Crypto insiders lauded Gary Gensler’s nomination to chair the Securities and Exchange Commission (SEC) last February. The MIT professor who had taught blockchain classes would bring an enlightened approach to crypto compared to the scattershot, perplexed style of his predecessor Jay Clayton. But a year in the professor gets an F in crypto guidance and leadership. He has encouraged the worst bureaucratic instincts of the federal government, deepened regulatory confusion, and thwarted any hope of progress during his tenure—all whilst claiming the mantle of little-guy defender and public-interest protector.
Cynics contend this cabal comprise his real audience; those that can help the uber ambitious Gensler climb the bureaucratic ladder to Treasury Secretary or beyond. But even without questioning his motives, his tenure related to crypto has been a farce.
Gensler analogizes his role to that of football referees. “Imagine a football game without referees. Without fear of penalties, teams start to break rules. The game isn’t fair and maybe after a few minutes, it isn’t fun to watch.” Yet the dystopian present he has fomented invites a different analogy: The referees are the only ones who know the rules, won’t tell the teams what they are, but still call a penalty on every play—the players discovering ex post facto the play was verboten.
Former acting Comptroller of the Currency, Brian Brooks, described the scene recently in Congressional testimony: “What happens in the United States is you have a new crypto project and you walk into the SEC and you describe it in great detail and you ask for guidance and they say we can’t tell you and you list it at your own peril.”
Crypto doesn’t want Professor Gensler’s protection
This is particularly disheartening when the teams have plays the fans want to see. Although Gensler couches crypto edicts in protecting the populace against scams, many high-profile cases the SEC has prosecuted during his (and his predecessor’s) tenure had active, happy user bases. Kik, Telegram, and ongoing cases against LBRY and XRP/Ripple focused on selling “unregistered” securities via a security type (investment contract) absent in the federal code and defined through a three-part test by the Supreme Court a year after WWII ended.
Lawyer James Burnham opines the current Supreme Court zeitgeist would likely preclude such broad administrative diktat on crypto absent new Congressional mandate. But such agency reprimand would require a company spend gargantuan legal fees and endure years of litigation for even the chance to argue the case. The Commission understands its ability to bleed belligerents dry and force settlements before they obtain meaningful judicial review. As it stated in its 2018 budget request: “[T]he SEC’s litigation efforts also help the SEC obtain strong settlements in other cases by providing a credible trial threat and making it clear that the SEC will go deep into litigation and to trial, if necessary, in order to obtain appropriate relief.”
For his part, Gensler has directed the Enforcement Division to discourage meetings with investigatory targets and eliminate “unnecessary process.”
Professor Gensler is not serving the public interest
Commissioner Hester Peirce described a previous era of “broken windows” theory compliance at the SEC as the “Sanctions” and Exchange Commission. Now it may better be labeled the “Sanctions and Enforcement” Commission.
Under Gensler, the SEC has declared a permanent crypto war. It has refused to approve any Bitcoin spot Exchange Traded Products despite myriad applications, new projects are refused guidance and told to take their chances, and the Chair recently gave a speech one commentator called the “the most aggressive and hostile stance re U.S. crypto regulation to date from the SEC.” An SEC this stroppy to crypto innovation may serve entrenched interests in Washington and other global financial destinations. It does nothing, however, for the American public. Those that think otherwise should go back to school.
The gulf between Securities and Exchange Commission Chair Gary Gensler’s rhetoric and the results of his leadership continues to widen. Mr. Gensler boasts fealty to working families in interviews and speeches yet thwarts their ability to climb the economic ladder.
The SEC may raise the accredited investor (AI) net-worth threshold from $1 million to $10 million, Bloomberg reports. Because of their wealth or other sophistication criteria, AIs may invest in private companies in ways others may not.
In December, the Commission indicated it would review the threshold “to more effectively promote investor protection,” in a little noticed regulatory agenda document. The scope of the proposed change apparently just became known. The Commission will seek public comment in April.
