The end of February 2023 brought new turmoil to the global cryptocurrency market. This time, it was triggered by an interview with SEC Chair Gary Gensler, in which he once again voiced his opinion on the status of cryptocurrency. According to Gensler, any cryptocurrency other than Bitcoin can be considered a security. This statement prompted harsh criticism from lawyers and traders. After all, if the official’s statement is followed by official action, almost all cryptocurrencies will be subject to U.S. government regulation, and their sale will only be possible with SEC registration.
Andrey Elinson, the founder of an international school of cryptocurrency trading, has tried to assess the possible consequences of declaring crypto as a security and weigh up the arguments for and against this decision.
What are the SEC’s arguments?
“On the one hand, Gary Gensler’s position is understandable. His reasoning goes something like this, ‘Cryptocurrencies are created by businessmen through complex mechanisms to attract investors; investors expect to make profits that are generated through the efforts of intermediaries.’ From a formal point of view, cryptocurrencies (except Bitcoin) pass the Howey Test,” says Andrey Elinson, reciting the SEC’s arguments and noting that in this case, Bitcoin would fall under the authority of the Commodity Futures Trading Commission (CFTC).
The expert also draws attention to the SEC’s main fears, which explain its desire to keep crypto on a short leash. First, the SEC doesn’t like the non-transparent nature of crypto promotion mechanisms. Second, Gensler doubts that digital assets can be a store of value or a reliable payment instrument. “The collapse of the FTX crypto exchange in 2022 only served to spur the SEC’s fears. The crypto platform founder’s unauthorized use of customer funds for questionable investments shocked both the market players and officials. The chain of events is clear: dubious operations of a major player, problems with liquidity, bankruptcy, and the desire of regulatory bodies to ‘clean up’ and make the market more transparent for investors,” muses Andrey Elinson.
Overall, the SEC has good intentions, but will the results of its work be equally good? That’s the rhetorical question Andrey Elinson asks. There is a reason Gary Gensler’s interview caused such a stir in the expert community. Lawyers, for example, immediately argued that the SEC had no competence or authority to regulate cryptocurrencies, that the decision on each digital asset had to be made by the court, and that statements such as the one made by the SEC Chair could only cripple the market. Many market players believe that the CFTC, not the SEC, should regulate the industry.
Cryptocurrency: the “whats” and “whys”
But the most urgent question concerns the nature of cryptocurrencies, believes Andrey Elinson. Do they really have the attributes of securities? The answer is not so simple. The expert stresses that digital assets have different purposes: some are traded in exchange for an issuer’s service or product, some are used for payments (as an alternative to fiat money), and some are used to generate profit. Theoretically, the latter tokens should be subject to state regulation.
Analyzing an asset’s indirect characteristics is also not as straightforward. For example, all securities (whether stocks or bonds) have issuers. It is assumed that the SEC can influence the situation through the issuer in case of dubious transactions. But cryptocurrencies have no centralized issuers because the very point of this tool is decentralization.
According to Andrey Elinson, “A market player can’t choose to issue digital assets — they simply get blocks of not-yet-created assets under a special algorithm… There are also technical differences. For example, a share is an indivisible unit, while a token can be split. There is also an obvious problem with the notion of income. Every asset suggests a stable cash flow, but many coins have no guarantees of future income and are only supported by the trust of the crypto community.” Given all these factors, many market experts consider the status of cryptocurrency an open question, notes the cryptocurrency trading school founder.
Is there a need to rush?
Andrey Elinson points out that the first candidates for the security status were Ripple (XRP), Stellar (XLM), Zcash (ZEC), and Horizen (ZEN). Last fall, Ethereum was also included in this list, although the likelihood of it coming under SEC control is much lower. In any case, the expert deems it risky to urgently recognize all cryptocurrencies as securities. We should at least develop clear criteria for assigning the new status to assets. Together with the expert community, we need to find answers to technical questions. For example, will any change in the protocol be considered an offer? And what will happen to the price of cryptocurrencies to which the SEC assigns the new status?
The Securities and Exchange Commission assures that it has all the necessary tools at its disposal to effectively supervise the industry. However, Andrey Elinson wonders if this is actually true. The consequences of rash decisions will be more than serious. Thousands of tokens worth billions of dollars could technically be outlawed. “It’s not just the cost of registration, which for many people will become unaffordable,” explains Andrey Elinson. “The problem is that many companies will find themselves under the burden of enormous fines. They will have to stop working on protocols, reject preliminary designs, and delist tokens. Their costs will rise sharply. Disclosure, capital and liquidity compliance, and risk management are expensive measures. All this could result in thousands of lawsuits and the bankruptcy of multiple cryptocurrency exchanges.” Andrey Elinson believes that the most dangerous thing in the issue of cryptocurrency regulation is unnecessary haste and a haphazard approach. He says the innovative market will not benefit if the access of small players to it is restricted.
“Chen Li Min (Ed.: Head of Trading Operations at ICB Fund) has already suggested that the desire to protect consumers may hinder the development of the new industry, which is actively challenging major traditional financial players. These days we hear such opinions more and more often,” says Andrey Elinson. He also recalls that last fall, Tom Emmer, a member of the U.S. House of Representatives, denounced the SEC for its unsystematic approach to cryptocurrency market players. In his opinion, this was what caused the FTX fiasco.
The expert says the cryptocurrency market is anxiously waiting. Gary Gensler has promised to make cryptocurrency regulation a priority for the SEC in 2023. His opponents are preparing arguments against tighter supervision. They are counting on the SEC to be flexible on the issue. Most market players, meanwhile, are hoping for the sanity and prudence of the U.S. financial authorities.