Why does everyone want to regulate Crypto?

Author: Jack, BlockBeats

In less than a week, the two largest cryptocurrency exchanges in the world were consecutively sued by the SEC, and more than a dozen mainstream cryptocurrencies were classified as securities and brought under SEC regulation. The SEC's strong "Power Move" against the crypto industry has shocked everyone, and the current SEC chairman Gary Gensler, who is actually in command, has become the notorious "executioner" in the crypto field.

In 2021, the crypto industry welcomed Gary Gensler's appointment with enthusiasm. This former MIT professor who taught blockchain courses was widely regarded as an ally of the crypto world at high levels of authority. However, after taking office, Gensler "turned the tide," sending a series of strong regulatory signals against cryptocurrencies, and has now become the "culprit" sweeping through the crypto space.

What accounts for such a stark contrast in Gensler's stance before and after taking office? Speculations such as "lost money in trading" and "personal vendetta against Binance" often appear in conversations among industry practitioners. On Wednesday evening, a hearing in the U.S. House of Representatives caught BlockBeats' attention. Originally intended as a hunt for crypto platforms by regulatory agencies, it unexpectedly turned into a denunciation conference against the SEC. It turns out that even under the "strictest" regulatory environment in history, there are significant differences among regulatory agencies.

A closer look at the history of crypto regulation reveals that Gensler's relentless attacks on the crypto space are backed by an escalating power struggle and endless infighting among U.S. regulatory agencies. As a victim of the conflict, Crypto is caught in a predicament with unprecedented uncertainty.

1. Distorted Hunting

After filing a lawsuit against the world's largest cryptocurrency exchange Binance on June 5, the SEC did not give the industry even a single day to breathe, filing a similar lawsuit against the publicly listed Coinbase the very next day, while classifying more than a dozen mainstream cryptocurrencies such as SOL, ADA, and MATIC as securities. From any perspective, this lightning strike against the crypto industry is undoubtedly a "Power Move" showcased by the SEC.

In terms of effectiveness, this move has undoubtedly satisfied the SEC. Under regulatory intimidation, Robinhood immediately announced it would delist tokens classified as securities within a week. Meanwhile, Binance.US, facing an SEC asset freeze application, delisted hundreds of token trading pairs overnight. However, in reality, the two lawsuits are unlikely to yield any substantial results in the short term. The SEC is well aware of this, as even the Ripple case has dragged on for years, let alone this time targeting the industry's top two players.

Interestingly, the panic caused by the SEC's heavy-handed approach was not limited to practitioners in the crypto industry; it also affected their "peers" from the regulatory side. Perhaps the SEC understands very well that its target in this strike is actually someone else.

Just hours after the SEC accused Coinbase of violating securities laws, the U.S. House Agriculture Committee held a dual-panel hearing to discuss the regulation of the cryptocurrency spot market, attended by CFTC Chairman Rostin Behnam, Coinbase Chief Legal Officer Paul Grewal, and Robinhood Chief Legal Compliance and Corporate Affairs Officer Dan Gallagher. In this hearing, the SEC became the target of everyone's criticism.

The committee straightforwardly asked CFTC Chairman whether the SEC should have complete control over digital assets. Behnam's response was quite thought-provoking.

"This is not a zero-sum game; the legislative or legal authority that the CFTC may gain is not taken from others. But there is a regulatory vacuum; there is a gap in the regulation of digital commodity assets," Behnam said. "The SEC has authority over assets classified as securities. However, the largest token, Bitcoin, is a commodity, as determined by U.S. courts. And under U.S. law, it is unregulated… Given that most crypto commodity assets listed on trading platforms are rarely formally classified as commodities, there is an urgent need to empower regulatory agencies with additional authority over the crypto commodity space."

