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Despite several implosions last year in the world of crypto, it is back on the path of recovery and continuing its journey toward mass adoption.
However, regulatory uncertainty remains the main challenge. All, from investors to businesses and governments, are focused on regulatory monitoring. Regulatory clarity is expected to push crypto toward a tipping point. Clear regulation is necessary, especially for traditional finance (TradFi) to fully embrace digital assets.
The Securities and Exchange Commission (SEC) is a prominent regulatory body in the US and has a considerable impact on the crypto market. The agency has been investigating crypto projects to determine if they are selling what should be categorized as securities.
Unsurprisingly, the hallmark of the regulatory environment for digital assets in the US is a lack of clarity. After all, unlike other jurisdictions in the world, there's no federal statute or regulation specifically governing digital assets, said Daniel Stabile, Co-Chair of Digital Assets & Blockchain Technology Group at Winston & Strawn LLP. She added:
“That's a problem because digital assets can have a nearly infinite variety of different properties and characteristics, so figuring out the taxonomy (categorizing which are securities, commodities, or currencies) is crucial.“
Decoding the Regulatory Challenges
This year, with Gary Gensler at the helm, the SEC started cracking down on the sector, but the broader industry expects that the SEC's lawsuits against cryptocurrency exchanges Coinbase and Binance may provide some clarity. However, this may not come for some time, with the potential for these to drag on for months or even years.
“The SEC here is taking a very aggressive approach of regulation by enforcement,” said Stabile, noting the agency is “trying to shoehorn digital assets” within the catch-all phrase investment contract, which is “creating all sorts of problems.“
Regulatory clarity has been a recurring issue for crypto, but the situation may finally take a turn for the better.
“Things are going to continue to advance not just for security tokens and fully regulated businesses that are using blockchain but for those that are going to be outside of the regulatory sphere of the US and SEC,”
– Mark Powers, ex-SEC and advisor at STA, at the inaugural TokenizeThis conference by Security Token Market (STM).
According to him, this is only going to happen “either through the courts or through Congress because (SEC Chair Gary) Gensler is not going to do it.” The only way to have the SEC come around is by forcing them to come around, he added.
Assessing Regulatory Progress
Sentiments in the US are changing, though, with the crypto sector having secured two wins against the SEC, giving hope for regulatory clarity.
In July this year, Ripple scored a partial victory when a US District Court ruled that the sale of Ripple's XRP token on exchanges did not constitute investment contracts. However, XRP's institutional sale did violate federal securities laws, the court said.
Talking about the Ripple case, Powers noted that the judge could have said that Ripple is not going to repeat itself because they're just an issuer, and there's no likelihood of future violations. But instead of going that route, she went the full route of saying there was no security. So, what happened is you have the Ripple case where she's clearly sending a message to the SEC that “you should start thinking about reforming or being more combative to the blockchain space.”
However, another federal judge, Jed Rakoff, who is involved in Terraform Labs' Terra USD token, contradicted Judge Analisa Torres' ruling, stating digital currencies can be considered securities when sold to the general public.
Stabile, who called Ripple's victory “a watershed moment for the industry,” said there is one thing in common between the two opinions, and that's very important because they said that digital assets themselves “are not in and of themselves securities.”
The point that they were making is that under certain circumstances, they can be sold in investment contracts in the same way that oranges in the Howey test can be sold in a securities offering, he added.
Analyzing Yet Another Legal Win
Recently, digital asset manager Grayscale Investments scored a major victory against the SEC in its efforts to convert its Grayscale Bitcoin Trust (GBTC) into a Spot Bitcoin exchange-traded fund (ETF).
This win, according to Stabile, will help “normalize digital asset trading” and “could potentially open the floodgates for investment in Bitcoin” due to the fact that those big entities who are unable to custody digital assets themselves can now have the exposure via an ETF.