Raising Accredited Investor limits would harm startups in the middle of the country
The problems with this proposed change are countless. First, it would lessen opportunity for both investors and entrepreneurs. Most startups, especially in scaling industries like technology seek investment first from AIs under Regulation D 506(b) (Reg D). Raising the bar for who qualifies as an AI means less startup funding. And it would have disproportionate geographic and demographic consequences falling hardest on regions and entrepreneurs already struggling for funding.
Wealth in the United States and thus access to capital is mostly confined to a few elite coastal zip codes. Raising the accredited investor threshold would further solidify these venture-capital meccas. As described in a recent SEC Small Business Capital Formation Advisory Committee, which recommended expanding not contracting AI criteria.
Indeed, the Commission should question the whole concept of AIs. It excludes most Americans from participating in higher risks and higher rewards startup funding. Professor Usha Rodrigues calls this securities law’s ‘Dirty Little Secret’:
The dirty little secret of U.S. securities law is that the rich not only have more money-they also have access to types of wealth-generating investments not available, by law, to the average investor. . . .
[C]urrent law . . . discriminates on the basis of wealth, as a proxy for sophistication, or the ability to fend for oneself. Securities law thus in theory, as in practice, marginalizes the average investor without acknowledging that it does so, let alone justifying it.
Accredited Investor limits entrench social stagnation
In practice the rich get richer via access to the most promising companies when prospects fir massive returns are biggest. Raised thresholds would mean even less people would have the chance at generational wealth.
Yet raising the AI thresholds would not only harm the rich, its aftereffects would stymie the entire private investment market. The only way retail investors can currently play in the private markets is through Regulation Crowdfunding (Reg CF). In March 2021, the SEC loosened some Reg CF restrictions to make it more attractive. One move was to remove the investment cap for AIs. This allowed small money to follow smart money into Reg CF. Thus, an AI could place a bit bet on a startup and lots of retail investors could join that bet on the same terms. Raising the AI threshold will mean startups will get less traction with big investors. And retail investors won’t benefit as much from large investor due diligence.
Supporters of tighter restrictions like some state Attorney Generals and the North American Securities Administrators Association, justify raising the AI threshold on the basis of some fraudulent issuers. But this claim fails scrutiny. Accredited Investors use Reg D and Rule 144A. These two markets dwarf the public markets which raised $1.2 trillion. Reg D alone outpaced the public market (registered offerings) in 2019 with almost $1.5 trillion. These numbers would be impossible if investors feared fraud.
The crypto revolution has destroyed the rationale for Accredited Investor limits
The crypto revolution has also refuted arguments restricting the private markets. The Commission recently settled with virtual marketplace BlockFi for $100 million dollars. As Commissioner Hester Pierce stated, BlockFi had always paid out its promised returns so it’s hard to say who Mr. Gensler was protecting. If the end result is savers receive anemic rates the heavily regulated banking industry pays instead of the comparatively gargantuan returns of BlockFi, working families will clearly lose.
In fact, crypto shows the folly of artificially restricting anyone’s ability to invest in non-fraudulent assets of their choice as articulated by podcaster Nathan Whittemore:
[W]e need to be a lot more careful about who we view as someone who needs protection. In the [Elizabeth] Warren-Gensler mindset, anyone who is not an institutional investor needs to be protected. That may make sense to Gary who made $120 million off his time at Goldman. And in other parts of the very, very walled gardens of traditional finance. But it simply isn’t the case, when “retail” spent the last decade kicking the ever-loving s**t out of institutional investors in one of the biggest wealth creation moments in history. Maybe we think a little bit before we lump all retail investors into some paternalistic bucket of little guys who need protection. In fact, it is the first time in history that this was possible because crypto’s permissionless nature inherently obliterates barriers to entry. In other words, the first time in history that retail investors weren’t structurally pushed out or denied access to an investment opportunity. They completely beat nearly every professional investor to it.
SEC BlockFi settlement misfires for working families
The Securities and Exchange Commission (SEC) has a three-part mission: protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Chair Gary Gensler focuses on the first, “Every day, I am animated by working families and what the SEC means to them.”
