Embedded in the mythologies, religions, and folklore of the world, are instructive and cautionary tales meant to illustrate the importance of respecting one's elders. Relationships of the wise guiding the young are viewed as universally paramount to the success of any society. This top-down transfer of knowledge, skills, and traditions has been deemed the bedrock of culture and can help communities avoid repeating the mistakes of the past. However, while well-intentioned, there are myriad examples throughout history of overreach and overcorrection from watchful guardians on populations pulling toward a desired world. The thinking is that to preserve society, it must be yoked for its own protection.
We’re seeing something very similar play out in the crypto regulatory landscape, most notably in the United States. To be fair, the Securities and Exchange Commission (SEC) is not alone in its skepticism of certain assets and platforms. China is the largest market to have banned digital assets from its borders, but other countries, such as Pakistan, could follow suit. While such extreme reactions by nations constrict the financial freedom of their citizens, these policies at least offer a clear set of rules and guidelines. Current traders, curious newcomers, and industry leaders alike all know where they stand with these states and the institutions they contain. This is not the case in America.
Following the SEC’s recent lawsuits against Binance and Coinbase, there’s a palpable sense of uncertainty in the crypto space. Where the regulator once worked to understand its jurisdiction, participants are now bracing for a showdown.
Regulatory Retrograde
A self-described melting pot, America’s inconsistencies can be hard to spot on the surface. Passengers flying into Los Angeles can see the Crypto.com Arena sitting squat amidst the downtown sprawl, but potent lawsuits that could undermine the digital economy are less visible. While the exact origin of this slippage is difficult to pin down, part of the incongruence stems from what could be described as a lack of imagination. Prior iterations of the SEC took the responsibility of defining their jurisdiction in such a way that balanced the health and pace of the financial world. This practice led the institution to update its terms and definitions of market phenomena as its structures progressed beyond the technology and thinking of the 1930s.
Events of the middle past help reveal recent instances of regulatory recalibration, and the acceptance of this process necessitating a collaborative atmosphere between key stakeholders. In a speech by former Director, Office of Compliance Inspections and Examinations for the SEC, Lori A. Richards from 2002, we’re given an outline of the institution's legacy of malleability:
“I never get bored with my job, and for that, I can thank this dynamic industry and the creative people who work in it. Changes occur so rapidly. Of course, the astounding increase in the number of investors, and the staggering amount of assets under management have caused many of the changes. But make no mistake, much of the change in the industry also arises from innovations — witness the myriad of new products that have been offered under the banner of investment management. In 1940, who foresaw money market funds, or funds of funds, or wrap-fee programs or exchange-traded funds? The ability of the industry to meet the changing needs, and make-up, of its investors has contributed to its success.”
The curiosity and wonder in Richards’ address are indicative of the SEC’s then in-house stance of approaching new developments in finance with an open mind. It implies that the challenges of adapting to novel forms of investing could go so far as to include updating the institution’s very understanding of what it means to invest. In 2002, who could have foresaw liquid staking? The positive tone and obvious thrill expressed are wholly absent from the SEC’s communique to and between crypto leaders, even those trying to act in good faith.
In a post-FTX world, there’s an argument to be made that the regulator could be flexing its muscles out of genuine concern. While Richards’ speech makes explicit mention of the laws put in place after catastrophic instances of fraud, its totality still reflects a progression away from the individual and toward system-wide assessments. The growth, both of active firms and cumulative assets under management, help explain the institution’s need to pivot and be scrupulous with resources to remain agile. Yet, when market analysts note the SEC’s strapped budget and personnel, their whack-a-mole approach to crypto regulation is even more curious in light of its expressed shift toward systemic assessments.
Where the introduction and rapid advancement of the crypto ecosystem seemed poised to inherit the same decades-long relationship, more and more companies are finding themselves in regulatory crosshairs. The repeated unwillingness to continue evolving its working definition of “exchange” has led many, including current SEC Commissioner Hester M. Peirce, to assert the regulator is bucking historical precedent. Peirce argues this clear deviation from institutional norms, even under the guise of shielding curious consumers, should itself be placed under the microscope.
In her dissent of SEC Chairman Gary Gensler’s decision to apply outdated terms to emerging solutions in the crypto industry, Commissioner Peirce did not mince words:
“[T]oday’s Commission aggressively expands its regulatory reach to solve problems that do not exist. Today’s Commission treats its basic approach to exchange regulation as something that must not—indeed cannot—be altered to allow room for new technologies or for new ways of doing business. Today’s Commission tells entrepreneurs trying to do new things in our markets to come in and register. When entrepreneurs find they cannot, the Commission dismisses the possibility of making practical adjustments to our registration framework to help entrepreneurs register, and instead rewards their good faith with an enforcement action. Today’s Commission treats the notice-and-comment rulemaking process not as a conversation, but as a threat.”
While this helps explain some of the discord within the institution, its resolute posture against innovations in global finance runs counter to even that of its closest geopolitical allies. The EU’s recent adoption of MiCA legislation is providing new guidance for the region, while the U.K. continues to position itself as amenable to the industry. While far from linear, the growth and adoption of digital assets have continued to withstand external pressures and successive incursions from bad actors within the ecosystem. Lately, the greatest threat to crypto’s existence is coming from a body that continues to send mixed messages. Curiously enough, recent unsealed documents in the SEC’s lawsuit against Ripple, and its XRP token, have added further fuel to the confusion.
A Ripple in the Argument
On June 13, documents were unsealed in Ripple’s ongoing legal discord with the SEC that revealed more inconsistencies within the institution. Known as the Hinman documents, their contents center on a speech and emails by former SEC Chair William Hinman explaining why ETH should not be regulated as a security. The brief dossier shows how the SEC was discussing these matters internally as recently as 2018 with clarity and candor that has been absent in the body’s recent actions.Much like the speech by former Director Richards, Hinman is cognizant of the SEC’s role in helping to define and understand the intricacies of its jurisdiction. This is most evident when he pivots the focus away from whether digital assets are securities, and toward a more nuanced discussion of their usage and transfer:
“To start, I think a better line of inquiry is: ‘Can a digital asset or token that was originally offered in a securities offering ever be sold in a manner that does not constitute a securities offering?’... But what of those cases where there is no central enterprise being invested in and where the digital asset or token is sold only to be used to purchase a good or service available through the network which was created? I believe in these cases the answer is a qualified ‘yes.’”
Hinman goes on to state the SEC is not interested in playing “regulatory gotcha” and is prepared to work with industry partners toward a better understanding of the changing environment. Much of Hinman’s assessment of Ethereum and thinking with regard to the crypto space is reflected concisely in a caveat about utility tokens. Using a Supreme Court case to break down the evolution of securities law, Hinman noted that “the economic substance of the transaction determines the legal analysis, not the labels.” Given the SEC’s recent emphasis on taxonomical definitions, the past five years have clearly seen a deterioration of this former mindset.
It’s frustrating to be once again litigating the use and function of technologies that are co-evolving with our legacy institutions. Skeptics can point to ample instances of foul play in the digital economy but fail to acknowledge the latitude we allow traditional finance for similar missteps. However, as technological advancements continue to reorient vectors of communication, education, and wealth transfer, communities will continue to embrace viable alternatives to existing systems. We must choose whether these fault lines remain persistent barriers to realizing the full potential of technologies and ideas that don’t comport to the world as it currently exists. We should strive, like the SEC at its inception, to make peace and change with the times.