The Breakdown - Gensler’s Latest Take on Crypto and Securities Rules

Episode Date: September 10, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   On this edition of the “Weekly Recap,” NLW digs in on the latest speech from SEC Chairman Gary Gensler. It appears reasonable, but does the crypto industry believe him?  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company ensures the safety of your funds by employing five key fundamentals including real-time auditing and recently increased $775 million insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “Razor Red” by Sam Barsh and “The Life We Had” by Moments. Image credit: Mark Wilson/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.  

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, September 10th, and that means it's time for the weekly recap. Before we dive into this show, however, a quick note. There are two ways to listen to the breakdown. You can hear it on the Coin Desk podcast network, which comes out every afternoon alongside other great Coin desk shows, or you can listen on the breakdown-only feed, which comes out a few hours later in the evening. Wherever you listen, if you would take the time to go leave a rating or a review, I would

so appreciate it. It makes a big difference. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Finally, I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas. Ideas is designed to facilitate capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source and invest in the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass and register today at coindesk.com slash ideas.

All right, this week kind of snuck up on me. Around about the middle of the week, it didn't seem like all that much was going on. We were pretty well mired in the pre-fed prediction phase, waiting to see what August inflation numbers come in at next week, and generally watching our favorite crypto assets circle around the drain. But then there were just an absolute flurry of communications regarding crypto, Bitcoin, Bitcoin mining, stable coins coming from all parts of the U.S. government. So today we're going to hone in on one of those communiques, this one from Gary Gensler, the head of the Securities and Exchange Commission.

He gave a speech this week called Kennedy and Crypto at the Practicing Law Institute. And for those wondering, the Kennedy he's referencing is Joseph P. Kennedy, the first head of the SEC and the father of JFK. The speech does something of a normal setup for Gensler. He discusses the securities acts in the 1930s, how innovative and forward-thinking they were.

He then says, over the generations, Congress has refined and amended these key statutes, adding, amongst other things, oversight of clearing agencies and the over-the-counter market for securities. The core principles from these statutes apply to all corners of the securities markets that include securities and intermediaries in the crypto market. Nothing about the crypto market is incompatible with securities laws. Investor protection is just as relevant regardless of underlying technologies. And this is in many ways the thesis statement of the whole piece. Nothing about the crypto markets is incompatible with the securities laws.

investor protection is just as relevant regardless of underlying technology. Genzer then goes on to break his discussion into two parts. The first regards tokens and the second regards intermediaries. He writes, Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.

He says that he believes there is a wide scope to determine what a security is. As Justice Thurgood Marshall put it in describing the scope of securities laws, Congress painted the definition of a security with a broad brush. He further stated, Congress's purpose in enacting the securities laws was to regulate investments in whatever form they are made and by whatever name they are called. And then he gets to another key point. Quote, in general, the investing public is buying or selling crypto security tokens because they're expecting profits derived from the efforts of others in a common enterprise. For those who have been paying attention, it is, of course, that definition of common enterprise.

and the efforts of others that have been thorny as it relates to mature crypto networks. There was another big message in this speech that was yet another rejection of the premise that the SEC hadn't been clear. Quote, for the past five years, the commission has spoken with a pretty clear voice here through the Dow report, the Munchy Order, and dozens of enforcement actions. Not liking the message isn't the same thing as not receiving it. Effectively, Gensler is saying that it's you guys sticking your fingers in your ears and not listening, not that we're not being clear. However, reflecting on this speech as relates to tokens,

it feels quite like Gensler is focused on the initial sale of a crypto asset. It feels almost as though the SEC remains living in an ICO world. Listen to this passage. Investors are following crypto projects on social media and scouring online posts about them. These tokens have promotional websites featuring profiles of the entrepreneurs working on the projects. It's not about whether you set up a legal entity as a nonprofit and funded it with tokens. It's not about whether you rely on open-source software or can use a token within some smart contract. These are not laundromat tokens. Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others. Therefore, investors deserve disclosure to help them sort between

the investments that they think will flourish and those they think will flounder. Investors deserve to be protected against fraud and manipulation. The law requires these protections. Now let's hold aside that last paragraph about whether investors should be able to make clear decisions. When Gensler is talking about promoters marketing them and entrepreneurs being on web pages, and it really frankly sounds like the earliest stages of a token's life from a few years ago. In many ways, it feels like Gensler is choosing not to address what tokens might become later or even what they can become. It seems like Gensler is willfully ignoring that part. Interestingly, that's the part that Congress is making clear they're explicitly trying to deal with.

