The birth and emergence of cryptocurrencies and other digital assets has been fascinating to observe for veteran commodities traders. From a regulatory point of view, different frameworks for trading physical assets like gold, oil, or soybeans, or trading financial instruments on their future value, evolved over time through a series of laws. This jurisprudence largely kept pace with the markets’ needs to be fair and orderly, but most importantly to provide regulatory clarity. As the speed of innovation in cryptocurrency and digital assets has accelerated since the invention of Bitcoin (BTC) in 2008, one would expect regulators to rise to the occasion and do what is necessary to provide vital guidance and clarity. New crypto and digital asset law, however, has yet to even leave the gate.
Regulatory uncertainty is becoming increasingly problematic for the escalating number of start-ups that use cryptocurrencies and blockchain technology for products and services they want to sell. Suffice to say, we are far beyond the question of viability of Bitcoin. Blockchains and digital tokens are powering network solutions for global payment systems like PayPal, supply chain management, publishing, and even the art world. Yet, there are still no federal laws or rules which make clear how to regulate these assets.
This regulatory void has given the U.S. Securities and Exchange Commission (SEC) a sense of all-encompassing encouragement to test the limits of its authority. The Commission’s recent enforcement action has not only boggled observers with its bravado, but also sent a chill throughout the industry.
Previous SEC leadership presided during a period of enormous growth and expansion of blockchain technology and the ballooning market capitalization of cryptocurrencies. Nevertheless, the agency steadfastly refused to propose any new rules to give clear guidance on how it should be treated and took increasingly hostile actions against developers. In December 2020, the SEC filed a lawsuit against Ripple (XRP), one of the largest players in cryptocurrency. The suit alleged that seven years’ worth of sales of the XRP token that Ripple currently holds in escrow were one, continuous, unregistered securities offering. This hit the cryptocurrency and digital assets industry like a bomb, citing billion-dollar fines sought, to head-spinning details contained in the complaint.
Ripple is a company that sells software solutions for banks and payment companies so that customers can make cross-border money transfers between different currencies using the XRP ledger as the go-between. In essence, it makes the peer-to-peer feature of blockchain available to traditional banking. These transfers are faster, cheaper, and safer compared to slow and expensive bank wires that have diminishing value for today’s consumers. The service has a robust customer base in Asia, where many different currencies exist in an increasingly integrated retail and consumer regional market. But the XRP ledger is not owned or controlled by Ripple, and billions of XRP tokens have been sold and distributed widely by users and holders who have never even heard of Ripple or its products.
The SEC lawsuit decimated the token’s market value and scared enough cryptocurrency trading exchanges to either halt XRP trading or delist the token entirely. This meant millions of holders could do nothing but watch helplessly as their locked holdings dropped and later see-sawed in value. The investors the SEC were supposed to protect were now victims of their actions.
Cryptocurrency projects take time to build. Constructing a network and an ecosphere for a blockchain ledger to do something innovative and disruptive is a process. This usually entails distributing many tokens so that they can provide liquidity and move across that network. The process is similar to installing plumbing and electrical systems when building a new house. Unfortunately, the SEC has not been the helpful home inspector, checking on progress and dispensing clear advice. To cryptocurrency start-ups, the SEC has been more like an outside observer, arbitrarily deciding when to tear down the structure and start over. To those investors inside the house, they have no indication of what the SEC plans to do next. This is the opposite of fair and orderly.
The SEC was repeatedly asked if XRP was a security or not, and for years, it steadfastly refused to answer. The Commission stood and watched as billions of XRP tokens were sold on secondary markets by millions of retail holders who had no connection to Ripple. The regulator also witnessed a division of the Treasury Department classify XRP as a currency in 2015. The SEC still had nothing to say. Didn’t this “action of no action” actually set precedence?
Additionally, the SEC took requests from cryptocurrency exchanges years before this lawsuit. These exchanges were persistently asking for clarity on XRP, as well as permission to list the token for trading. An astounding seven years went by as the XRP ledger became a full-fledged and decentralized network before the SEC suddenly announced that Ripple, its executives, and every retail holder of XRP worldwide should have known for the last seven years that the token was an unregistered security and they had all broken the law. This was devastating to those investors that purchased XRP.
As the filings from the SEC have shown from the beginning, the agency believes that the lack of any clarity on cryptocurrency regulation is why it will prevail in this case, no matter how illogical its reasoning becomes. Like with every enforcement action against this entirely new asset class, the SEC relies on tortured interpretations of the 1933 Securities Act – a law enacted when blockchain innovation could not even be imagined.
The enormous potential for innovation in this new financial sector – in widening the options for safeguarding value and creating and distributing wealth – will continue to be hindered due to the confusing, unnecessary regulatory void, unless Congress and the Biden administration take the opportunity to end this tragic cycle of regulatory uncertainty by implementing a clear set of rules for everyone. These contemporary rules, moreover, must acknowledge we have entered a new, technologically driven world. Antiquated analogies to orange groves or soybean fields from 80 years ago are moot. The hope is that wisdom will prevail.