On February 6, 2018, Chairman Clayton of the Securities and Exchange Commission (SEC) and Chairman Giancarlo of the Commodity Futures Trading Commission (CFTC) testified before the Senate Banking Committee (the Committee) on their agencies’ oversight role for virtual currencies. Consistent with his prior statements, Clayton took a strong stance on SEC regulation of Initial Coin Offerings (ICOs). But, when it came to cryptocurrencies themselves, he and Giancarlo struck a somewhat more circumspect tone. In particular, despite acknowledging that their existing jurisdiction does not extend to spot transactions in cryptocurrencies, the Chairmen did not yet seek additional regulatory authority.
However, Chairman Clayton particularly expressed concerns about whether virtual currency exchanges provided adequate protections for investors and whether state regulation as payment services was sufficient. While the Chairmen did not request new authority, it is clear that there would be support within the Committee for legislation in this area, and Clayton and Giancarlo committed to work with each other and other authorities (including bank regulators and law enforcement authorities) to develop an appropriate approach. When the Chairmen of the SEC and CFTC express that they are “open” to exploring whether increased federal regulation is needed, there is a clear message.
The CFTC’s Regulatory and Enforcement Authority and Approach
CFTC Chairman Giancarlo noted that, although the CFTC has broad authority to regulate sales and trading of derivatives on cryptocurrencies, the CFTC may only police cryptocurrency spot transactions for fraud and manipulation. Giancarlo defended the CFTC’s recent decision to permit trading in Bitcoin futures as a step in the right direction because it disabused the market of the perception that cryptocurrency trading was entirely unregulated. Through futures exchanges’ new arrangements with spot exchanges, the CFTC now has an indirect window into the spot Bitcoin market. Giancarlo emphasized that the CFTC “intends to be very aggressive” with seeking out fraud and manipulation in this market.
Though not a primary focus of the hearing, Chairman Giancarlo in his written testimony contrasted cryptocurrencies from the underlying distributed ledger technologies. He argued that heightened federal regulatory oversight may be warranted for cryptocurrencies, but a “do no harm” approach is appropriate for the distributed ledger technology supporting cryptocurrency trading. Giancarlo expressed the view that this technology had “extraordinary potential” to provide economic and social benefits across the world, for example, to provide banking services in emerging markets, more efficiently distribute charity, and support refugee resettlement efforts. He also cited economic commentary suggesting that cryptocurrencies themselves might have a fundamental economic value.
The SEC’s Regulatory and Enforcement Authority and Approach
By contrast, SEC Chairman Clayton expressed skepticism regarding the value of cryptocurrencies, both as investments and in providing external benefits. Couching them as just another type of disruptive technology, he noted that cryptocurrencies have a very high likelihood of being a poor investment. Chairman Clayton continued to express reservations about permitting listing of exchange-traded funds linked to Bitcoin, which the SEC has repeatedly indicated do not now satisfy the current standards for ETFs. He also expressed concerns that, although cryptocurrency “exchanges” resemble stock exchanges in form, they are in substance operated by money transmission services licensed and regulated under a patchwork of disparate state-based regimes, not the federal securities laws.
As Clayton emphasized repeatedly at the hearing, the SEC has focused its efforts to date on ICOs. He largely reiterated the SEC’s unequivocal stance (described in statements and investor bulletins and discussed on our blog) that ICOs are securities offerings that must be either registered with the SEC or qualify for a private placement exemption. In expressing this view, Clayton implied that existing securities laws provide sufficient tools to police ICOs. He said several times that the SEC would not hesitate to begin enforcement proceedings against gatekeepers, such as accountants, lawyers, and underwriters, who enable illegal ICOs.
Chairmen Giancarlo and Clayton noted the critical importance of regulatory coordination, and they identified several avenues of cooperating with counterparts. Domestically, they noted participation in two groups. One is a task force, convened by the Treasury Department, of the SEC, CFTC, the Federal Reserve Board, and FinCEN. The other is a working group of the Financial Stability Oversight Counsel convened to monitor whether cryptocurrencies could present systemic risk. Internationally, Clayton has been active in several supervisory colleges on coordinating cryptocurrency regulation, in addition to discussing the issue with counterparts on a bilateral basis. Given the international nature of cryptocurrency trading, he emphasized the importance of these efforts moving forward because the existing “patchwork is probably not sufficient.”
