2023: Regulation and Decentralization Coming to Head
As we’ve written, 2022 was a confusing, unstable year in a lot of ways, not the least of which was in the realm of regulatory clarity and reform. We believe there is a way through this dark forest in the coming year, with several good starting points for discussion such as the Lummis-Gillibrand crypto bill in the Senate.
Crypto industry attorney Mike Selig writes at Coindesk that it may get worse before it gets better in 2023, as the US Securities and Exchange Commission and the Commodity Futures Trading Commission jockey for turf in regulating crypto. This, he says, is all the more reason the industry and its advocates need to get involved in the coming year. It’s not enough to follow the free market mindset of staying out of government activity, because that activity is coming for crypto. We need to help shape the policies going forward, or else people who oppose DeFi, privacy and economic freedom will make it for us.
While crypto projects continue to push the boundaries of decentralization and community governance, the SEC and CFTC will likely push the boundaries of their existing authorities through novel enforcement actions. With neither agency poised to issue new crypto rules, 2023 will be the year of regulation versus decentralization.
It has been more than a decade since Satoshi introduced the world to the peer-to-peer electronic cash system called Bitcoin, and yet the regulatory landscape for crypto-assets remains a dark forest. After one of the most eventful years in crypto to date, what can we expect from the Securities and Exchange Commission and Commodity Futures Trading Commission (crypto’s primary U.S. market regulators) in 2023?
The SEC nearly doubled the size of its crypto-asset enforcement team in early 2022 and will likely continue to regulate by enforcement in 2023.
SEC Chair Gary Gensler believes that the “vast majority” of crypto assets are securities. He said “probably only a few” may not be securities. While he might “think CryptoKitties is not a security,” the SEC is also reportedly investigating non-fungible tokens.
The SEC regards many crypto assets as a type of security called an “investment contract.” In SEC v. W.J. Howey & Co., the U.S. Supreme Court defined an investment contract as a contract, transaction or scheme whereby an investor invests money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.
During his prior tenure as chairman of the Commodity Futures Trading Commission, Gensler oversaw the implementation of new swap market regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in the wake of the 2008 financial crisis. As SEC chair his approach to regulating crypto assets resembles his CFTC approach to regulating swaps. The Gensler-era CFTC disregarded industry opposition and leveraged the existing futures regulatory framework to hurriedly adopt a swaps regulatory framework that did not work for much of the market.
In the case of crypto assets, Gensler has “asked the SEC staff to work directly with entrepreneurs to get their tokens registered and regulated, where appropriate, as securities.” However, it appears unlikely that rules specifically tailored to crypto assets will be proposed during 2023. Gensler’s view is that most crypto assets are securities and therefore most crypto-asset issuers and intermediaries are subject to the same laws and regulations as other securities issuers and intermediaries. Gensler may face pushback from the Republican-controlled House Financial Services Committee in 2023, but is not likely to reverse course.
The regulatory narrative will continue to be shaped by the SEC’s enforcement actions. Since 2017 the SEC has brought dozens of actions for failing to register offers and sales of crypto assets as securities. These actions have mostly involved “utility tokens” sold in the days of initial coin offerings. The legal theory advanced by the defendants in many of these cases has been that the crypto assets were not part of an investment contract because the assets had consumptive use and therefore purchasers should not have reasonably expected profits. But lower courts have thus far rejected this argument, concluding that a crypto asset may be sold as part of an investment contract even if it has consumptive use.