Yet paradoxically, his zeal to enforce securities laws has had the opposite effect. Far from helping working families, he is quashing their wealth-creating opportunities.
The SEC’s latest foray into enforcement-policy-gone-wrong is the widely reported settlement with virtual marketplace and crypto lender BlockFi. Details reportedly include a massive $100 million dollar fine and promise to stop accepting new accounts. (At the time of settlement, 32 state securities agencies were also investigating BlockFi, collectively they will receive half the fine).
SEC BlockFi settlement didn’t end fraud it ended earning opportunities for working families
A reader unfamiliar with the Gensler-led SEC might presume the commission had just ended a major scam operation or stopped fraudsters raising capital by promising the unsuspecting lavish and unattainable returns on some pie-in-the-sky crypto venture.
Indeed, in speeches Mr. Gensler frames his enforcement push exactly this way:
Without examination against and enforcement of our rules and laws, we can’t instill the trust necessary for our markets to thrive. Stamping out fraud, manipulation, and abuse lowers risk in the system. It protects investors and reduces the cost of capital. The whole economy benefits from that. . . . It is critical that our enforcement program have tremendous breadth, be nimble, and penalize bad actors so we discourage misconduct before it happens. . . .
Some market participants may call this “regulation by enforcement.” I just call it “enforcement.”
Stamping out fraud, manipulation, and abuse, sounds great until one realizes BlockFi had done none of this. In a press release the SEC claims BlockFi failed to disclose the level of risk in its interest-bearing products. But no one was ever defrauded, as Commissioner Hester Peirce relayed in a statement, “While penalties this size are intended to deter bad conduct, here there is no allegation that BlockFi failed to pay its customers the money due them or failed to return the crypto lent to it. BlockFi’s misrepresentations about over-collateralization are serious, but the combined $100 million penalty nevertheless seems disproportionate.”
Virtual Marketplaces Provide passive income to impoverished people
What BlockFi was doing was providing working families an opportunity to generate passive income. These assets (Bitcoin and other crypto) that has seen startling market gains with the potential for much more. (One investment firm predicts Bitcoin will reach $1 million by 2030).
Working families could park their Bitcoin and other crypto holdings with BlockFi and earn between 5-10 percent APY. BlockFi relends these holdings at even higher rates and splits the interest with account holders.
Thus, working families benefited in two ways: (i.) any asset appreciation was theirs after they withdrew their holdings (of course any loss was too, but that’s a function of the supply and demand); (ii.) the interest earned in crypto was theirs as well.
These are game changing numbers for working families. Someone spending buying Bitcoin with their $1,200 stimulus check in April 2020 would have had $11,000 in October 2021. A BlockFi account would have provided an additional5-10 percent interest. The numbers are less now but history says they will rebound at some point.
SEC BlockFi settlement latest example of crypto hostility from federal government
The story has played out across the crypto world in the past four years (pre-dating Mr. Gensler). As the commission has attacked companies without a hint of fraud including Kik and Telegram and currently lawsuits against XRP/Ripple and LBRY. Non-fungible tokens (NFTs) are likely next.
In addressing securities professionals last November, Gensler chided them for their lack of public spiritedness. “You all have our own clients, to be sure. Working in a field such as finance that touches so many lives, though, you also have another responsibility: a responsibility to the public.”
A corollary to this exists. Bureaucrats should not harm the public by using their position to climb the ladder to more powerful positions. Cynics accuse Mr. Gensler of using crypto enforcement to do just that.
But whether he is actually animated by working families, his own ambition, or both, he only hurt working families.
Note: In a tweet thread by BlockFi’s CEO, the company announced today it will register its products with the SEC. And it may eventually accept new accounts.
“The Commission has no basis for the position that investing in the derivatives market for an asset is acceptable for investors while investing in the asset itself is not.” This statement to the Securities and Exchange Commission (SEC) by lawyers representing Grayscale Investments should be manifest. Grayscale seeks approval for a Bitcoin Exchange Traded Product (ETP) that reconciles to Bitcoin’s global price. Thus far, the Commission has only approved Bitcoin ETP futures (derivatives) not those tied to the “spot” (asset) market.
