Having served as the first chief of the SEC’s crypto unit from 2017 to 2019, I’m often asked what kind of crypto enforcement we should expect to see from the new administration. My first answer is that I do not know. My second answer is that I believe it will be different, but it will not disappear.
To anticipate the future of crypto enforcement, we should begin by reviewing the past.
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The SEC’s crypto enforcement unit was formed in 2017 during the first Trump Administration. The early focus was on one, fraud, and two, core capital raising events. Regulation of capital raising is the principal purpose of the Securities Act of 1933. When an investor gives money to an entrepreneur who will use it in a business to generate profit, the investor is entitled to certain information about the business. Early crypto investigations were focused on this fundraising activity, which was usually in the form of an unregistered initial coin offering (“ICO”). The idea was that many ICOs at that time were not so different in substance than equity or debt offerings, and should be regulated similarly.
The industry responded responsibly and now, crypto entrepreneurs often raise money in compliance with the federal securities laws. In one of several options, some offerings are exempt from SEC registration because they are limited to accredited investors. The entrepreneurs then use the capital to build a blockchain protocol or other crypto product. Once built, sales of tokens probably are not securities offerings because people are not buying tokens as an investment in someone’s business. Even if there is hope for profit, that profit would come from the activities of the buyers and other participants, not the efforts of a central business manager.
During the last four years, the SEC has focused more of its enforcement activity on secondary markets such as centralized trading platforms and decentralized protocols. It is less clear how the federal securities laws apply to these markets. These transactions generally do not involve a central entrepreneur collecting money from investors and using it in a business. Instead, there are thousands or even millions of crypto participants interacting with each other, sometimes anonymously via autonomous software. Token buyers might not know who sold them tokens and there may be no central actor that’s key to future success. Federal district courts have reached different conclusions and there are reports that the SEC might drop one of these key cases.
More broadly, enforcement became the dominant focus of SEC regulation. The SEC doubled the size of the crypto unit, creating new supervisory and trial attorney positions. It spent years and a tremendous amount of resources litigating several non-fraud cases. Many additional non-unit lawyers worked on crypto investigations, and crypto appeared to be the main focus of SEC enforcement.
This approach did not generate useful guidance to the industry. Many SEC rules have technical aspects that are incompatible with the anonymous decentralized ledger that is blockchain technology. Under the enforcement approach of recent years, the very premise of the technology was treated not as a feature, but as a bug. The result was existential enforcement risk to a burgeoning industry and economic activity being pushed offshore.
I do not believe the crypto industry wants a Wild West of no regulation. They want a sensible rulebook that makes compliance feasible, and they also want regulators to crack down on fraud. No legitimate actor benefits from fraud in the industry.
What does this mean for the next four years of enforcement?
First, enforcement is just one component of regulation. We likely will see increased resources dedicated to the other parts of effective regulation — new guidance and rules that offer an achievable regulatory framework. Acting SEC Chairman Mark Uyeda recently announced a new crypto task force for developing a “sensible regulatory path,” and Commissioner Hester Peirce, who will lead the task force, included in her objectives “preserv[ing] industry’s ability to offer products and services.” The dedicated crypto unit also has been reduced in size and repurposed to cyber and emerging technologies, with many staff returning to general enforcement duties.
Second, we could see a renewed focus on fighting fraud. The Commission did not stop bringing crypto fraud cases during the last four years, but many headline cases were non-fraud regulatory disputes. That might change; as Commissioner Peirce said in her objectives speech, “We do not tolerate liars, cheaters, and scammers.”
Third, once there is a new rulebook, we can expect the SEC to enforce those rules. That will take time. We might see a transition period, with some non-fraud cases but more focus on writing the new rulebook. Once adopted, enforcement of that rulebook could come after a fair notice period for the industry to adapt to it.
I expect SEC crypto enforcement to continue, but with different priorities. Investor protection will be balanced with the SEC’s co-equal mandates of facilitating capital formation and maintaining orderly markets. The crypto industry is filled with good actors who want to be compliant; they just need a rulebook that makes compliance achievable. A renewed approach will allow the industry to grow without abandoning investor protection.
The SEC has been the most assertive crypto regulator so far, but it is not alone. Other federal agencies may emerge as co-equal regulatory leaders, either through legislation or otherwise, especially if the SEC no longer takes the position that every cryptocurrency (except Bitcoin) is a security. Some state authorities have been active in crypto, and that likely will continue or even increase.
A client recently reminded me that there will be another election in four years. The new regulatory approach, and the industry’s business and product decisions, must be durable. If they are not, the renewed approach to crypto over the next four years could be undone as easily as that of the last four years.
