The Breakdown - Two Regulatory Hearings Show Difference in SEC and CFTC Approaches to Crypto

Episode Date: September 17, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   On this edition of the “Weekly Recap,” NLW looks at the latest in market action plus how two congressional hearings highlighted differences in the approaches the CFTC and SEC are taking to crypto.  - 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. Photo of Sen. Pat Toomey (R-Pa.), credit: Anna Moneymaker/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 ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, September 17th, and that means it's time for the weekly recap. A quick note before we dive in, however, there are two ways to listen to the Breakdown podcast. You can find us on the CoinDesk podcast, network feed, which comes out every afternoon, alongside other great CoinDesk shows, or you can find us on the breakdown only feed, which comes out a few hours later in the evening.

Wherever you listen, if you were enjoying the show, I would so appreciate it if you would take the time to leave us a rating or a review. 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, which 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 coin desk.com slash ideas. Well, folks, this ended up

being a pretty huge week. It kicked off on Tuesday with an inflation surprise. Markets have convinced themselves that we were going to see a continuation of the trend from last month and a further decline in month-over-month inflation. Instead, we got a much higher than anticipated increase in month-over-month inflation. This led to the worst market day since June of 2020, and an increase likelihood that the Federal Reserve will raise rates by 100 basis points, a full percentage point, at next week's FOMC meeting. Since then, there's really been a settling in of the reality,

that this inflation is going to be persistent and thorny, and any idea of a pivot is pretty well off. Market turmoil continued at the end of the week with a fairly shocking earnings report from FedEx. The company withdrew its 2023 earnings guidance and announced significant cost-cutting measures, flagging a softness in global shipments. FedEx's CEO said in the press release, quote, global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S. We are swiftly addressing these headwinds, but given the speed at which conditions shifted, first quarter results are below our expectations.

During an interview later that day with Jim Kramer, the CEO responded to Kramer's question of whether the world is heading into a global recession with, I think so. These numbers don't portend very well. FedEx will be closing 90 office locations, five corporate office facilities, deferring new hiring and reducing flights. Now, what's important about this is that FedEx has long been considered a global bellwether for economic conditions. shares were down 22% when markets opened. FedEx's biggest drop since at least 1980. Joe Wisenthal

tweeted ominous from FDX. I remember in Greenspan's Day, this was the company he used to gauge the state of the economy. Javier Blas, the Energy and Commodities columnist at Bloomberg writes, FedEx has withdrawn its annual financial guidance after a poor Q1FY 23 quarter, particularly over the last few weeks of August. When the package delivery giant sneezes, it's a clear sign the global economy has caught a cold. The question now, of course, is will this push the recession narrative further? Or will inflation remain the chief concern? It was also, of course, merge week. The long-anticipated transition from proof-of-work to proof-of-stake on Ethereum happened on Thursday, basically without a hitch. Since then, crypto-Twitter has been non-stop political infighting. Bitcoiners are saying

this makes Eth more of a security, while some Ethereum's and VCs are saying that proof of work is stupid. Candidly, it's all pretty predictable and in line with where I would have expected the BS to be after the merge. It's certainly not as bad as it might be, and I don't think it really matters anyway. What will matter is if and how new narratives creep into the regulatory discourse. Speaking of regulatory discourse, let's actually turn our attention to two hearings from Thursday. SEC Chair Gary Gensler appeared at a Senate Banking Committee hearing. Now, this hearing was the annual oversight hearing for the SEC, so it covered a range of topics from stock buybacks to environmental disclosures, but obviously I'm going to focus on the crypto discussion.

Senator and Republican Ranking Committee member Pat Toomey framed the crypto portion of the hearing in his opening remarks, drawing attention to the fact that the SEC had brought enforcement action against BlockFi in February but was apparently asleep at the wheel as multiple bankruptcies rocked the rest of the crypto lending industry in the middle of this year. Toomey also questioned the SEC's failure to, quote, clarify the rules of the road for crypto assets beyond assertions that most tokens are securities. He raised a point regarding the definition of a security noting that most crypto tokens do not represent, quote, a financial claim on the issuer, suggesting that these could make tokens, quote, very different from the vast majority

of ordinary securities. Toomey concluded his opening by asking, what is the crypto-specific roadmap for crypto intermediaries to register with the SEC? He even noted Matt Levine's criticism of Chair Gensler's approach to regulating the industry, noting the specific line, Chairman Gensler's posture is that he should be in charge of writing the rules for crypto, but not write them. At the same time, Tumi recognized that, quote, Congress ought to step in and provide clarity. In particular, we need to revisit the definition of security as part of a larger effort to tailor a regulatory framework that is calibrated to the unique risks and activities of the crypto market. Nexo 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. Eager to make more informed decisions around crypto, chainelysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support for all crypto assets.

for organizations like Gemini, Crypto.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at Chainalysis.com slash CoinDesk. The breakdown is sponsored by FTXUS. FtXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction, fees and no withdrawal fees.

