Prepared Remarks of Gary Gensler On Crypto Markets Penn Law Capital Markets Association Annual Conference
Our reading of the speech and what it entails for US policy on financial regulation of crypto assets. We attempt to translate "policy jargon" into normal English and read between the lines about the Biden administrations developing policy by what they are signalling across multiple officials and agencies.
Today, you’ve invited me to talk about the roughly $2 trillion crypto markets.
In February, you all might have noticed Super Bowl ads for several crypto platforms. This wasn’t the first time we’d seen some new innovations getting air time on the biggest TV event of the year.
Public interest in crypto assets has grown extensively. Yet regulation has not caught up.
Seeing these ads reminded me that, in the lead-up to the financial crisis, subprime lender AmeriQuest advertised in the Super Bowl. It went defunct in 2007. A few years before that, according to Axios, “Fourteen dotcom companies advertised during the 2000 Super Bowl, most of which are now defunct.” I know many in the audience may just have been young children at the time, but the internet was relatively new back in 2000. The dot-com bubble burst, though, created significant tremors in our markets.
Crypto is a bubble. And bubbles don't end well for most people who try to time them. They also can cause massive damage to the economy if left unchecked.
Ads, thus, don’t equal credibility. In crypto, there is lots of innovation, but plenty of hype. As in other start-up fields, many projects likely could fail. That’s simply part of the entrepreneurial spirit in the U.S.
Matt Damon is probably hawking the new pets.com.
The SEC’s remit is overseeing the capital markets and our three-part mission: protecting investors, facilitating capital formation, and maintaining fair, orderly, and efficient markets. Within the policy perimeter, regulators also care about guarding against illicit activity, a role that is so important to us and our partners at the Department of the Treasury and the Department of Justice; and about financial stability, which is important to all financial regulators.
There’s no reason to treat the crypto market differently just because different technology is used. We should be technology-neutral.
The SEC oversees activities, not technologies. Its remit oversees regulating investment contracts and it doesn't matter if those investments are done on a blockchain. The laws still apply.
So I’d like to mention three areas related to the SEC’s work in this area: platforms, stablecoins, and crypto tokens.
First are the crypto trading and lending platforms, whether they call themselves centralized or decentralized (DeFi).
These platforms have scale, recently trading crypto worth more than $100 billion a day.
The crypto market is highly concentrated, with the bulk of trading taking place on only a handful of platforms. Amongst crypto-only exchanges, the top five platforms make up 99 percent of all trading, and just two platforms make up 80 percent of trading. In crypto-to-fiat transactions, 80 percent of trading is on five trading platforms. Similarly, the top five DeFi platforms account for nearly 80 percent of trading on those platforms.
Furthermore, these platforms likely are trading securities. A typical trading platform has dozens of tokens on it, at least. In fact, many have well in excess of 100 tokens. As I’ll address later, many of the tokens trading on these platforms may well meet the definition of “securities.” While each token’s legal status depends on its own facts and circumstances, given the Commission’s experience with various tokens that are securities, and with so many tokens trading, the probability is quite remote that any given platform has zero securities.
DeFi is engaging in regulatory arbitrage. Almost all of them are likely breaking the law.
Thus, I’ve asked staff to work on a number of projects related to the platforms.
First is getting the platforms themselves registered and regulated much like exchanges. Congress gave us a broad framework with which to regulate exchanges. These crypto platforms play roles similar to those of traditional regulated exchanges. Thus, investors should be protected in the same way.
The U.S. has the greatest capital markets because investors have faith in them. We have rules with respect to safeguarding market integrity, protecting against fraud and manipulation, and facilitating capital formation. If a company builds a crypto market that protects investors and meets the gold standard of our market regulations, then customers will be more likely to trust and have greater confidence in that market.
The US has deep and fair capital markets that are the best in the world and we want to keep them that way. Companies that want to work with US investors need to come under US law.
In my view, regulation both protects investors and promotes investor confidence, in the same way that traffic laws protect drivers and promote driver confidence. It’s at the core of what makes markets work.
Regulation builds public trust in markets. Public trust in markets is good.
