The heads of Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) continue to weigh in on their future oversight of the growing cryptocurrency market. SEC Chairman Jay Clayton and CFTC Chairman Christopher Giancarlo recently wrote an op-ed in the Wall Street Journal and testified before the Senate Banking Committee.

In both public statements, the two regulators emphasized the risks cryptocurrencies pose for both investors and the financial system as a whole, largely due to the lack of comprehensive federal oversight. However, they also called for regulation to help the industry mature rather than quash it.

The high-profile remarks coincide with recent events highlighting the volatility of cryptocurrencies. On January 25, a hacker stole $534 million in NEM tokens from the cryptocurrency exchange Coincheck. Several days later, the SEC halted another initial coin offering (ICO), the third in the last several months. Amid the uncertainty, the price of bitcoin has fluctuated wildly.

Wall Street Journal Op-Ed

On January 24, 2018, Chairmen Clayton and Giancarlo published a commentary piece in the Wall Street Journal, entitled “Regulators Are Looking at Cryptocurrency.” Clayton and Giancarlo emphasized the need for caution when investing in cryptocurrencies and ICOs, while also acknowledging the potential of the high-tech currency. "The willingness to pursue the commercialization of innovation is one of America's great strengths," the chairmen said, noting that "some of the dot-com survivors are among the world's leading companies today."

Following up on recent enforcement actions by the SEC, the regulators reaffirmed that federal securities law often applies to cryptocurrencies. They also emphasized that they plan to aggressively pursue those who try to dodge registration. As Clayton and Giancarlo wrote:

The SEC is devoting a significant portion of its resources to the ICO market. Through statements, reports and enforcement actions the SEC has made it clear that federal securities laws apply regardless of whether the offered security—a purposefully broad and flexible term—is labeled a “coin” or “utility token” rather than a stock, bond or investment contract. Market participants, including lawyers, trading venues and financial services firms, should be aware that we are disturbed by many examples of form being elevated over substance, with form-based arguments depriving investors of mandatory protections.

While the CFTC has also exercised its authority over bitcoin futures products and exchanges, the op-ed highlighted that federal authority in some areas is “murkier.” The chairmen wrote:

A key issue before market regulators is whether our historical approach to the regulation of currency transactions is appropriate for the cryptocurrency markets. Check-cashing and money-transmission services that operate in the U.S. are primarily regulated by states. Many of the internet-based cryptocurrency-trading platforms have registered as payment services and are not subject to direct oversight by the SEC or the CFTC. We would support policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era.

Going forward, the chairmen stated that they were committed to both promoting innovation and protecting investors. "The CFTC and SEC, along with other federal and state regulators and criminal authorities, will continue to work together to bring transparency and integrity to these markets and, importantly, to deter and prosecute fraud and abuse," Giancarlo and Clayton wrote. "These markets are new, evolving and international. As such they require us to be nimble and forward-looking; coordinated with our state, federal and international colleagues; and engaged with important stakeholders, including Congress."

They added: "This longstanding, uniquely American characteristic is the envy of the world. Our regulatory efforts should embrace it."

Testimony Before Senate Banking Committee

On February 6, Clayton and Giancarlo testified before the Senate Committee on Banking, Housing, and Urban Affairs. The two chairmen offered prepared testimony and answered questions from the committee.

In his prepared testimony, SEC Chair Clayton addressed ICOs, again clarifying that many fall under the oversight of the SEC as securities. “Many ICOs [initial coin offerings] are being conducted illegally. Their promoters and other participants are not following our security laws,” Clayton said. “Some people say that’s because the law isn’t clear. I do not buy that for a moment.”

He went on to issue another stern warning to companies conducting unsanctioned ICOs, as well as their financial and legal advisors. “Those who engage in semantic gymnastics or elaborate structuring exercises in an effort to avoid having a coin be a security, are squarely in the crosshairs of our enforcement provision,” he said.

In his remarks, Giancarlo highlighted that the agencies’ increased enforcement activity had caught the attention of the cryptocurrency industry. “The message is getting through that this is not off the grid,” he told the committee. “Now you are seeing it in the Bitcoin prices as word is getting out that we will go after misconduct.”

While the regulators agreed that additional regulation is needed, they again did not go so far as to write off the entire industry. “It strikes me that we owe it to this new generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one,” Giancarlo stated.

With regard to specifics, Giancarlo’s prepared testimony offered some insight. “Appropriate federal oversight may include: data reporting, capital requirements, cybersecurity standards, measures to prevent fraud and price manipulation and anti-money laundering and ‘know your customer’ protections,” he wrote. “Overall, a rationalized federal framework may be more effective and efficient in ensuring the integrity of the underlying market.”

What’s Next?

Additional cryptocurrency oversight is likely on the horizon, although the exact timeline is much less certain. As highlighted in the Senate hearing, many lawmakers are just becoming familiar with terms like blockchain, ICO and virtual currency. It also remains to be seen whether regulation ultimately legitimizes the cryptocurrency or handicaps it.

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, at 201-806-3364.