One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use referral code breakdown to support the show. Now for his part, Chair Gensler spent his time in opening reiterating recent talking points. He asserted that quote of the nearly 10,000 tokens in the crypto market, I do believe that the vast majority are securities. given that, it follows many crypto intermediaries or transacting insecurities and have to register

with the SEC in some capacity. Chair Gensler refocused attention to the idea that in creating reforms for crypto markets, Congress and the SEC should ensure that they don't, quote, inadvertently undermine the securities laws underlying a $100 trillion capital market. That's the mother load. That's our capital market. Crypto is one one hundredth that size. He concluded by noting that the SEC is, quote, anchored by the laws Congress passes, the court's interpretation of those laws, economic analysis, and public input. Now, as you can see, in back and forth, the first big topic dealt with was how the SEC defines crypto assets as securities. Senator Toomey used the example of Bitcoin, which Chair Gensler has

publicly stated does not meet his definition of a security. He asked whether decentralization was the determining factor in this process. Chair Gensler began by referring to the Supreme Court definition as he sees it. Quote, whether the investing public is anticipating profits based on common enterprise. Senator Toomey, questioned whether a common enterprise could exist in the absence of centralization. While struggling to reach a clear answer, Chair Gensler eventually settled on the idea that Bitcoin's status as a non-security hinged on the idea that, quote, the investing public is not betting on someone in the middle. To draw a line under his point in this questioning, Senator Toomey stated, quote,

it is not reasonable to fail to provide clarity, to provide the definition of exactly where on this continuum you have a sufficient common enterprise that it qualifies as a security in where you don't. You've said Bitcoin doesn't. Some of your colleagues have said Ethereum doesn't, but a reasonable developer that wants to comply with this doesn't know where that line is drawn. That prompted Genser to return to his view that his definition of common enterprise hinged on whether there is a group of developers in the middle, and the investing public is betting on them relying on them. Senator Toomey moved to some discussions of how investors had been let down by the SEC and their failure to properly regulate crypto intermediaries. He noted that during the

bankruptcy of crypto lenders this year had led to loss of customer funds due to the lack of regulations allowing for the segregation of customer funds. Senator Toomey concluded by saying, My concern is that the approach you're taking with these one-off discussions, if it did even result in an opportunity to comply, it would be this idiosyncratic exemptive order negotiated with a single company. That's not a good way to pass rules. Chair Gensler followed up,

I think we've been very clear through 70 or 80 actions. I look at other times in history. The SEC and the asset-backed securities market took 10 or 11 years where they did these exemptive orders and relief to individual issuers and did a rule at the end of that 10 or 11 years based on all of that experience. Seeming to imply that this regime of the SEC just going after enforcement actions is a 10 or 11 year process before we get any sort of clarity.

A couple of other senators also grilled Gensler on the crypto industry. Senator Round, Republican from South Dakota, directly addressed the issues surrounding the SEC's regulatory strategy of suing crypto companies for issuing securities for the last five years while refusing to put forward any agenda to adapting securities and disclosure rules for the crypto industry. quote, it seems to me you want to regulate an entire marketplace, but clearly it doesn't appear that you've got rules in place to do so at this time. In my mind, this is simply unacceptable. He noted that he had heard from several crypto companies who tried to work with the SEC

only to be faced with heavy enforcement actions or the SEC slow walking the process. Senator Cynthia Lummis discussed the bill she and Senator Gillibrand had proposed earlier this year, specifically seeking feedback on the proposed disclosure framework contained in the bill. She also reaffirmed her and Senator Gillibrand's desire to continue to work with the SEC in crafting their bill. She suggested that they might be reintroducing it in January. Now, after all of this, there were big fireworks based on comments to reporters. Following the hearing, Gensler offered a generic opinion on crypto staking and how it relates to a token status as a security. Quote, from a coin's perspective, that's another indicator

