size of the crypto unit and created new supervisory and legal laws. It spent years and a huge amount of resources that posted several non-void cases. Many additional non-unit lawyers worked on crypto studies, and crypto seemed to be the main focus of sec enforcement.
This approach did not generate useful guidance to the industry. Many SEC rules have technical aspects that are incompatible with the anonymous decentralized headbox, which is blockchain technology. Under the last year’s enforcement method, the actual prerequisite for the technology was not treated as a function but as an error. The result was existential enforcement risk to a burgeoning industry and economic activity that was pushed offshore.
The future
I don’t think the crypto industry wants a wild west of no regulation. They want a sensible rulebook that makes compliance possible, and they also want regulators to crack down on fraud. No legitimate actor benefits from fraud in the industry.
What does this mean for the next four years of enforcement?
First, enforcement is only a component of regulation. We are likely to see increased resources dedicated to the other parts of effective regulation – new guidance and rules that offer an attainable regulatory framework. Working SEC President Mark Uyeda recently announced a new crypto -Taskforce for the development of a “sensible regulatory path” and commissioner Hester Peirce, who will lead the task force, included in her goal “Conserves[ing] Industry’s ability to offer products and services. “The dedicated crypto unit is also reduced in size and recycled to cyber and new technologies, with many staff returning to general enforcement tasks.
Secondly, we could see a renewed focus on the fight against fraud. The Commission did not stop bringing cases to crypto fraud in the last four years, but many headline cases were non-fraud-disrupting disputes. It can change; As Commissioner Peirce said in his goal of his goals, “We do not tolerate liars, cheat and scammers.”
Third, when there is a new rule book, we can expect SEC to enforce these rules. It will take time. We may see a transitional period with some cases that are not scams, but more focus on writing the new rulebook. Once adopted, enforcement of this rule book could come after a fair notice period for the industry to adapt to it.
Conclusion
I expect SEC Crypto Enforcement to continue, but with different priorities. Investor protection will be balanced with SEC’s co-equal mandates to facilitate capital formation and maintenance of orderly markets. The Crypto industry is filled with good actors who want to be compatible; They just need a rulebook that makes compliance achievable. A renewed approach allows the industry to grow without giving up investor protection.
SEC has so far been the most assertive crypto regulator, but it is not alone. Other federal agencies may arise as co-equal regulatory leaders, either through legislation or otherwise, especially if SEC no longer takes the opinion that any cryptocurrency (except Bitcoin) is a security. Some state authorities have been active in crypto and it will probably continue or even rise.
A client recently reminded me that there will be another choice of four years. The new regulatory approach and the industry’s business and product decisions must be durable. If they are not, the renewed approach to crypto for the next four years could be undone as easily as in the last four years.