The most noteworthy aspect of this statement is Behnam's terminology regarding cryptocurrencies. He did not use the term "digital assets" but rather "digital commodity assets." Behnam acknowledged that the SEC has regulatory authority over all assets classified as securities, but he does not concede that digital currencies should be classified as securities. Throughout his speech, Behnam repeatedly hinted that only by allowing the CFTC to regulate cryptocurrencies as commodities can the current regulatory vacuum in the industry be resolved.

In addition to the struggle over the classification of crypto assets, the current regulatory enforcement model of the SEC has also come under fierce criticism. House Agriculture Committee Chairman Glenn Thompson sided with the CFTC, clearly stating, "Regulating through enforcement is not the appropriate way to manage markets, adequately protect consumers, or promote innovation."

2. CFTC and SEC Tear Each Other Apart for Crypto

In fact, the clashes between the CFTC and SEC over cryptocurrency regulation have occurred more than once. In August 2021, as the SEC called for an expansion of its regulatory scope over the cryptocurrency industry, then-CFTC Chairman Brian Quintenz tweeted that cryptocurrencies belong to commodities and should be regulated by the CFTC rather than the SEC. He wrote in his tweet, "The SEC has no jurisdiction over pure commodities or their trading venues, whether those commodities are wheat, gold, oil, or crypto assets." Subsequently, the House Agriculture Committee immediately supported the CFTC, stating that cryptocurrencies fall outside the SEC's jurisdiction.

Earlier, former CFTC Chairman Christopher Giancarlo also tweeted that the CFTC has more experience in regulating Bitcoin and the crypto market than the SEC. Giancarlo wrote, "If the Biden administration truly wants to regulate the cryptocurrency industry reasonably, it needs to nominate a CFTC chairman."

To some extent, Giancarlo's remarks are not without merit. In terms of jurisdiction over cryptocurrencies, the CFTC's legal basis is indeed much clearer than that of the SEC. The CFTC has always regarded cryptocurrencies as commodities under Section 1(a)(9) of the Commodity Exchange Act (CEA), falling within its regulatory scope. This interpretation has been recognized by federal courts, allowing the CFTC to exercise regulatory authority over crypto derivatives and enforce anti-fraud and anti-manipulation laws in spot crypto trading.

Since 2016, many crypto giants, including Bitfinex, Tether, BitMEX, and Binance, have received fines from the CFTC. From this perspective, the CFTC indeed has more experience in regulating crypto platforms. (Note from BlockBeats: For more information on CFTC's fine records, please read "The Fines the CFTC Has Imposed on Crypto Companies Over the Years")

In contrast, the SEC's consistency in regulating cryptocurrencies is much lower. Before Gary Gensler took office, the SEC seemed uninterested in cryptocurrencies. The only clear actions taken were against projects involved in initial coin offerings (ICOs), as such activities clearly fell under unregistered securities issuance. However, the SEC had previously maintained a hands-off attitude toward broader regulatory attempts regarding cryptocurrencies. Therefore, although the total fines imposed by the SEC in the crypto industry exceed $100 million, the targets of these fines have been projects like Tezos, Block One (EOS), and Ripple, which had engaged in token financing, seemingly posing no threat in the eyes of crypto institutions.

After Gensler took over the SEC, the situation changed significantly, with the SEC becoming increasingly aggressive in its regulation of cryptocurrencies. In August 2021, Gensler, as SEC Chairman, stated at the Aspen Security Forum that many areas of cryptocurrencies involve securities laws and need to be subject to SEC regulation. This statement immediately provoked a strong reaction from the CFTC, leading to the confrontational scene mentioned earlier. Gensler did not back down, subsequently stating multiple times in public that the vast majority of tokens are securities and should fall under the SEC's regulatory functions.

On this basis, Gensler's "enforcement team" began a series of investigations into different tokens and provided complex interpretations of "investment contracts" based on the Howey Test, attempting to push the narrative that "cryptocurrencies are securities" into the mainstream. On November 8, 2022, a U.S. District Court in New Hampshire ruled in favor of the SEC in its case against LBRY for issuing unregistered securities, determining that LBRY's issued cryptocurrency LBC is a security. The SEC achieved an important victory in the battle for "cryptocurrency securitization," adding new leverage to its protracted tug-of-war with Ripple (XRP).

