On April 4, 2022, Securities and Exchange Commission (SEC) Chair Gary Gensler presented his views on decentralized finance (DeFi) platforms and crypto tokens, which reiterated the active stance the SEC is prepared to take on the nascent industry. In his prepared remarks addressed to the Penn Law Capital Markets Association, Gensler expressed his determination to use existing regulatory tools to supervise crypto platforms, stablecoins, and other crypto tokens.1In Gensler's view, the SEC already has sufficient means to protect investors from crypto platforms and crypto issuers. This is consistent with the positions previously taken by Gensler and the SEC in asserting jurisdiction over crypto markets. Gensler also unveiled several projects that the SEC is planning to prod the crypto industry into the regulatory frameworks already in place.
Regulation of Crypto Platforms
Gensler first remarked that the crypto platforms are currently highly concentrated, with only two platforms making up 80% of all trading by crypto-only exchanges. To protect investors, Gensler stated that he directed the SEC to consider three projects. First, the SEC is examining whether crypto platforms should register and be regulated as securities exchanges. While acknowledging that there have been arguments that exemptions from registration for alternative trading systems (ATSs) should also be available to crypto platforms, Gensler did not agree with the analogy. In his view, ATSs are generally inhabited by large institutional investors. Crypto platforms, on the other hand, have "millions and sometimes tens of millions of retail customers directly buying and selling on the platform without going through a broker." The presence of retail customers has compelled the SEC to step in and assess how to provide customers of crypto exchanges with the protections retail investors have on traditional exchanges.
Second, Gensler announced that he has directed the staff to collaborate with the Commodity Futures Trading Commission (CFTC) on how to jointly regulate crypto platforms. Since many crypto platforms list both crypto commodity tokens and crypto security tokens, Gensler finds that coordination between the two regulatory agencies would establish a comprehensive regulatory regime for these platforms.
Third, Gensler finds it appropriate for crypto platforms to insulate their custodial services and market-making functions from their trading services. Gensler noted that most crypto platforms, unlike traditional exchanges, take custody of their customers' assets and that "more than $14 billion in value was stolen" last year. To address this concern, he has directed the SEC to consider whether custody should be segregated as a means to protect customers' assets. Moreover, many crypto platforms act as market makers, hence they are often counterparties to their own customers. This, according to Gensler, is troublesome for such a highly concentrated industry, particularly raising market integrity questions, as mentioned below.
Regulation of Stablecoins
In addition to his reservations over crypto platforms, Gensler also expressed his concerns about stablecoins. According to Gensler, stablecoins pose a risk to the financial stability of the general market. Gensler discussed the importance of regulation and oversight over the peg that stablecoins claim to ensure so that a failure of one stablecoin does not "reverberate across the wider crypto ecosystem." Stablecoins' potential for use in illicit activities and potential for conflicts of interest were also points of concern. Specifically, Gensler mentioned that many crypto platforms actually own the stablecoins that are heavily traded on their platforms. Hence, those crypto platforms become counterparties to many of their customers. This fact, along with the fact that many retail investors do not have direct rights of redemption for the stablecoins, can create an issue of market integrity for the platforms.
Reiteration of the Authority of the Howey Test
Finally, Gensler reminded his audience that he believes most crypto tokens are securities because they meet the definition of "investment contracts" as defined by the U.S. Supreme Court's decision in SEC v. Howey.2Under the Howey test, an investment contract involves an investment of money by entrepreneurs in a common enterprise with an expectation of profits from the efforts of others. Such an investment contract comes under the jurisdiction of the SEC. According to Gensler's view, most crypto tokens carry this hallmark of an investment contract: "Without prejudicing any one token, most crypto tokens are investment contracts under the Howey Test." Gensler warned that issuers of such crypto tokens must register with the SEC and comply with its rules.
Conclusion
Gensler mentioned in his prepared remarks that the Super Bowl this year showcased numerous ads for crypto platforms and services. This "hype" reminded him of subprime lender AmeriQuest's ad in the 2006 Super Bowl, before going defunct during the financial crisis, and of the "dotcom companies" advertised in the 2000 Super Bowl, many of which have also disappeared since. "Ads, thus, don't equal credibility." Gensler was careful to note that the SEC is willing to work with crypto platforms to help them comply with the SEC, raising the recent settlement with BlockFi as an example (discussed in a previous article here). Since joining the SEC, Gensler has emphasized his determination that existing legislations and regulations already confer the SEC ample authority to oversee the crypto industry. He had told Congress in October 2021, for example, that "the SEC's authorities in [the crypto space] are clear" and that "Congress painted with a broad brush for the definition of security."3 Although Gensler's view has been coherent, his detailed remarks about crypto platforms and stablecoins and his plans for upcoming projects at the SEC should alert the crypto industry. It would be prudent for crypto platforms and issuers to prepare for the several projects that Gensler has in mind for the SEC.
Winston & Strawn Law Clerk Jeremy Chu also contributed to this blog post.
Footnotes
1. Gary Gensler, Prepared Remarks of Gary Gensler on Crypto Markets, U.S. Securities and Exchange Commission (Apr. 4, 2022), https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422.
2. 328 U.S. 293 (1946).
3.Oversight of the U.S. Securities and Exchange Commission: Wall Street's Cop Is Finally Back On the Beat, 117th Cong. No. 117-51, at 8 (2021).
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