The Commission distinguishes Bitcoin from other assets because it is globally traded and outside a federal regulatory framework. Its irrational fear of the global Bitcoin marketplaces puts applicants in an impossible position where denial of spot ETPs is preordained.
SEC arguments against a BTC ETP don’t work
The Commission avers spot ETP applicants have failed the anti-fraud and market manipulation provisions of Section 6(b)(5) of the Exchange Act. It sets out two ways they could theoretically meet this burden: (1) entering into “a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying or reference bitcoin assets” or (2) “establish[ing] that the underlying market inherently possesses a unique resistance to manipulation beyond the protections that are utilized by traditional commodity or securities markets,” although “[s]uch resistance . . . must be novel and beyond those protections that exist in traditional commodity markets or equity markets[.]”
As Grayscale argues, after four years and multiple denials the Commission still not established metrics for markets of “significant size” or what “novel” investors protections would pass muster.
Applicants have tried various approaches. For market size, they have suggested tying prices to the Chicago Mercantile Exchange (CME) market where futures ETPs trade to no avail.
SEC BTC ETP standards are impossible
For the “novel” and “beyond traditional markets” standard applicants have proposed various solutions, all lacking sufficient “novelty”:
[Exchanges have argued] among other things that index pricing would be based on the CME’s manipulation-resistant CF Bitcoin Reference Rate, that “the geographically diverse and continuous nature of bitcoin trading render it difficult and prohibitively costly to manipulate the price of bitcoin,” and that “[f]ragmentation across bitcoin platforms, the relatively slow speed of transactions, and the capital necessary to maintain a significant presence on each trading platform” make it especially resistant to manipulation. But the Commission has found in every instance that the justifications are insufficient to satisfy Section (6)(b)(5): the Commission’s “unique,” “inherent” and “novel” protections standard evidently cannot be satisfied.
Commissioner Hester Peirce is a lonely dissenting voice
SEC Commissioner Hester Pierce in a now-famous dissent from the 2018 Winklevoss Bitcoin Trust on Bats BZX Exchange, Inc. (“BZX”) spot ETP denial argued the Commission’s focus on the global Bitcoin market misread its mandate.
The Commission erroneously reads the requirements of Section 6(b)(5). The disapproval order focuses on the characteristics of the spot market for bitcoin, rather than on the ability of BZX—pursuant to its own rules—to surveil trading of and to deter manipulation in the ETP shares listed and traded on BZX. . . . Section 6(b)(5), however, instructs the Commission to determine whether “[t]he rules of the exchange” are, among other things, “designed to prevent fraudulent and manipulative acts and practices [and] to promote just and equitable principles of trade,” and “are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers.” It says nothing about looking at underlying markets, as the Commission often has done in its orders.
The SEC showed its cards in that denial by complaining “a substantial majority of Bitcoin trading occurs outside the United States, and even within the United States, there is no comprehensive federal oversight of Bitcoin spot markets.”
Bitcoin’s global reach and non-security status prevents the kind of draconian federal oversight the Commission insists on as a matter of course. Game over.
BTC ETP denials have several negative externalities
The SEC’s de facto position has several negative effects for investors and the agency itself.
It’s discriminatory: Grayscale claims blanket denials of spot ETPs combined with acceptance of futures ETPs lack legal basis and expose the Commission to challenges under the Administrative Procedures Act.
It embroils the Commission in merit review: As Grayscale asserts, “The Exchange Act does not authorize the Commission to regulate the suitability of an asset class, such as Bitcoin, or particular securities, such as BTC shares, relative to competing assets and securities.”
It suppresses institutional participation: Commissioner Peirce: Spot ETP denials “discourage new institutional participants from entering this market” and delays market maturation because “potential institutional investors may reasonably conclude that the Commission will continue to repress market forces for the foreseeable future.”
It denies Bitcoin exposure less tech savvy investors: Some people do not not have the time, desire, wherewithal, or risk tolerance to purchase Bitcoin from an online exchange.