The day after the LBRY case victory, FTX collapsed. A multi-billion-dollar super unicorn vanished in just 48 hours, directly leading to a renewed regulatory battle between the CFTC and SEC. Both agencies took enforcement actions against SBF, accusing him of violating securities laws and commodity trading laws, respectively.

When accusing FTX executives Caroline Ellison and Gary Wang, the SEC claimed that they manipulated the FTT token and explicitly described FTT as a "cryptocurrency security." The CFTC did not specify the legal status of FTT but used Bitcoin, Ethereum, and Tether as examples of "digital commodity assets," implying FTT's asset attributes. The struggle over the interpretation of token attributes was exceptionally intense, culminating in CFTC Commissioner Caroline D. Pham directly issuing a statement condemning the SEC's actions as "a classic example of enforcement regulation" and encouraging the CFTC to use all feasible means to enforce the Commodity Exchange Act in the crypto space.

3. The "Cash Cow" of Regulation

Why are regulatory agencies making such a big deal over cryptocurrencies?

Before the collapse of FTX, the authoritative community seemed to reach a "new consensus" that Congress should establish a comprehensive regulatory framework for the crypto industry. For instance, the Financial Stability Oversight Council (FSOC) recommended to Congress in October 2022 to provide regulatory agencies with rule-making authority over "non-security crypto assets" through legislation. However, the committee did not provide a clear direction on whether it should be the CFTC or the SEC.

Moreover, the "Digital Commodity Consumer Protection Act," proposed by Senators Debbie Stabenow and John Boozman in August of the same year, defined cryptocurrencies like Bitcoin as commodities but did not provide detailed guidance on which crypto assets should be classified as "securities." Clearly, this granted the CFTC more jurisdiction over crypto. Subsequently, the "Financial Innovation Act," initiated by senators like Cynthia Lummis, further indicated that the similarities of most digital assets to commodities far exceed those to securities, further supporting the CFTC as the primary regulatory agency for cryptocurrencies.

A very important commonality between the two aforementioned bills is that both would allow the CFTC to raise funds by charging user fees to crypto companies. The "fee-based fundraising" approach is a power that the SEC has long held in the securities market. It is worth noting that the fees collected by the SEC from securities trading and other market activities are a major source of its budget.

Since Congress significantly expanded the CFTC's responsibilities in 2009 to include swap trading under its jurisdiction, the CFTC's budget has never kept pace with its expanded authority and still relies on appropriations from Congress. Therefore, compared to the SEC's budget of about $2 billion, the CFTC's budget of $300 million is an entire order of magnitude lower. For an underfunded agency, obtaining the right to "collect protection fees" is an absolute game changer.

For the SEC, a significant portion of its annual budget comes from fees collected from the securities market. These fees include registration fees (paid by companies when publicly issuing stocks or bonds), trading fees (paid by securities exchanges and other market participants when conducting transactions), and many other minor fees. Of course, there are also various fines. Therefore, although its budget must be approved by Congress, the SEC seems to never rely on congressional appropriations.

Undoubtedly, the ability to levy user fees will greatly ensure that the CFTC effectively fulfills its mission. The CFTC's earlier fines against Bitfinex and Tether reached $1.5 million and $41 million, respectively. In 2021, the CFTC reached a settlement with BitMEX, which directly paid the CFTC a $100 million fine, accounting for one-third of the CFTC's budget that year.

As CFTC Chairman Rostin Behnam stated, the regulation of crypto assets is in a vacuum. Therefore, the regulatory agency that gains the upper hand not only can seize the initiative and gain more power but also can obtain obvious benefits. For regulatory agencies, finding their "cash cow" has become increasingly important in the context of a serious U.S. fiscal deficit and nationwide discussions about the debt ceiling.