Why SEC & Government is Against Cryptocurrencies?

Over the past five years or so, cryptocurrencies have grown from a small market cap to more than $2 trillion as of now. This explosive surge of a financial instrument has been rarely seen in history. And the governments have been watching closely, including the Securities and Exchange Commission (SEC) of the USA.

This article will look at the overall history of the SEC in its actions against cryptocurrencies: suing ICO scams, disapproving the bitcoin ETF year after year, the famous Ripple XMR tokens lawsuit, and a man who has heavily affected the SEC’s stance on blockchain technology, Gary Gensler.

Before 2017

Cryptocurrencies were not very well known before bitcoin first reached a market cap of above $10 billion in 2017. It wasn’t widely adopted. And there were only small exchanges that allowed you to buy or sell cryptocurrencies, bitcoin mainly.

The ICO boom and bust

The early adopters

Silicon Valley folks are obviously trying to get ahead of any new technology trend before it takes off, and blockchain was no exception.

Some of the earliest adopters of bitcoin were tech-savvy people from the valley, most notably the Winklevoss twins, who turned their early bitcoin purchases into a million-fold investment as of now.

Decentralization and cryptographic protection

Another innovation that these tech masters could not look away from was how a blockchain could issue currency tokens without any centralized authority like a bank or a government. The cryptographic protection would ensure ownership. And the distributed and decentralized nature would ensure no centralized tampering of the information on the blockchain.

Traditional fundraising with stocks

This led to the notion of using crypto tokens to sell shares of a company, instead of selling stocks through the traditional financial systems. In the venture capital world, there are many difficult steps a company has to go through in order to get listed at a stock exchange. This means fundraising is tough for most companies.

Fundraising with ICOs

But if you sell crypto tokens in exchange for ownership of a company or a utility token, fundraising becomes much easier. This created the concept of the Initial Coin Offering (ICO). It sounds just like an Initial Public Offering (IPO) of a stock company. That is because it is effectively serving the same purpose.

Take the Brave browser ICO for its Basic Attention Token (BAT). They raised $35 million within 30 seconds. Many other top companies also raised capital by issuing crypto tokens.

In total, billions of dollars worth of ICO tokens were sold, as reported here.

The legal grey zone

When millions of dollars were being raised like this, the government was obviously watching. This was the first time such an ICO was being done on such a large scale. Hence scrutiny from the government was only a matter of time.

Since ICOs are essentially an alternative to stock share selling and similar methods, the traditional laws are very confusing. Right after the ICOs, the SEC started investigating these companies. It mainly claimed that cryptocurrency tokens are financial securities. Therefore, the securities laws must apply to them.

The ICO scams

Taking advantage of this very new technology, many tech companies jumped on the opportunity to fundraise. On the other hand, looking at how easy it is to buy crypto tokens, many investors spent immensely in purchasing these tokens. They hoped that the new blockchain-based tokens would gain price greatly. The stock never gives you multiplicative returns. Stocks are also not nearly as volatile as crypto assets. Hence, investor greed also powered the ICO boom.

However, many companies sold tokens and completely stole the money.

Crypto tokens are not like stocks. You can not go to court if the crypto tokens get stolen from your wallet. Neither can you charge the executives of the company for any large price drops of the token.

And viewing this boom, the SEC published messages to warn the investors against scams. Regardless, many investors kept purchasing tokens from untrustworthy sources and lost money.

SEC files lawsuits

The SEC investigated all the major ICO sales and fought back with lawsuits to many of the top companies. Most famously, the Kik chat app sold the Kin token, and after it was charged by the SEC and fined millions.

As for the Telegram chat app, its token “Grams” was stopped too. They were also fined millions. Other major cases include those with Block.one.

What is security? The Howey test

The SEC sees some of the cryptocurrency tokens as “securities” like stocks and bonds. The way it determines whether something is a security is through the Howey test.

The Howey test is over 70 years old and looks mainly at four things:

According to the SEC, the cryptocurrency tokens sold in some ICOs pass this test. Therefore, companies like Kik and Telegram were selling unregistered securities and violating the law.

This Howey test will also become very important in the later discussed Ripple vs. SEC lawsuit.

Crypto tokens that are not securities

For example, some crypto token that the SEC didn’t label as securities is TurnKey and Pocketful. This is because the “expectation of profit” condition is not met in these tokens. For example, the TurnKey tokens will be used to buy airline tickets. Hence, it's not a token that is intended to make a profit.

The consequences of these lawsuits

These actions by the SEC have discouraged other companies in the US from launching ICOs. Even if a company thinks of launching a crypto token, it must register with the SEC and get approved.

Overall, the actions of the scammers have reflected badly on legit cryptocurrencies. Even though there are many legal crypto tokens, lawmakers are very careful with all cryptocurrencies.

Read more about the ICO history here.

The bitcoin ETF

What is an ETF?

ETF means Exchange Traded Fund. It is a security that can be bought and sold at an exchange like NYSE similar to stocks.

Rejections in the past

Cryptocurrencies such as bitcoin are not seen as legitimate currencies and securities by the law. Hence, approving a bitcoin ETF seems unlikely. At least that was the mood during the early years.

The Winklevoss twins filed for bitcoin ETFs very early in 2013, and got rejected. Ever since then, many other companies have also tried and failed. Other countries like Canada had already approved bitcoin ETFs before the US.

SEC approves first bitcoin ETF

Finally, in October 2021, the SEC approves the first bitcoin ETF. This is seen as a big step for cryptocurrencies since a lot more ETFs are therefore coming to the US exchanges.