It denies investor choice: Commissioner Peirce: Commission denials, “preclude investors from accessing Bitcoin through an exchange-listed avenue that offers predictability, transparency, and ease of entry and exit.” The futures market provides a less attractive product as CoinDesk’s Michal Casey explains, “On an annualized basis, if investors held shares in a Bitcoin futures fund that had rolled over every month for the past year, they’d have ended up with a cumulative cost of 28% relative to the spot market.”
So long as the SEC views the nearly 13-year-old Bitcoin with undue suspicion it will likely keep denying spot ETP applications.
“A digital economy is not simply an industrial economy on the internet.” The Blockchain Innovation Hub at the Royal Melbourne Institute of Technology in Australia recognizes a truth governments worldwide have not. Web 3.0, the approaching next internet phase with unprecedented methods of commerce, is unique in history. The Industrial Revolution transition is analogous. Changes of this magnitude require governments to reevaluate their economic oversight role. Web 3.0 will challenge old models of what constitutes a firm, a security, and a commercial transaction. The Royal Melbourne Institute provides some worthwhile proposals to welcome this new cyber world.
In the future, shareholders will run companies directly through smart contracts coded into decentralized applications—no management required. Cars will pay each other to pass or change lanes. Houses will rent out spare bedrooms upon predefined criteria. Computers will sell extra file storage to the continuously, to the highest bidder. And people will buy, share, and exchange value in myriad forms without any impeding central authority.
Web 3.0 threatens government dominance over the economy
Thus far wary governments have reacted in two ways. The more authoritarian ilk seek to capture the new technology whilst eliminating private competition. For instance, China began researching digital money in 2014. It plans to force exclusive use at the cost of privacy, freedom, and political dissent.
Western democracies seek to force Web 3.0 innovations into compliance with familiar legal structures with which they share little. The administrative state’s paternalistic for-your-own-good dictates contradict the bottom-up-individual-empowered future. Risk aversion defines this approach as SEC Commissioner Hester Peirce conveyed in a recent speech, “Regulators . . . tend to be skeptical of change because its consequences are difficult to foresee and figuring out how it fits into existing regulatory frameworks is difficult.” Overly cautious officials create confusion and uncertainty whilst forcing firm capital into legal departments.
SEC is the Web 3.0’s biggest enemy
Nowhere has government ineptness been more prominent than Ms. Peirce’s agency, the Securities and Exchange Commission. Chair Gary Gensler began his term calling for an active policy agenda and vigorous crypto prosecutions. The Commission’s legal basis for these prosecutions is the Supreme Court’s interpretation of ‘investment contract’ arising from a 1940s dispute over orange groves.
Orange groves as analog to code that can serve as currency, gateway keys, representations of physical objects, and countless other functions makes no sense. Nonetheless, through dated legal interpretations, the government has forced or threatened the shutdown of platforms the were or could have benefited the masses. The commission’s litigation against Ripple has exposed its abusive tactics. But unless Congress limits what constitutes ‘investment contracts’ or removes it from the definition of security completely, the commission will continue its war on innovators.
Unfortunately, the SEC is hardly an outlier. The Commodities and Future Trading Commission and IRS have also moved to limit Web 3.0’s potential. Their allies in Congress have urged them forward.
SEC should learn from Oz
Brighter minds at the Royal Melbourne Institute of Technology have suggested a better way which embraces innovation and discards the staid bureaucratic mindset. US policy makers should heed their proposals lest Oz surpass America as the future’s preferred home.
These proposals include:
A new classification for management-less crypto firms known as Decentralized Autonomous Organizations (DAOs). Limited Liability DAOs would exempt token holders from liability in the same manner as principals in Limited Liability Companies.
Treating stablecoins pegged to fiat currency as ordinary currency without any special compliance features.
Safe Harbors for innovation to shield nonfraudulent activity provided they meet certain requirements.
Avoiding state-level licensing schemes like New York’s Bit License.
Simplifying tax reporting.