I thought one of the most impressive attempts of the Lumas-Gillabrand Responsible Financial Innovation Act, whatever quibbles one might have had with it, is the fact that they didn't shirk this question. As to the determination of whether most tokens are securities or commodities, effectively Lemmiss-Gillabrand rejects the premise of the binary. Instead, it says in principle, and this is 100% me paraphrasing, many crypto assets end up appearing to be some form of digital commodity. The bill doesn't use the phrase sufficient decentralization, which previous commissioners of the SEC had, but this is the general idea. There is a point at which that the success or failure of the token is not

reliant upon the efforts of others in a common enterprise, but is part and parcel of a decentralized network of contributors. At that point, even if a token appeared security-like in its early days, Lovis Gillibrand gives it a path to resolve to its natural digital commodity-like state. Now, for what it's worth, that bill also gives you. the SEC primary oversight responsibility during those early years? It is to the SEC that those tokens have to report and give disclosures. It just doesn't pin them down as securities forever. Now again, I think that there are probably many ways to come at this question of things that look more like a security at the beginning, but then not so much later on. But ultimately,

it reinforces that it needs to be Congress who can zoom a level up from the folks at the SEC or the CFTC, who each have their mandates in spheres of influence, and look at the problem holistically. Nexto is a security-first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets, safeguard your funds, making Nexo the right place for you to buy, exchange, and borrow against your assets safely. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io.

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and use referral code breakdown to support the show. Now other notes from the speech, Gensler flags that stable coins may in some cases be securities as well. Quote, depending on their attributes, such as whether these instruments pay interest directly or indirectly, through affiliates or otherwise, what mechanisms are used to maintain value, or how the tokens are offered, sold, and used within the crypto ecosystem, they may be shares of a money market fund or another kind of security. If so, they would need to register and provide important investor protections. If it hasn't been clear yet, it should be now that this discourse around stablecoins is going to touch such a wide swath of regulatory agencies, from the Office of the Comptroller of the

currency, to the Treasury Department, to the Federal Reserve, to the SEC. Now, when it comes to intermediaries, Gensler's argument is pretty simple. If some tokens on crypto exchanges are securities, then crypto exchanges need to be registered with the SEC in some capacity. Now, of course, that's why the designation of tokens being securities or not is so important, and that's why clarity around statutory authority also matter so much. But to be fair, there's a lot in here that's completely reasonable. For example, a quote, crypto investors should benefit from exchange rulebooks that protect against fraud, manipulation, front-running, wash sales, and other misconduct. I don't think most people in crypto would disagree with that.

There was also a bit of an olive branch in the speech in terms of the SEC-C-T-Turf war that we followed. Genzer says, regulation of crypto security tokens and related intermediaries at the SEC. Further, to the extent that crypto intermediaries may need to register with both the SEC and the CFTC, I would note we currently have dual registrants in the broker-dealer space and in the fund advisory space. Finally, Gensler argues, as he has before, that all of this compliance will expand rather than contract the market. Quote, after the Exchange Act was passed, as Kennedy later wrote, it was prophesied that the securities markets of the country would dry up within a few months. Of course, the opposite happened.

Instead, every important stock exchange in the U.S. registered with the SEC and our markets thrived. So a few notes about all of this. First, I think it's worth covering because obviously Gensar has inserted itself as one of the loudest and most important actors in the U.S. government as relates to upcoming crypto regulation. When it comes to what people think, let's look at the intermediaries first. SBF, the CEO of FTX, writes, I'm not a regulator. This is not legal advice. But my current best guess is consistent with what Gary Genser says, that the CFTC says. will regulate spot-in futures for non-security tokens, and the SEC will regulate spot in issuance of tokens that are securities. SBF says this is also consistent with a huge number of other bills

and what the chair of the CFTC has said publicly. He goes on and says it seems pretty likely that BTC, ETH, and many forks or variants will not be securities, and that many other tokens will be securities. How about other large tokens, or futures or swaps on security tokens, or tokenized stocks, and what exactly is a stable coin? We'll see. And for what it's worth, I think this is all pretty reasonable, and a resolution providing regulatory oversight along these lines would be healthy for consumers, protect against risk, prevent scams, give clarity to the industry, and allow liquidity to come back to the U.S. Now, basically all the comments are some version of Gaborger-Box, who works with Vanek.

