“This should serve as a massive wake-up call to the crypto industry,” said Charley Cooper, a former CFTC chief operating officer now with software and blockchain technology firm R3. “A policy or a posture of ignoring Washington or showing disdain for Washington … will ultimately be a failed strategy.”
The enforcement actions are fueling debate about how cryptocurrency players fit into financial regulations. Federal regulators say the new digital currency platforms must adhere to existing rules, but industry players counter that it’s not that simple and that it’s time for Congress to pass new laws that are more tailored to crypto.
“This regulation by enforcement that we’re seeing is not the way to go because it doesn’t create good policy,” said Kristin Smith, who advocates for the cryptocurrency industry as executive director of the Blockchain Association. “Regulators — in particular the SEC — think that the laws and regulations are crystal clear and that they’re very easy to interpret. But for those of us on the other side of the table that are working in the industry and its ecosystem, the laws aren’t clear, and it’s very difficult to figure out how to apply them.”
The market value of Bitcoin and other digital currencies hit $2 trillion again this week, meaning the stakes have never been higher for companies looking to enter the space. The movement has also spawned a whole sector of decentralized finance applications — so-called DeFi apps — that offer automated, autonomous trading and lending services with minimal human interaction. One such DeFi service, Poly Network, disclosed losing $600 million in a breach earlier this month.
Regulators in recent weeks have made clear they’re zeroing in on crypto exchanges and DeFi platforms.
Two high profile cases in August — a $100 million CFTC and Treasury settlement with crypto derivatives service BitMEX and a $10 million SEC settlement with digital asset exchange Poloniex — revolved around charges that the companies were operating unlicensed trading platforms. Another SEC settlement this month with decentralized lender DeFi Money Market accused its backers of selling more than $30 million in unregistered securities using so-called smart contracts and DeFi technology.
Some of the targeted crypto companies are trying to signal that they now take the rules more seriously. BitMEX CEO Alexander Höptner said in a blog post after his exchange’s settlement that “crypto is becoming more responsible.”
“We are committed to becoming a regulated exchange and are looking to set the benchmarks in this new era for crypto,” said George Godsal, spokesperson for BitMEX operator 100x.
The federal cases came as five states including New Jersey, Texas and Kentucky took action against the startup BlockFi for offering interest-earning accounts that regulators say could be unregistered securities products.
BlockFi spokesperson Madelyn McHugh said the company believes its products and services are lawful and appropriate for crypto market participants, and that “we remain steadfast in our commitment to protect consumers’ rights to earn interest on their crypto assets.”
“We’re hopeful that BlockFi will lead the charge in collaborating with regulators to define a regulatory path for our ecosystem going forward,” McHugh said.
Lawyers tracking the cases said they showed that, even though some digital assets businesses assert certain laws don’t apply to them, that doesn’t stop the government from taking action.
“We’ve all been telling our clients and we’ve been telling people publicly for years that just because you come up with some name for something doesn’t mean that the laws don’t apply,” said Stephen Palley, partner at the law firm Anderson Kill.
Vincent McGonagle, the CFTC’s acting enforcement director, said in a statement that “there is a strong need for regulatory compliance in the digital asset market space and for bad actors to be identified and held accountable.”
“The CFTC will continue to use the tools available to us to the fullest extent possible to closely monitor these evolving markets,” McGonagle said. “The recent resolution with BitMEX and other enforcement actions by the commission, including those in the spot markets for digital assets, reflect our strong commitment to aggressively pursue actionable conduct within our jurisdiction.”
Davis Polk partner Robert Cohen, former chief of the SEC’s cyber unit, said that agency has taken an active approach to crypto enforcement since 2017, and it’s no surprise it’s continued under the Biden administration.
One of Trump-era SEC Chair Jay Clayton’s final actions at the helm of the agency last December was to sue financial technology startup Ripple for allegedly selling unregistered securities in the form of the XRP cryptocurrency. The move triggered litigation between the SEC and Ripple that continues to this day over the extent to which digital currency should be regulated as an investment product.
“A question going forward is whether there will be progress on rulemaking and guidance for the community that provides the clarity and certainty needed to operate within the SEC’s regulatory system,” Cohen said.
Some lawmakers are beginning to push back on the enforcement crackdown and warn there is an urgent need for Congress to draft new rules for the industry’s business model.
Rep. Patrick McHenry of North Carolina, the top Republican on the House Financial Services Committee, said “regulation through enforcement hinders innovation.”
“It’s creating uncertainty in a really important and growing industry in the United States and globally,” McHenry said in an interview. “If we don’t bring regulatory clarity here in this space, it’s going to go to other regimes around the world that are more conducive for its development.”
Rep. Don Beyer (D-Va.) has introduced legislation that would require the CFTC and SEC to issue new cryptocurrency rules. His bill would give the CFTC — which today regulates derivatives linked to things like oil and also fiat currencies — authority over digital assets. It would give the SEC — the U.S. stock market regulator — authority over digital asset securities.
McHenry has also proposed a bill that would convene a working group between the SEC, CFTC and industry to report on cryptocurrency regulation.
“The lack of legal clarity has hindered investment and innovation, and Congress should provide clear rules of the road for this growing market,” Beyer said in a statement.
Gensler, who has been leading efforts to rein in crypto as SEC chair, said this month that his agency needs additional authorities to prevent transactions, products and platforms from falling between the regulatory cracks.
“Right now we are turning to the courts to settle our disputes, which is not necessarily a bad thing — that’s why they’re there,” said Joseph Rotunda, director of the enforcement division at the Texas State Securities Board. “But that also provides a lack of certainty.”