WReturn to our Regtech 2022 series, where we trace the evolution of regtech adoption in the financial services and legal industry, the regtech financing market, and the specific strengths and weaknesses of regtech. in Our last postWe set out to survey the complex regulatory landscape of crypto and decentralized finance (DeFi). Here, we continue to navigate this challenging terrain.
The SEC strengthens its claim to supervise digital assets
In April 2021 – a week before President Gensler confirmed it – Hester Pierce (also known as Crypto Mom) published an updated version of her “Token Safe Harbor” proposal for digital assets and crypto. Commissioner Pierce added “Exit Guidelines” to her proposal. according to CoinDesk“[u]Under Token Safe Harbor 2.0, companies will have to hire an outside consultant to evaluate their projects and create a report that assesses whether a project meets certain criteria to be considered “decentralized” or “functional.” Once again, the commission refused to formally consider the commissioner’s proposal, even though the new chair, Mr. Gensler, spoke frankly about the SEC’s authority to regulate digital assets.
Gensler’s boss has repeatedly argued that digital assets may fall within the SEC’s purview if investors purchase them to fund a business or project with the intent of capitalizing on those efforts. This determination is based on Howey’s Analysis, a 1946 US Supreme Court decision defining investment contracts. Despite the small CFTC’s forays into digital asset enforcement and US Treasury tax regulations on digital assets, the Securities and Exchange Commission has continued to make its claim as the primary regulator of digital assets. The SEC strengthened its ties to the DeFi community when it authorized the first registered investment firms to primarily invest in bitcoin futures on CFTC-approved exchanges. On December 7, 2019, a potentially infamous day, the Securities and Exchange Commission (SEC) approved the NYDIG Bitcoin Strategy Fund, a closed-end management investment firm that invests primarily in bitcoin futures. At the time, Commissioner Pierce tweeted that the approval was “some progress.”
Two years later, the Securities and Exchange Commission (SEC) approved the first ETF investing in Bitcoin futures, the ProShares Bitcoin Strategy ETF. A month later, employees approved the IDX Risk-Managed Bitcoin Strategy Fund, a mutual fund that invests primarily in Bitcoin futures. (IDX funds attempted to launch a similar fund for Ether futures, but the Securities and Exchange Commission required IDX funds to withdraw their registration statement until the Ethereum merger is complete.)
The Securities and Exchange Commission (SEC) continues to focus on digital assets, as stated in its examination priorities for 2022, and has nearly doubled the size of its crypto enforcement unit. The increase in the Enforcement Division’s Crypto Asset and Electronic Unit was announced on 3 May 2022. The Commission has also added special funds to its list of high priority areas. President Gensler noted at the International Association of Limited Partners Summit in November 2021 that the $17 trillion in assets of private funds are increasing in size, complexity and number. While many of the fund’s investors (or partners or limited members) are wealthy, tiered retirement plans, government retirement plans, and other unaccredited investors invest in these funds. The recent rise in crypto funds has occurred within the framework of private funds. There is no doubt that the commission’s focus on private funds will put it in close contact with cryptocurrencies and other DeFi assets.
Years after the first ICO offerings, US regulations are in shambles
On June 6, 2022, U.S. Senators Cynthia Loomis (R-WY) and Kirsten Gillibrand (D-NY) proposed a bipartisan crypto bill (DeFi Bill) that would begin applying a legal framework to the digital asset space. The 69 page invoice It covers a lot of areas, including tax, securities, commodity regulation, consumer protection, and more. It also seeks to establish definitions throughout the space. The bill would also require a study of the environmental impact of crypto mining and other industry-related activities.
I have written about how the Securities and Exchange Commission (SEC) beat the CFTC in a regulatory land grab to be the de facto regulator of cryptocurrency. Well, the DeFi Bill will identify cryptocurrencies under the commodity category. Specifically, the CFTC will have exclusive authority to regulate the spot markets for cryptocurrencies, which will be defined as commodities and not securities. The Securities and Exchange Commission will have some supervisory responsibilities when issuing digital assets as equity, debt, or other similar forms of securities. In addition, companies offering stablecoins will need to create 100 percent reserves of the digital asset and provide detailed disclosures.
The general reaction of the crypto community was somewhat optimistic because the bill was reasonable and the innovation supported. In addition, the CFTC is about one-sixth the size of the Securities and Exchange Commission, and tends to engage in less rule-making and enforcement activity. All the positives for a market that still looks like a digital wild west.
According to CFTC Commissioner Goldsmith Romero, most digital assets that rely on the administrative efforts of the issuer, but are not equity in the issuer, are secondary assets that are CFTC regulated commodities. She agrees that the DeFi law will make the CFTC the dominant regulator, but notes that US federal courts will interpret law enforcement on a case-by-case basis, which could change law enforcement. Oddly enough, the SEC will still oversee the reporting requirements for additional assets, even though they are regulated by the CFTC, possibly because the SEC has more disclosure review staff.
After all this, what next?