The US Court of Appeals circuit judge Neomi Rao called SEC's rejection of Grayscale's Bitcoin trust conversion arbitrary and capricious when they have already allowed Bitcoin futures ETF to be traded. This has already sparked action with established traditional finance players like BlackRock, Fidelity, Schwab, and Citadel embracing digital assets and announcing applications for ETFs in the crypto space.
“I believe by the end of this year that they have no choice but to allow the ETF, maybe they'll try and punish Grayscale and not let them be the first one,” by pushing BlackRock ahead, said Powers.
In addition, Powers believes the SEC is also “going to lose” in the Coinbase case, which is being heard in the third circuit for failing to put forth regulations around blockchain advancement.
A Spotlight on Legislative Initiatives
Over the past couple of years, several digital asset bills have also been introduced to the US Congress, aiming to govern everything from stablecoins to the jurisdictions of US regulators. This includes the digital asset market structure (DAMAS) bill, which will allow crypto exchanges to register with the SEC as an alternative trading system (ATS) and digital commodities and stablecoins to be traded on these platforms.
The Financial Innovation and Technology for the 21st Century Act would clarify the jurisdictions of regulators, while the Digital Commodity Exchange Act (DCEA) will see stablecoin providers registering as a “fixed-value digital commodity operator” with recording and reporting requirements.
The most important, however, is the Lummis-Gillibrand bill or the Responsible Financial Innovation Act (RFIA). According to Powers, the Lummis-Gillibrand legislation “should get the most traction, and will because it's bipartisan and puts the CFTC as the primary regulator.” The bill aims to clarify the SEC and CFTC's roles in crypto regulation and provide digital asset tax treatment clarity along with equitable treatment for crypto firms regarding bank applications. It would also see depository institutions be the ones allowed to issue stablecoins and would cover DAOs in the tax code.
“It will create the regulatory framework that we need in the United States in order to be the world leader in digital assets,” said Cynthia Lummis (R-W.Y.) in an interview recently. The bill will be passed in segments, starting with the stablecoin component that'll set the stage for “the most important components, which are how the SEC and the CFTC regulate.”
Currently, Kirsten Gillibrand (D-N.Y.) and Lummis are urging the inclusion of an illicit finance amendment to the final version of the Senate's defense spending package. This will direct the Treasury to create regulations regarding how to prevent illicit finance and terrorism financing. It will not only assess how best to regulate things like mixers and tumblers, but it will also give the regulatory authority to the Treasury and agencies to form a set of principles and regulations in the US to prevent terrorism financing.
And due to Congress's limited understanding of cryptocurrency, there's a heightened focus on its role in illicit financing. Thus, when crypto is spotlighted for such illicit involvement, “the knee-jerk reaction” is to view this illicit use as its primary purpose, explained Lummis.
“If we have a regulated market in the United States, then we can have really good commerce here,” and without regulation, it's just like, “let's put our head in the sand and hope it goes away. Well, it will not be going away, it will just be going abroad,” said Senator Lumis.
Future Outlook in the US
Currently, what's happening is that the SEC is trying to fit 20th-century regulations into 21st-century technology. So, there's a disconnect between what we've had in the past, the US common law, which is based on precedent when crypto “is literally an unprecedented technology, and so it's going to take an unprecedented maneuver by regulators to be able to balance” consumer safety and foster innovation, said Adrien Alvarez, founder of InvestReady.
For now, regulation remains a challenge along with the reputational stigma, which Stabile believes “is going away” when major institutions purchase ETFs.
Stabile's views are also supported by Lummis and Gillibrand, who believe that as mainstream financial institutions enter the space, it will signal to Congress members that this is a “legitimate industry.”
“I think the timing, the confluence of events, both because the industry is matured and because the Congress is seeing it being more adopted and embraced by traditional finance, is going to create the enthusiasm and support to move forward,” said Lummis.
In the end, as regulators and TradFi players come around, the regulatory landscape will improve not only for security token markets but also for the broader cryptocurrency markets. This isn't because Gensler desires it but because “he's got no choice,” said Powers.
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