that under the Howey test, the investing public is anticipating profits based on the efforts of others. The Wall Street Journal then reported these comments as an indication that Ethereum staking model may raise fresh questions from the SEC about whether or not it should be classified as a security. This had a lot of anti-Etherium folks frothing at the mouth to say that the SEC thinks Ethereum is a security, but clearly not everyone agrees. Jake Trevinsky from the Blockchain Association wrote, I'd say I haven't heard a compelling argument as to why staking makes an asset more like a security under the Howie test, but actually, I haven't heard any argument at all. It's just something people say without regard for either, one, how staking works, or two,

what the law is. The general idea seems to be, if you squint hard enough, staking sort of looks like a dividend or interest, and some actual securities have those, so maybe staked assets are securities, too. That's not how the law works. That just means holders of staked assets expect profit, which alone doesn't make the assets into securities. Expectation of profit is only one of four highway test prongs, and likely the least important for volatile assets. People hold all kinds of assets with an expectation of profit, gold, cars, watches, etc. Now, this was not the only hearing. Also on Thursday, the Senate Agriculture Committee, which oversees the CFTC, held a hearing to discuss the Digital Commodities Consumer Protection Act. This is the bipartisan bill that was

introduced last month to grant the CFTC oversight over spot and derivatives markets for digital assets that act like commodities. Chairwoman Debbie Stabenow specifically referred to Bitcoin and Ethereum has two examples of tokens which may fit into this classification. Senator Stabenow framed the hearing as being about the importance of delivering the necessary federal regulatory oversight to crypto markets which have been blighted by bankruptcies, hacks in a major drawdown, harming in particular low-income investors. Quote, this is a glaring hole in our financial system, and I believe we must close it. CFTC Chairman Rustin Benham was the primary witness for the hearing. He established that he had already directed his agency to begin preparing to be the major fully funded regulator for much of

the crypto market. He said the volatility in the market and its impact on retail customers, which may only worsen under current macroeconomic condition, emphasizes the immediate need for regulatory clarity and market protections. Another aspect of the bill would call for the CFTC to examine the environmental impact of cryptocurrency mining, with Chair Benham noting the Ethereum merged during his testimony. Quote, an event occurred last night with Ethereum which is going to reduce energy consumption, a step in the right direction, but certainly not resolving the problem. One of the issues with setting up a regulator for the crypto industry has been funding the regulatory effort. Chair Benham estimated that this additional regulatory jurisdiction would require an additional

$112 million over the first three years on top of the existing CFTC budget of $320 million per year. There were a couple witnesses as well. Christine Parker, the Deputy General Counsel for Coinbase said, quote, we are at a crossroads when it comes to crypto. She asked lawmakers to set a clear distinction between commodities and securities in the bill, arguing that it could be, quote, strengthened by further defining digital asset commodities to ensure assets that do not meet the definition of securities are regulated by the CFTC and not by enforcement through the SEC. Heath Tarbert, a former CFTC chairman and current chief legal officer for Citadel Securities, also supported the bill at the hearing, drawing attention to three regulatory goals which he viewed as being achieved by the bill, consolidating regulatory oversight within a single agency,

and arming the CFTC with the ability to set market rules and standards rather than just take enforcement action. He said he viewed this step as enabling large firms like Citadel to confidently enter the market, which would enhance liquidity and replace the, quote, bucket shops and boiler rooms. He also said that the bill would enhance customer protection for American investors, as well as laying out a framework for enhanced market stability and safety. Now, this bill has a lot more support in the crypto industry. There are definitely issues, as Jake Chervinsky and others pointed out, questions of the definition of a digital commodity, some provisions that make it, quote, unworkable for

defy, questions about threats to financial privacy and more. But ultimately, these two hearings show such a big contrast. The CFTC is talking about the really big segments of crypto markets, Bitcoin and Ethereum spot and derivatives markets, and how they can be made to operate properly with robust consumer protection. The SEC is really dealing with crypto fundraising, dealing with the ICO problem, and just generally ensuring that unregistered public fundraising and other securities offerings don't happen with impunity. It's a big, high-profile headline-grabbing thing, but ultimately a small fraction of what goes on in these markets. Now, of course, ultimately, it's going to be to Congress, again, I keep saying this

like a broken record, to decide who actually has authority over what. But at least, as you can see from these hearings, that that's the conversation that they're actually having. For now, I want to say thanks again to my sponsors, nex0.io, chain alysis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.