He says the real question is how tokens will be categorized in various buckets, commodity, security, etc. I've been talking to regulators about tokens for eight years. I think it's good that multiple regulators are taking interest in providing more certainty. progress is good. Eric Vorhees from Shapeshift says when will we see a list from SEC of which tokens are securities? Even just clarifying the top 100 would be very helpful. If the quote-unquote law is clear, then the list should be pretty easy to put together, no? Another line of discussion that I thought was interesting came from Jake Trevinsky.

The Wall Street Journal piece that reported this was titled something to the effect of Gensler supports CFTC having oversight of Bitcoin and Ether. I noticed when I was reading it that there was no mention of Ethereum, and this is exactly what Jake gets into. He says, This isn't what the article says. It claims Chair Gensler supports CFTC regulation of cryptocurrencies such as Bitcoin and quotes him referring to crypto-nosecurity tokens. There's no mention of ETH except in reference to the DCCPPA,

a bill he hasn't expressly supported. For context, there have been rumors for a while that Chair Gensler's SEC would love to walk away from its June 2018 guidance saying ETH isn't a security, but they haven't found a credible way to do that yet. There isn't one. I don't read this article as him giving even an inch. Here's a transcript. He says nothing about ETH or the SEC's June 2018 guidance, a notable omission, given that it's both the most important statement the SEC has made on the Howie Test and an

accurate description of the law. There has been far too much speculation on what Gary Gensler thinks about ETH in its security status already, but I do think its absence is notable. Finally, I can't but help a hard agree with Gabriel Shapiro, the General Counsel at Delphi Digital Labs, who writes, The most frustrating thing about Gensler's speech is that I agree with much on the surface level, but the SEC's long-standing refusal to customize the securities law for crypto as many of us pushed make his words deeply disingenuous. It is a fantasy that small software teams with no revenue-generating business can afford to become

full-blown Exchange Act reporters, a regime costing millions per year. Further, the majority of those costs arise from accounting formalities that make no sense is applied to a purported implied-by-law investment contract that does not represent a claim on a company's assets. The SEC could have, and should have, long ago, created a custom reporting regime for tokens, and steadfastly refused to do so. Therefore, stepping into that regime is practically impossible. Therefore, no one reports. The SEC is harming the markets through stubbornness. The idea that thousands of tokens, and therefore thousands of token issuers can just comment in register is simply wrong. Only the bluest of blue chip revenue-generating corporations can afford

this. This won't be compliance. It will be extinction. Who is harmed? You, me, great innovative developers, the economy, the markets. Who benefits? Investment banking incumbents and some bureaucrats seeking to use this as a badge of accomplishment. Matt Levine, the renowned Bloomberg columnist, who is by no means a pushover on crypto, also found the speech just kind of weird. His article about it was called Gary Gensler wants to regulate crypto, and it's long and worth a full read. Here's how it concludes, though. I do not understand the game here. Gensler's posture seems like a massive bet against crypto ever being important. His message is basically, I should be the main regulator of crypto, and as the main regulator,

my plan is mostly to ban it. That's not abstractly an insane posture. That's more or less the view that the U.S. Drug Enforcement Agency takes towards cocaine, for instance, or the view that China takes towards crypto, for that matter. But most of the people who are jockeying to be the main regulator of crypto want to regulate a thriving ecosystem. They want it to be big and they want to be in charge of it. Gensler wants to be in charge of it and have it be irrelevant and cumbersome and slow moving.

That might be a good pitch now in the crypto winter, when so many crypto stories are about people losing their life savings to unregulated scams. But it is not going to appeal to anyone in the crypto industry, and I don't think it's going to appeal to politicians who are interested in crypto and who are writing their own legislation to decide who should regulate it. Gensler's posture is that he should be in charge of writing the rules for crypto, but not write them. I don't see how that can work.

So there you have it. In many ways, it's much of the same. But I do think it reinforces for me that we are approaching the endgame as relates to who is going to have authority over what. To me, this is Gensler trying to say the same things he's been saying for a while, but in a more reasonable way. I certainly think there's a role for the SEC in regulating crypto, and that many of the tokens have properties that make them security-like. But as is probably clear from this presentation, I think it takes Congress, individuals and a body who together have the ability to zoom up from any interagency discussions, to see the whole picture and recommend the right course of action. For now, I hope you're

having a great weekend, and I just want to say thanks one more time to my sponsors, nexus.com. Chainalysis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.