SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo testified today before Congress on the subject of virtual currencies. The prepared remarks of both contained very little that they had not already said in previous public comments. (For example, Mr. Clayton repeated that the ICOS he has seen would qualify as a “security” and this need to be registered) Each also referred to the enforcement actions that their agencies had taken (mostly over the past few months) almost of all which have also been previously mentioned in this blog.
In Chairman Clayton’s prepared remarks, the main message was that, in some ways, current laws apply and they have been used to protect the public. But there are also some holes. Investors transacting on the cryptocurrency markets do not receive many of the market protections that they would when transacting through broker-dealers on registered exchanges or alternative trading systems (ATSs), such as best execution, prohibitions on front running, short sale restrictions, and custody and capital requirements. Many Main Street investors probably do not appreciate these differences and the resulting substantially heightened risk profile.
He also expressed concern that many of the U.S.-based cryptocurrency trading platforms have elected to be regulated as money-transmission services. Traditionally, from an oversight perspective, these predominantly state-regulated payment services have not been subject to direct oversight by the SEC or the CFTC. Traditionally, from a function perspective, these money transfer services have not quoted prices or offered other services akin to securities, commodities and currency exchanges. In short, the currently applicable regulatory framework for cryptocurrency trading was not designed with an eye to the trading of the type currently taking place. It is easy to read this as identifying a potential hole that might require federal legislation.
Perhaps the highlight of Chairman Giancarlo’s prepared remarks was his “do no harm” comment:
During the almost 20 years of “do no harm” regulation [of the Internet], a massive amount of investment was made in the Internet’s infrastructure. It yielded a rapid expansion in access that supported swift deployment and mass adoption of Internet-based technologies. Internet-based innovations have revolutionized nearly every aspect of American life, from telecommunications to commerce, transportation and research and development. This robust Internet economy has created jobs, increased productivity and fostered innovation and consumer choice.
“Do no harm” was unquestionably the right approach to development of the Internet. Similarly, I believe that “do no harm” is the right overarching approach for distributed ledger technology.
Virtual currencies, however, likely require more attentive regulatory oversight in key areas, especially to the extent that retail investors are attracted to this space.
And, like Chairman Clayton, he identified a possible hole where federal regulation might be appropriate. Namely, under current rules, cash or “spot” transactions in virtual currencies and trading platforms are governed by state law. That patchwork system can be difficult to enforce and could also lead to gaps.
Both Chairmen stressed the importance of finding the right balance. They made clear that regulators need to embrace the pursuit of technological advancement and innovative techniques for capital raising. At the same time, it cannot be at the expense of the principles undermining the well-founded and proven approach to protecting investors and markets.
The takeaway is that the SEC and CFTC will remain vigilant and see their main role as protecting investors. Some new federal regulation might be required. Indeed, during his testimony, Chairman Clayton said, “We may be back with our friends from the U.S. Treasury and the Fed to ask for additional legislation.” However, at least for now, there will not be anything like the same type of crackdown as seen in places like China.
