Senator Elizabeth Warren's July 7 letter to SEC Chair Gary Gensler should serve as a wake-up call to the digital asset market. The letter lays bare a bias to regulate an industry that the Senator seems to view as a Wild West of risk for investors and consumers, and it potentially foreshadows more intense regulation and enforcement activity in the digital asset space. But the letter also creates opportunity. Digital asset market participants should recognize the need to continue to help regulators protect consumers and investors, while at the same time seizing the opportunity to educate regulators on the rapidly evolving digital asset space.
The letter appears to be a strong encouragement for the SEC to regulate more deeply and broadly in the digital asset space. In the letter, Senator Warren expressed the view that cryptocurrency exchanges pose risk to investors and consumers. She suggested that those exchanges are not being regulated to the same extent as securities exchanges. And she posed questions regarding the SEC's authority to properly regulate those exchanges, including whether Congress should pass legislation to ensure the SEC "has the proper authority to close existing gaps in regulation" for the protection of investors and consumers. She also expressed the concern that some exchanges might "escape federal regulation" if the digital asset being traded does not qualify as a security under federal law.
In addition to repeating criticism of how certain well-known cryptocurrency exchanges operate, Senator Warren focused on perceived flaws of decentralized finance (DeFi) platforms, which the letter appears to conflate with cryptocurrency exchanges. For example, the letter suggests that MicroStrategy might be serving as a kind of "pseudo-Bitcoin ETF." (MicroStrategy's CEO, Michael Saylor, has become a strong advocate for Bitcoin and the company has added significant purchases of Bitcoin to its balance sheet.)
The letter ended with a series of leading questions that seem designed to elicit answers that will prompt further regulation from the SEC. It would not be surprising that the SEC's response will voice agreement with the need to further regulate and perhaps aggressively enforce of all forms of digital assets and digital asset trading.
The letter seems to indicate that the current critical scrutiny of digital assets not only will continue, but will increase in volume and intensity. That might be particularly so given anticipated industry developments, such as new projects and products arising from the continued rollout of the Ethereum "Layer 2," the pace of which has been described by some as a "Cambrian explosion." As those projects become more creative and complex, they likely will generate new forms and varieties of regulatory challenges. The letter does not reflect an appreciation that the existing securities and commodity and futures regulatory regimes might not fit the digital asset ecosystem, or that this new asset class might need a tailored regime. Nor does the letter seem to consider the potential value and benefit to investors and consumers that creative U.S. regulatory approaches might create.
Those lapses crystallize the challenge and the opportunity for participants in the digital asset space. The industry needs to confront quickly and aggressively any ongoing instances of fraud, which are quite real, to avoid a draconian regulatory oversight framework that will stifle innovation and drive legitimate activity offshore. Otherwise, opponents of the industry will identify, analyze, amplify, and frequently repeat examples of this kind of unscrupulous behavior, thus creating the impression that such behavior is the rule and not the exception. Thus, the industry needs to both continue to cooperate with regulators to help protect consumers and investors, and to educate regulators on the rapidly evolving digital asset space when possible.
The industry likewise needs to continue to work with its allies in Congress to push for enactment, where appropriate, of legislation that recognizes that certain digital assets are a new asset class and should be regulated accordingly.
DISCLAIMER: This article was originally published by McGonigle PC prior to their combination with Davis Wright Tremaine LLP. The article is published here with permission.