Congress must fix crypto rules perimeter, say policy-makers

CFTC and SEC officials say public debate needed on jurisdictional boundaries as investment ramps up

The classification of cryptocurrencies as commodities or securities should be settled by Congress, according to senior policy-makers, ending a long-running regulatory debate that has delivered a patchwork of inadequate rules.

“Congress is the place where we should talk a lot about a lot of this stuff,” said Paul Balzano, senior professional staff for the House Committee on Agriculture.

“It’s not great to have regulators run around and – I don’t want to say ‘make stuff up’ – but take small parts of their statute that mean one thing and expand them into meaning other things. That’s not a really great way for markets to operate.”

Balzano was speaking on October 27 at a conference in New York organised by the International Swaps and Derivatives Association.

The US Commodity Futures Trading Commission (CFTC) claimed jurisdiction over cryptocurrencies in 2015. However, the US Securities and Exchange Commission (SEC) has asserted that cryptocurrencies are securities and rejected numerous applications to issue exchange-traded funds (ETFs) tracking bitcoin.

Speaking on the same panel, policy-makers from both regulators supported a jurisdictional ruling by Congress.

“There’s so many stakes being made by so many different regulators that it is starting to look like Congress is probably the more appropriate venue to decide where the appropriate regulatory scheme is,” said Coy Garrison, counsel to SEC commissioner Hester Peirce.

Summer Mersinger, chief of staff to CFTC commissioner Dawn Stump, said having such decisions made as part of a public debate would be more appropriate than “jurisdiction-grabbing through enforcement”.

“Let’s have hearings and bring in experts and get testimony,” she said.

I think there’s a risk there of going too far in making new changes and trying to develop a regulatory structure

Summer Mersinger, CFTC

Mersinger added it was important to establish whether jurisdiction lies with the CFTC or SEC “before layering on new regulations”, but sounded a note of caution: “Sometimes Congress goes really far in making changes. I think there’s a risk there too of going too far in making new changes and trying to develop a regulatory structure.”

Balzano said a number of bills “floating around” attempt to redefine a security: the Token Taxonomy Act from Congressman Warren Davidson, and the Securities Clarity Act from Congressman Tom Emmer.

At least three other crypto-related bills are in progress: the Digital Commodity Exchange Act, sponsored by former congressman Michael Conaway, which would offer a framework for registering and regulating crypto exchanges under the CFTC’s aegis; congressman Patrick McHenry’s Clarity for Digital Tokens Act; and congressman Donald Beyer’s Digital Asset Market Structure and Investor Protection Act.

The latter, in Balzano’s opinion, “solves basically every problem in the crypto industry in one bill.”

The debate comes as cryptocurrencies make increasing strides into the mainstream. Cryptocurrency investing by US mutual funds more than doubled in the first quarter of this year to top $1 billion. The first US bitcoin futures ETF – issued by ProShares but lacking formal approval from the SEC – launched last week. Meanwhile, in London, a digital token named after Elon Musk’s new dog Floki is getting advertised on public transport.

But concern remains that the crypto sector lacks sufficient regulatory oversight. SEC chairman Gary Gensler has likened the crypto industry to the Wild West and said it lacks investor protection.

Balzano added that Congress needs to provide supervisors with the appropriate tools to regulate what is currently a confusing market: “It’s unfair to the public who have to live under these rules that are sort of made up by regulators as best they can.”

The CFTC has fraud and manipulation enforcement authority over derivatives products on digital assets, “but we aren’t regulating these entities day-to-day”, said Mersinger.

Token gesture

The SEC’s Garrison said there was “a serious lack of regulatory clarity” on whether digital tokens are securities.

It’s a concern shared by Balzano. “If there’s ambiguity about whether or not these tokens are securities, the answer that some members have come up with is just telling people that they are not securities. I think that leads to a question of what happens next once we’ve removed them from the securities laws.”

Garrison singled out digital tokens sold in securities transactions as an area where there may be more certainty over the securities classification. The nuance is that these instruments are “sold wrapped in certain promises. So it’s the token plus those promises that create the investment contract. The token itself is not the security”.

SEC commissioner Peirce proposed a safe harbour this year that would provide a three-year window to establish whether tokens are securities. During that time, crypto developers could distribute tokens while being exempt from federal securities laws, although subject to anti-fraud provisions and minimal relevant disclosure requirements.

Even assuming all tokens are securities, however, Garrison said there was a paradox in that crypto platforms must register with the SEC to list a crypto security: “But you cannot currently operate as a registered entity under our existing rules, so therefore you cannot actually register with us.”

He added it was also unclear how an entity can safe-keep digital assets consistent with SEC rules surrounding custody, and whether a platform can trade crypto securities alongside digital assets that are not securities.

Mersinger also called for more investor education, warning of the differences between purchasing bitcoin and investing in bitcoin futures – the latter being “very different. There’s issues with position limits, issues with the fact that these contracts expire, and there’s a cost in rolling over the contracts into the next month.”