Potential Legislative and Regulatory Reforms
Chairman Clayton expressed an openness to working with Congress and tepidly endorsed additional legislation. In his prepared testimony, he wrote that the “currently applicable regulatory framework for cryptocurrency trading was not designed with trading of the type we are witnessing in mind.” In oral opening remarks, however, he stated that he was not seeking “expanded SEC jurisdiction” over spot trading in cryptocurrency markets, though “if asked, [the SEC] will work with other regulators to evaluate” whether regulation over markets that trade cryptocurrencies themselves is justified. When asked point-blank by Senator Richard Shelby (R-AL) whether legislation would be necessary, Clayton stated that he couldn’t give “a definitive answer,” but that the SEC and CFTC “may be back with . . . Treasury and the Fed to ask for additional legislation.”
Chairman Giancarlo echoed Clayton’s cautious approach, noting in prepared testimony that that were Congress to extend the CFTC’s legal authority to cover virtual currency spot markets, such an approach would represent a “dramatic expansion of the CFTC’s regulatory mission.” On the regulatory front, Giancarlo stated that the CFTC is considering heightened governance standards for clearing cryptocurrency futures.
The Chairmen’s remarks signal a continued aggressive enforcement environment for fraud or manipulation involving cryptocurrencies and securities law violations involving ICOs, but a more measured approach to further regulation of cryptocurrency spot markets. Neither Clayton nor Giancarlo explicitly endorsed a particular legislative approach to regulation of these markets, instead emphasizing that their near-term focus would be on civil enforcement. And they made repeated references to coordination with counterparts at other agencies, suggesting that there is not yet inter-agency consensus on what shape federal oversight should take.
The tenor of the hearing certainly suggests, however, that legislation could be on the horizon, should the agencies seek it or congressional attention on these markets continue. As policymakers consider their next steps, there are several issues worth consideration:
- The hearing highlighted some clear open questions. Should there be federal regulation (beyond anti-fraud and anti-manipulation authority) of spot transactions in cryptocurrencies? If so, what requirements should apply and who should apply them? And, if such regulatory authority is extended to such spot transactions in cryptocurrencies, how will it affect other markets?
- The history of U.S. financial market regulation is littered with examples of definitional issues and jurisdictional disputes that have clouded new markets with legal uncertainty. It is a justifiable accomplishment that, so early in the development of virtual currencies, the CFTC and SEC have come together to outline clear positions on the scopes of their respective jurisdictions. If history is a guide, however, it may not be as straightforward to reach consensus in future line-drawing exercises.
- Wherever the lines are drawn, the boundaries are likely to be fuzzier than they first appear. Especially as distributed ledger technology matures and becomes more widespread, the distinction between commercial (vs. financial) applications, or between “new” financial assets (“cryptocurrencies”) and existing financial assets (securities, currencies, gold, etc.), are likely to be less clear than they appear now.
- Tensions will also exist between tailoring any new regulations to fit characteristics of the cryptocurrency market, on the one hand, and, on the other hand, avoiding the creation of yet another distinct category for somewhat similar, but differently regulated, financial products. Further regulatory complexity and incentives for arbitrage could result.
In light of these issues, the CFTC and SEC would be wise to resist a rush to action, in favor of a studied and cautious approach.
 Statement of Jay Clayton before the Senate Banking Committee (Feb. 6, 2018), https://www.banking.senate.gov/public/_cache/files/a5e72ac6-4f8a-473f-9c9c-e2894573d57d/BF62433A09A9B95A269A29E1FF13D2BA.clayton-testimony-2-6-18.pdf.
 Statement of J. Christopher Giancarlo before the Senate Banking Committee (Feb. 6, 2018), https://www.banking.senate.gov/public/_cache/files/d6c0f0b6-757d-4916-80fd-a43315228060/A2A6C1D8DDBB7AD33EBE63254D80E9E3.giancarlo-testimony-2-6-18b.pdf