As the Institute states, “Transitioning to a digital economy is not simply placing our existing industries on the internet. It is a much deeper process of enabling and facilitating new business models and organizational structures, such as automation and decentralization.” To those creating the future economy this seems manifest. But only direct limitation of bureaucratic discretion will force government actors to agree.
Does crypto currency need new regulatory disclosure mandates from Washington in order to be of service to consumers? No, but that is what Securities and Exchange Commission Chair Gary Gensler is seeking. Gary Gensler’s crypto policy is insane.
As stated in a speech on August 3, Mr. Gensler indicated he wants to double down on the same tried-and-failed approach his predecessor used. From disclosure-heavy mandates to investor-protection obsession, everything Mr. Gensler proposes is a regulatory version of insanity – doing the same things but expecting different results.
Under the guise of technology neutrality, Mr. Gensler seeks to force the crypto industry to heel to the SEC. As he stated, “I think former SEC Chairman Jay Clayton said it well when he testified in 2018: ‘To the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.’” Indeed, one would be hard pressed to find a crypto innovation over which he doesn’t want to exert control. Stablecoins? Check. Exchanges? Check. DeFi? Check.
That hasn’t gone well so far.
SEC botched crypto policy from the start
By any account, the Commission’s crypto policy has been a mess. Former Chair Clayton seemed perpetually perplexed by such new technologies, finally appointing a crypto ‘Czar,’—career bureaucrat Valerie Szczepanik—in 2018. A year later she and Corporation Finance Director William Hinman produced a widely panned 13-page crypto “framework.” The document was so impenetrable, SEC Commissioner Hester Peirce compared it to a highly abstract Jackson Pollock painting.
The other major Clayton-era guidance came from a 2018 speech where Mr. Hinman declared ether—the currency for the second biggest crypto blockchain—was not a security. Given Ethereum’s size, success, and potential, the crypto world cheered. But in the closely watched Ripple litigation, the Commission has now disavowed that finding.
Other than these two instances, SEC “guidance” has largely come not from official rulemaking but from punative subpoenas and court appearances.
Gary Gensler’s crypto policy is failing retail investors
But even if the Commission was less scattershot, it’s not clear forcing the nascent industry into a Depression-era disclosure regime would protect those retail investors Mr. Gensler has in mind.
A review of recent Commission press releases reveals multiple enforcement cases against alleged fraudsters that were already beholden to Commission mandates. Empirical studies have repeatedly shown the federal disclosure regime does more to employ myriad compliance professionals than stop scam artists.
It is also telling that the least regulated way issuers can raise capital—Regulation D 506(b) (Reg D), which mandates no disclosures—is also the most successful. In 2019 it raised $1.5 trillion and outpaced the public markets—an impossibility if investors feared widespread fraud.
It’s too bad that securities law paternalistically blocks most investors from Reg D opportunities. Only 13 percent of people qualify because financial and sophistication thresholds limit eligibility. And they tend to cluster in America’s elite zip codes. This means the best deals go to people who need them least. Retail investors are left mostly left with post-IPO scraps. As Professor Usha Rodrigues states “Securities law . . . in theory, as in practice, marginalizes the average investor without acknowledging that it does so, let alone justifying it.” Under Mr. Gensler’s crypto leadership, SEC marginalizing will continue and where opportunities for wealth creation are greatest (perhaps in all of history).
Gary Gensler should make his crypto policy less insane
Instead, Mr. Gensler should change course and approach crypto with a measure of humility and cooperation. This would include:
Ditch the 2019 Framework.
Acknowledge the Commission’s role in creating the uncertainty surrounding crypto’s security status.
Ask Congress to update the definition of security to clearly define what digital assets fall under the Commission’s ambit and which do not.
Drop all prosecutions against nonfraudulent crypto issuers and impose a moratorium against further prosecutions until Congress updates its definitions.
Direct all crypto prosecutions against alleged fraudsters.
SEC regulators should want to give honest innovators certainty and breathing space. A more circumspect approach would also put major crypto policy questions back to Congress to decide and allow everyday Americans to explore the ingenuity crypto has to offer. And it may make the SEC less ‘insane.’
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