Increased adoption of crypto

This is a sign that the government is becoming more tolerant of the crypto economy. This is not surprising given that even big banks and hedge funds are also investing billions into cryptocurrencies. Take Standard Chartered bank, for example, it is reporting on cryptocurrencies as a financial asset. Even Citibank has a cryptocurrency unit.

Futures ETF vs. spot ETF

The recently passed ETF is what is called a ‘futures based ETF’. This is different from a ‘spot ETF’. In a spot ETF, the institution managing the ETF fund must purchase bitcoins and hold them. Whereas in futures ETF, the fund managers don’t need to purchase bitcoin at all.

However, a spot ETF is very likely in the coming months as reported here.

Ripple vs SEC

In December 2020, the SEC filed a lawsuit against a cryptocurrency called XMR. XMR is the token created by Ripple Labs. The lawsuit was similar to the ones before. This is because the SEC is calling XMR a security.

According to the SEC, the CEO of Ripple labs is responsible for promoting the currency. Therefore, there it satisfies the Howey test and XMR is security.

Ripple Labs has fought back saying that it doesn't fit the Howey test. It has been a year since the lawsuit started and many things have happened. Unlike Kik and Telegram, Ripple labs are fighting back hard. You can learn more about the details of the court trial here.

Effect of a lawsuit on XMR

Soon after the lawsuit, the XMR prices remained stagnant. XMR was delisted from Coinbase, which is one of the largest cryptocurrency exchanges in the US. Hence, in spite of being one of the top 10 cryptocurrencies by market cap, XMR is not doing well during the ongoing lawsuit.

Are Bitcoin and Ethereum considered securities?

According to the SEC, no. Bitcoin and Ethereum are decentralized and are not controlled by a single entity. Hence, they do not pass the Howey test. You can’t file a lawsuit against the CEO of bitcoin, because there is no CEO of bitcoin.

Leaders deciding the regulations

Gary Gensler

Gary Gensler is one of the top experts in the world on finance and economics. He has held many government offices in the past. He was also a partner at Goldman Sachs. Another impressive thing was that he was an adviser to Hillary Clinton. But the most impressive thing is that he is a blockchain expert.

In fact, he served as a professor at MIT and taught a course on blockchain. You can find the free lecture videos here. I personally took those classes and they unlocked my mindset about the FinTech industry. I highly recommended it to anyone who is interested in next-generation economics.

Gary Gensler was appointed chairman of the SEC when the Biden administration took office in 2021. Given his in-depth knowledge of blockchain, many people expected that he would be pro-crypto. However, he turned out not to be that friendly towards a free market for cryptocurrencies.

In his testimony in front of the senate, Gary Gensler answered many questions about cryptocurrency and blockchain. He strongly believes in Satoshi’s innovation. He is a supporter of the decentralized system.

But unfortunately, he believes most cryptocurrencies are securities. And therefore, they must abide by the laws for securities. Hence, unregistered securities are illegal, and US-based cryptocurrency exchanges must not buy/sell them. He also believes crypto investors are not adequately protected and therefore crypto needs regulation. Read more here.

Elizabeth Warren

Elizabeth Warren is a senator and a strong leader in the US. Over the past year, she has expressed her stance against cryptocurrencies, calling it “shadow banks”. She believes in strong regulations and completely banning some cryptocurrencies.

Bitcoin is the main payment that ransomware attackers use. And the US has seen thousands of ransomware attacks in the past years. Hence, most people in government see cryptocurrencies as a tool for criminals.

Therefore, leaders like Elizabeth Warren will be against cryptocurrency. It is yet to be seen how this plays out.

The crypto mom

Hester Peirce is a commissioner at the SEC and has been a key supporter of crypto for many years now. She does not believe in banning cryptocurrencies and simply believes they need some soft regulations. For example, she proposed that cryptocurrency tokens be allowed a “safe harbor period”.

In this proposal, decentralized crypto tokens will not need to register for a 3 years grace period. This means that the securities laws will not apply to them. Thus, this is meant to foster innovation in the crypto tokens industry. However, support for such proposals is lacking in the SEC.

Future regulation and stable coins

Push to regulate crypto

The traditional financial institutions are not happy with the crypto industry. Decentralized finance (DeFi) has grown into a trillion-dollar industry over the past year. DeFi applications offer cryptographically protected lending and borrowing via smart contracts. This is different from the traditional banking and insurance companies, where there are many financial laws.

Attack on stablecoins

Hence, governments are trying to stop such DeFi platforms from existing. In fact, the government has already published reports on stablecoins that aim to regulate it just like banks. In fact, the international regulator called FATF is calling for the same. Meaning, the decentralized features won’t really exist if the laws pass.

Hence, the sentiment in the government is against a free and open cryptocurrency market.

Conclusion

It is yet to be seen how the US decides the cryptocurrency regulations. If the US regulates cryptocurrencies heavily, the rate of growth will be much less for the crypto industry. In fact, crypto startups and exchanges will need to put in a lot more effort to maintain their businesses.

And we will likely see the governments, traditional banking, and financial industry keep opposing a free and decentralized crypto world. This is because many governments around the world are going to create a digital currency system called CBDC. This means “Central Bank Digital Currency” and it is not a cryptocurrency. It is more like a digital currency that is controlled by the central bank and government. Read more about it here. I believe it's going to be a permission-oriented blockchain system.

Therefore, in the coming years, we will see a battle against cryptocurrencies. And it is yet to be seen how this will play out for the crypto innovators.

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