Punishing Progress While Rewarding Confusion

The Securities and Exchange Commission (SEC) has trafficked in some high-visibility, low-value enforcements, like the overhyped fine against Kim Kardashian. Regulators sometimes use headline grabbing to send political messages and to demonstrates their value to stakeholders. The agency has been on an enforcement tear of late, eager to bash any and all crypto assets—even those which play by its rules. While SEC Chairman Gensler tells innovators to “come in and talk to us” to find out what the rules are, companies risk being hammered for doing something no one knew is wrong. Sadly, this egregious effort has deterred the innovations that investors want. Look at Grayscale, Ripple, Robinhood and Coinbase.

The SEC should work with industry to get it right

Sandra Hanna, leader of Miller & Chevalier’s Securities Enforcement practice who represents clients in investigations and proceedings by the SEC observes that important crypto industry players have asked for guidance and concrete regulation, but that has not been forthcoming. She explains:

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“The SEC should, however, work with the players trying to get it right in advance of a substantial offering. In other contexts, market participants often engage with the staff through a well-established process of “no-action” letters before engaging in some activity. A no-action letter provides some assurance that if the advisor does precisely what is laid out to the staff, the activity would not result in an enforcement action.

“The well-established crypto participants are, in good faith, trying to engage with the Staff. For reasons none of us understand, that process is too slow and cumbersome and has yet to bear fruit. It needs to move faster, for sure.”

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Markets move at lightning speed; regulators, at a snails pace. There will never meaningful clarity or protection unless the SEC does the minimum to publish rules in advance. This does not exist presently.

Grayscale: CFTC works for me, not for thee

Grayscale Investments is the world’s largest digital currency asset manager with $15 billion in assets under management. It holds the tokens underlying the investment vehicle in “cold storage” or offline, making it easier for investors to buy, sell, store, and safekeeps digital assets outside of exchanges like the fraud-ridden FTX. Whereas some crypto assets emerge specifically to arbitrage regulation, Greyscale’s vehicles are bound by U.S. financial rules and regulations, including U.S. securities law, and are designed with compliance in mind. With compliance being an inherent part of product development so to speak, Greyscale attempts to evolve with, if not exceed, regulators’ expectations.

As Greyscale developed its Grayscale Bitcoin Trust (GBTC) to a spot exchange traded fund (ETF), it followed the SEC’s guidance and instructions. Yet the SEC rejected Grayscale’s application, denying the use of the Commodity Futures Trading Commission (CFTC) methodology it had earlier recommended earlier. The SEC subsequently noted that its decision is consistent with every other spot bitcoin ETF application it receives.

This summer Grayscale sued the SEC, claiming the SEC’s inconsistent treatment of Grayscale’s products was arbitrary, discriminatory, and in excess of the Commission’s statutory authority; it also argued that the test the SEC has applied to bitcoin-related ETFs, and only bitcoin-related ETFs, is flawed and has been inconsistently applied with a “special harshness” to spot bitcoin ETFs. Multiple amici briefs support Grayscale’s view.

“Although bitcoin may be a relatively new asset, the legal issue here is straightforward,” Grayscale explains. In 2021 and 2022, the SEC approved several Bitcoin futures ETFs, but repeatedly rejected ETFs that hold bitcoin directly, or spot Bitcoin ETFs, including Grayscale’s application to convert GBTC. The brief highlights that bitcoin futures and spot bitcoin both generate their price based on overlapping indices, so the spot price of bitcoin in each product is subject to the same risks and protections.

“That stark arbitrariness cannot be justified or reconciled with the Commission’s mandate to treat like cases alike. Rather, it can be only understood as a substantive judgment on the merits of a spot bitcoin investment — the kind of substantive judgment that is outside the Commission’s authority,” the brief reads.

“The Administrative Procedure Act and Exchange Act require rules and regulations to be applied without favoritism for one type of product or another,” said Craig Salm, Grayscale Chief Legal Officer. “Over 850,000 million Americans own GBTC – a product designed so that investors could have regulated access to investing in bitcoin.

Ripple: Regulation by enforcement

A more egregious example is in the SEC’s lawsuit against enterprise blockchain company Ripple over its use of the XRP token in its cross-border payments software product for banks. The legal theory at the core of the SEC’s case is a microcosm of its sweeping argument that all crypto assets are securities. It argued from the start that all sales of XRP are investment contracts in Ripple, even if sold on the secondary market by token users with no knowledge of the company’s existence. Ripple countered that XRP is a commodity on a decentralized ledger that anyone can use or own or trade, and their efforts have little to do with its value or price.

The SEC’s arguments were so weak that Ripple’s attorneys rapidly turned the tables on the regulator in court and put the SEC itself on trial. By the end of arguments after two years of litigation, an unprecedented number of amicus briefs had poured in against the SEC’s legal theory, including from more than 75,000 XRP holders whom the agency was supposedly protecting.

In the end, the Ripple case will likely have exposed the SEC’s regulation-by-enforcement strategy as a flimsy attempt at expanding its turf rather than concern over investor protection.

Bitcoin IRA: Consumer protection by innovation, not regulation

Even in a world without regulation, markets evolve tools to address investors’ concerns about safety, simplicity, and transparency, including cryptocurrencies. Crypto-enthusiasts like the decentralized, anonymous nature of digital assets, but these characteristics also enable fraud, and hence concern regulators. Innovators, however, see these problems as features, not bugs. They see a market opportunity to build the systems which provide these missing pieces for investors and regulators.

Bitcoin IRA’s mission is to help Americans retire by an investment platform and education materials which facilitate their investment in cryptocurrencies. The platform includes a customer-centric mobile app, 24/7 customer service with live human beings, and state of the art, multi-signature encryption technology and cold-storage (offline) wallets. External, independent ratings agents also emerge to provide needed information to the market. While this does remove all risk from an investment, it helps investors make more informed decisions and balance risk within a given portfolio and strategy. This bottom-up innovation is important because it is customer driven. Apps and platforms must evolve to customer need or customers won’t use them.

The SEC’s anti-crypto strategy threatens to undermine all digital asset companies, legit and fraudent. Its one size fits all approach deters progress by punishing the very innovations which address investors wants and needs and provides value to the global economy, while sowing confusion that allows frauds like FTX to erupt unchecked.

Disclosure: The author does not own or trade in any digital assets. This article does not constitute an endorsement of any digital or crypto asset.