With the recent carnage in the crypto markets, bankruptcies by crypto service providers, and the clear threat of contagion across the industry, the government is finally starting to “talk” about acting. On July 7, 2022, the US Treasury released a fact sheet on a proposed regulatory framework that would help create interagency regulation of digital assets. On July 11, 2022, a Financial Stability Board (FSB) said it will issue, in October 2022, recommendations for harmonizing global rules for digital assets. Almost all of the focus is on stablecoins and central bank digital currencies (more to come in these cookies). As we will note later, the collapse of TerraUSD, an algorithmically backed stablecoin, triggered the first wave of bankruptcies and crises in the crypto space. Hence, the government considers these products as the most dangerous.
But DeFi Bill has tampered with the SEC’s momentum, and on Tuesday, June 28, 2022, President Gensler suggested on CNBC’s Squawk Box morning show that many digital assets, including crypto assets, have key attributes of securities, but he also suggested that Bitcoin (and perhaps other cryptocurrencies) will be considered a commodity. Ethereum seems to have the strongest argument for not being secure because the blockchain network works like a utility for smart contracts and other applications.
On July 14, 2022, President Gensler suggested that the Securities and Exchange Commission might exempt cryptocurrencies from certain securities laws, as previously reported. Bloomberg. At the same time, he suggested that there are many cryptocurrencies that are “incompatible” with the rules regarding unregistered securities offerings. About a week later, Gurbir S. Congressional Hearing on the Cryptocurrency Industry. He said very little, maybe because after a few days the Ministry of Justice and The Securities and Exchange Commission raised insider trading fees Against crypto insiders from Coinbase.
One area where the CFTC and the Securities and Exchange Commission seem to agree is the need for separate accounts. Both agencies want to know if deposits from clients belong to the issuer (and are kept in a mixed account) or the client (in which case each client’s assets should be kept in separate accounts). Commodity Futures Trading Commission Commissioner Goldsmith Romero raised the issue in Memo 2020 He recently mentioned it at an Axios news media event. SEC President Gensler has also raised this issue before. The issue gained even greater prominence when Coinbase suggested that the client’s assets were in a mixed account that could be vulnerable to the company’s bankruptcy. Ouch!
On March 31, 2022, the Securities and Exchange Commission issued Staff Accountancy Bulletin No. 121, which expressed employees’ views on “Accounting for obligations to protect crypto assets held by the entity to users of the platform.” CoinDesk stated that “[t]His move prompted Coinbase (COIN) to announce in a public filing that clients’ assets may be trapped with the company in a default state of bankruptcy.” Some clients are frightened. Most of them don’t notice.
Employees also request that public crypto companies value digital assets at the lowest price achieved during the reporting period (eg, quarterly). And the I made it clear Cryptocurrency companies like MicroStrategy cannot remove price changes in unofficial accounting numbers. Why is this important? Because forcing public crypto companies to value their assets at the lowest price during the period affects how these companies report earnings. So if the lowest price of bitcoin during the quarter ending June 30, 2022 is around $17,000, that is the number that public crypto companies should use when valuing their assets and reporting their earnings.
US Federal Reserve Chairman Jerome Powell disputed the staff position on June 22, 2022, during his monetary policy testimony before the Senate Banking Committee. As I mentioned CoinDeskPowell stated that[c]Off-balance sheet trust assets have always been, “and”[t]The SEC made a different decision as it relates to digital assets for the reasons he explained, and now [the Federal Reserve has] to look at these [decisions]. Unfortunately, as the CFTC, the Securities and Exchange Commission, and the Federal Reserve try to align with government policy, the cryptocurrency market has collapsed and some of the worst fears are beginning to materialize.
recent report by the Bank for International Settlement (BIS) found that most of Coinbase’s assets are off-balance sheet (i.e. client assets held in custody). According to the report, Coinbase reported $256 billion in assets on its platform as of March 31, 2022, but its balance sheet showed only $21 billion. Why the difference? As for customer assets, Coinbase records both assets and liabilities on its balance sheet. The associated liability is intended to reflect Coinbase’s commitment to protecting customer assets.
Custody issues draw attention to another concern: transparency. Many popular DeFi companies use an opaque central blockchain, which technically means that it is not DeFi. Celsius, a cryptocurrency lender, is a good example, and in June 2022, he used his control of the blockchain to stop withdrawals. There was no warning to consumers and the reaction was very violent. The centenary crash highlighted the need to protect customers’ digital assets.
Privacy and protection within encryption
As the centenary crash highlights the growing importance of protecting customers’ digital assets within the crypto game, other lenders have taken note, as well as the Securities and Exchange Commission and the US government. No matter how diversified their money is – whether it’s in stocks, commodities, cryptocurrencies, or outside of it – people want to protect it. They want to know that their investment is safe and not at risk of situations like liquidation or worse, theft. Cryptocurrency markets are evolving and these questions and concerns seem to be popping up all over the United States and even the world.
In my next blog post, I will discuss the global development and impact of cryptocurrency, litigation and related concerns, and the big question “What now?” Stay tuned and Access To our team if we can help you navigate the crypto space.
This post is part of a series originally published by Financial Technology Law.
The opinions and opinions expressed here are those of the author and do not necessarily reflect the views and opinions of Nasdaq, Inc.
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