Some have asked if the current exemptions for so-called alternative trading systems (ATSs) could be generally available to crypto platforms. ATSs for the equity and fixed income markets, though, are generally used by institutional investors. This is quite different than crypto asset platforms, which have millions and sometimes tens of millions of retail customers directly buying and selling on the platform without going through a broker. Thus, I’ve asked staff to consider whether and how the protections that are afforded to other investors on exchanges with which retail investors interact should apply to crypto platforms.
There is debate about whether the typical broker-dealer arrangement is appropriate for trading crypto assets. This is an open regulatory question.
Second, crypto platforms currently list both crypto commodity tokens and crypto security tokens, including crypto tokens that are investment contracts and/or notes. Currently, the venues that the SEC oversees solely trade securities. Thus, I’ve asked staff to consider how best to register and regulate platforms where the trading of securities and non-securities is intertwined. In particular, I’ve asked staff to work with the Commodity Futures Trading Commission (CFTC) on how we jointly might address such platforms that might trade both crypto-based security tokens and some commodity tokens, using our respective authorities.
Crypto exchanges will have to register with the SEC if they want to sell securities to the public. This would bring their products under the remit of traditional securities law.
The third area is around crypto custody. Unlike traditional exchanges, currently centralized crypto trading platforms generally take custody of their customers’ assets. Last year, more than $14 billion of value was stolen. I’ve asked staff how to work with platforms to get them registered and regulated and best ensure the protection of customers’ assets, in particular whether it would be appropriate to segregate out custody.
Further, unlike traditional securities exchanges, crypto trading platforms also may act as market makers and thus as principals trading on their own platforms for their own accounts on the other side of their customers. I’ve thus asked staff to consider whether it would be appropriate to segregate out market making functions.
Unlike traditional securities infrastructure that uses clearinghouses to custody products between sales, crypto exchanges are acting as fully vertically integrated market makers, clearing house and broker and this introduces conflicts of interests that may warp price formationi and enable market manipulation.
As it relates to crypto lending platforms, we recently charged BlockFi with failing to register the offering of its retail crypto lending product, among other violations. The settlement made clear that crypto markets must comply with time-tested securities laws, such as the Securities Act of 1933 and the Investment Company Act of 1940. It further demonstrates the Commission’s willingness to work with crypto platforms to determine how they can come into compliance with those laws.
Creating alternative lending platforms that offer extremely high interest rates, with no rationale for those rates, raises some red flags from a consumer protection perspective.
BlockFi agreed to attempt to bring its business into compliance with the Investment Company Act, and its parent company announced that it intends to register under the Securities Act of 1933 the offer and sale of a new lending product.
Turns out BlockFi was breaking the law. We sued BlockFi and we won.
The second area is the $183 billion (and growing) stablecoins market. Outside of use on crypto platforms, stablecoins generally are not used for commerce. Generally, you’re not using them to get a cup of coffee at Good Karma on your way to class from Center City. They are not issued by a central government and are not legal tender.
Stablecoins are like casino tokens for moving money between different offshore entities outside of the regulatory perimeter.
Stablecoins, though, in offering features similar to and potentially competing with bank deposits and money market funds, raise three important sets of policy issues.
Stablecoin are acting as non-bank financial institutions and offering products that resemble uninsured bank deposits.
First, stablecoins raise public policy considerations around financial stability and monetary policy. Such policy considerations underlie regulations that banking regulators have with respect to deposits and that we at the SEC have with respect to money market funds and other types of securities. Many of those issues are discussed in the recent President’s Working Group Report. For instance, what backs these tokens so we can make sure that these holdings can actually be converted to dollars one-to-one? Further, stablecoins are so integral to the crypto ecosystem that a loss of the peg or a failure of the issuer could imperil one or more trading platforms, and may reverberate across the wider crypto ecosystem.
Stablecoin are vulnerable to runs like we saw in the 1930s. Bank runs are very bad. If stablecoins are allowed to scale and still have run risk then this introduces systemic risk into the whole economy.
Second, stablecoins raise issues on how they potentially can be used for illicit activity. Stablecoins primarily are used for crypto-to-crypto transactions, thus potentially facilitating platforms and users avoiding or deferring an on-ramp or off-ramp with the fiat banking system. Thus, the use of stablecoins on platforms may facilitate those seeking to sidestep a host of public policy goals connected to our traditional banking and financial system: anti-money laundering, tax compliance, sanctions, and the like.
