Congress stepped into the crypto currency world this week, holding hearings that focused on the digital currency markets. Specifically, the Senate Committee on Banking, Housing, and Urban Affairs heard testimony from SEC Chairman Jay Clayton and CFTC Chairman J. Chrisopher Giancario on the subject.
Each regulator discussed the virtual currency markets, the limits of their jurisdiction and their efforts to coordinate with other agencies. The prospect of legislation was mentioned by Mr. Clayton, who offered on behalf of both agencies to discuss the subject with Congress. Chairman Giancario noted only that it would be a “dramatic” increase in the authority of the agency if its jurisdiction was expanded to include certain areas involving virtual currencies. Overall, the hearings did not appear to be a call for additional regulation of the virtual currency markets. SEC Chairman Jay Clayton, Testimony on Virtual Currencies: The Oversight Role of the U.S. SEC and the US. CFTC, Senate Committee on Banking (Feb. 6, 2018)(here); CFTC Chairman J. Christopher Giancario, Testimony Before the Senate Banking Committee (Feb. 6, 2018)(here).
Each regulator discussed the development of the new technology and the opportunities it may open for investors and the markets in favorable terms. For example, Chairman Clayton state that “I am very optimistic that developments in financial technology will help facilitate capital formation, providing promising investment opportunities for institutional and Main Street investors alike.” At the same time the Chairman expressed significant concern in view of the enthusiasm of investors who often are not fully educated on the new products: “regardless of the promise of this technology, those who invest their hard-earned money in opportunities that fall within the scope of the federal securities laws deserve the full protections afforded under those laws . . . [but] when enthusiasm for obtaining a profitable piece of a new technology . . . is strong. . .Fraudsters . . prey on this enthusiasm.”
The popularity of these products creates a “question for market regulators,” according to Chairman Clayton, about the applicability of the historic regulatory approach and its application to the current situation. Many of the U.S. based cryptocurrency trading platforms have elected to be regulated as money-transmission services, typically the subject of state regulation. These services have not traditionally been regulated by the SEC or the CFTC. This presents an issue regarding the regulatory approach. Both agencies “are open to exploring with Congress . . . whether increased federal regulation of cryptocurrency trading platforms is necessary or appropriate. We are also supportive of regulatory and policy efforts to bring clarity and fairness to this space,” Chairman Clayton testified.
Both agencies are monitoring current cryptocurrency related activities of regulated market participants in their respective areas, according to the testimony of each Chairman. The SEC, for example, is monitoring brokers, dealers and other market participants that permit payment in cryptocurrencies, allow customers to purchase those currencies or otherwise used them to facilitate transactions. Chairman Clayton stated that entities involved in these kinds of activities should exercise “caution.” The Chairman also testified that while there have been applications for products such as cryptocurrency-linked ETFs, there are a number of issues surrounding them which include liquidity, valuation and custody of funds’ holdings that must be resolved before moving forward with new products.
Chairman Giancaerio essentially concurred. The Chairman stated, for example, that futures exchanges have self-certified new products on twenty-four hours notice prior to the commencement of trading. While this process has been considered to work well, the exchanges involved and the staff have had “numerous discussions and exchanged numerous draft product terms and conditions.” As a result there is what the Chairman called “a set of enhanced monitoring and risk management steps” in place with regard to these products.
This “balanced approach” to self-certification has created other positive results, Chairman Giancaerio told the Committee: “It has resulted in the world’s first federally regulated Bitcoin futures market. Had it even been possible, blocking self-certification would not have stopped the rise of Bitcoin or other virtual currencies.” Rather it would have resulted in them being traded in the spot market where the CFTC’s jurisdiction is limited to fraud actions.
Initial Coin Offerings or ICOs are another significant development in this area discussed by Chairman Clayton. This is a growing market in which an estimated $4 billion was raised in 2017. While the offerings take many forms Chairman Clayton warned again, as he has in the past, that gatekeepers – market professionals including accountants and attorneys – must be alert to the proper application of the federal securities laws, citing the SEC’s Section 21(a) report on DADO Tokens which concluded that the coin offering was of a security. Despite this guidance in many instances “a particular ICO appear to elevate form over substance,” according to the Chairman. It is for this reason that gatekeepers must be vigilant the Chairman declared: “On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities.”
Finally, each Chairman reviewed recent enforcement actions by their respective agency. An analysis of these actions highlights the dangers for investors in the virtual currency markets. Nevertheless, each Chairman concluded his testimony by noting the prospects for innovation in these new markets — “We are entering a new digital era in the world financial markets,” Chairman Giancario declared.