Stablecoins are currently being used for regulatory arbitrage and as a means to circumvent US law.
Third, stablecoins raise issues for investor protection. Stablecoins were first adopted and continue to be dominantly used on crypto trading and lending platforms. About 80 to 85 percent of trading and lending on these platforms involves stablecoins. When trading on a platform, the tokens actually often are owned by the platforms, and the customers just have a counterparty relationship with the platform. The three largest stablecoins were created by trading or lending platforms themselves, and U.S. retail investors have no direct right of redemption for the two largest stablecoins by market capitalization. There are conflicts of interest and market integrity questions that would benefit from more oversight.
The most popular stablecoins exclude US persons from withdrawing the USD equivalent of the stablecoin's marked value. This introduces a conflict of interest and makes the market vulnerable to manipulation by avoiding US regulatory oversight.
Then, thirdly from a policy perspective are all the other crypto tokens. The fact is, most crypto tokens involve a group of entrepreneurs raising money from the public in anticipation of profits — the hallmark of an investment contract or a security under our jurisdiction. Some, probably only a few, are like digital gold; they may not be securities. Even fewer, if any, are actually operating like money.
When a new technology comes along, our existing laws don’t just go away.
Regulation needs to be technology neutral. Selling an investment on a blockchain is no different than selling it on paper.
In the 1930s, Congress painted with a broad brush the definition of a security. Our laws have been amended many times since then, Congress has painted with an even wider brush, and the Supreme Court has weighed in numerous time. They’ve all said, basically, to protect the public against fraud, to protect the public against scammers, people raising money from the public had to register and make basic disclosures with a cop on the beat: the SEC.
Securities laws exist for a very good reason. To protect the public and ensure fair and transparent markets. Safe markets are in the public interest to encourage capital intermediation.
You might wonder: how might a crypto token be a security?
The Supreme Court’s 1946 Howey Test, which was about orange groves, says that an investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.
The Howey test is the precedent that the United States has used to determine whether an investment meets the criterion of a security. This test is still applicable to crypto investments.
My predecessor Jay Clayton said it, and I will reiterate it: Without prejudging any one token, most crypto tokens are investment contracts under the Howey Test. Even before the Howey test, in the first several years of our federal securities laws, some entrepreneurs were notified that they had to register their offerings of chinchillas, whiskey warehouse receipts, oyster beds, and live silver foxes as securities offerings, as “the purported sale of the…property was merely camouflage and not the substance of the transaction.”
Today, many entrepreneurs are raising money from the public by selling crypto tokens, with the expectation that the managers will build an ecosystem where the token is useful and which will draw more users to the project.
There are currently illegal security sales happening in the crypto ecosystem.
Thus, it is important that we work to get crypto tokens that are securities to be registered with the SEC. Issuers of crypto tokens that are securities must register their offers and sales of these assets with the SEC and comply with our disclosure requirements, or meet an exemption. Issuers of all kinds across a variety of markets successfully register and provide disclosures every day. If there are, in fact, forms or disclosure with which crypto assets truly cannot comply, our staff is here to discuss and evaluate those concerns. Any token that is a security must play by the same market integrity rulebook as other securities under our laws.
United States law still applies to crypto investments. Companies engaging in regulatory arbitrage should engage the SEC or risk being shut down.
In conclusion, new technologies come along all the time; the question is how we adjust to that new technology. But make no mistake: We already live in a digital age. That’s not what’s new here. We already can buy a cup of coffee with money stored in an app on our smartphones. The days of physical stock certificates ended decades ago. There’s nothing new about people raising money to fund their projects. Crypto may offer new ways for entrepreneurs to raise capital and for investors to trade, but we still need investor and market protection.
Technology may be new, but the same laws still apply to regulated activities done with new technology.
We already have robust ways to protect investors trading on platforms. And we have robust ways to protect investors when entrepreneurs want to raise money from the public.
Fair, orderly, and efficient markets encourage capital formation which is in the public interests. Regulation is a means to advance these ends.
We ought to apply these same protections in the crypto markets. Let’s not risk undermining 90 years of securities laws and create some regulatory arbitrage or loopholes.