Cryptographic blockchains enable people to transfer value directly over the internet, inexpensively, almost instantly, without an intermediary, and with an immutable, public record. This technology might be the most important American financial innovation in decades. But like any financial product or innovation, its success depends on legal and regulatory clarity. It is past time for Congress to enact a clear framework for the sensible regulation of crypto.
American financial markets have long been the most innovative in the world, thanks, in part, to our generally balanced and well-defined legal and regulatory frameworks including for our capital markets, enforced by the Securites Exchange Commission.
The SEC’s jurisdiction is strictly limited to securities and directly adjacent areas, such as issuers and securities exchanges. Importantly, the SEC is not authorized to pass judgment on the merits or suitability of securities. This restraint has enabled the development of many new financial instruments that help America maintain its competitive edge in finance.
From new asset classes like exchange-traded funds to money market funds, to equity-linked derivatives, the American capital markets have been a fount of innovation that the SEC, in keeping with its narrow, disclosure-based authorities, has facilitated with clear and tailored rules.
Until crypto, that is.
The vast majority of crypto tokens bear little or no resemblance to instruments universally accepted as securities. Crypto tokens typically come with no contract, and no ownership stake or claim on the assets of an issuer. It takes a tortured interpretation of the 1934 Securities Exchange Act and subsequent case law, including the Howey decision, to conclude that it applies to most crypto tokens. Federal courts are increasingly reaching that conclusion. But not SEC Chairman Gary Gensler.
Gensler insists that “the vast majority of crypto tokens are securities,” therefore granting the SEC regulatory authority over them, their issuers and the exchanges that trade them. In public Senate Banking Committee hearings while I was ranking member, Gensler refused to explain how he reaches these conclusions. While Gensler has acknowledged that Bitcoin is “not a security” when asked to explain what distinguishes Bitcoin from crypto securities, he refused to provide clear reasoning.
To make matters worse, while the SEC generally claims jurisdiction over crypto issuance and trading, it has refused to promulgate new, tailored rules to govern these activities. Crypto tokens are traded, settled and custodied differently than conventional securities. Even if some crypto tokens were securities, crypto market participants could not comply with rules designed for conventional securities.
Instead of providing upfront clarity on how existing securities laws apply to the crypto industry, the SEC has regulated by enforcement. This has chilled the development of the crypto and blockchain ecosystem in the United States. Entrepreneurs developing new blockchain applications are increasingly doing so overseas where jurisdictions have the legal and regulatory clarity that the United States lacks.
Since American firms are fighting SEC lawsuits, federal courts might eventually decide if and how to apply a 90-year-old securities law to an internet-based technology. But this will take years and the courts are not well suited to develop a complex regulatory framework. Meanwhile, the United States will lose its leadership role in developing one of the most significant financial innovations in years.
Congress can help us escape this quagmire by passing legislation that establishes how to regulate crypto token issuance and trading. Congress is much better suited than federal courts to weigh the relative merits of crypto policy alternatives. And members of Congress, unlike federal judges, are politically accountable to the American people.
Fortunately, Congress has taken significant steps toward a legislative framework for the issuance and trading of crypto generally, and for stablecoins in particular, an important subset of crypto tokens that require their own framework. Thoughtful legislators including Reps. Patrick McHenry (R-N.C.), Wiley Nickel (D-N.C.), and French Hill (R-Ark.) and Sens. Cynthia Lummis (R-Wyo.), Kirsten Gillibrand (D-N.Y.), John Boozman (R-Ark.), and Debbie Stabenow (D-Mich.), have advanced bipartisan legislation that would significantly clarify the rules of the road for this innovative technology.
While the Biden administration and certain prominent Democratic senators have obstructed legislative progress on crypto, the tide may be turning against them. This year, the House voted to pass FIT 21, a bill that would clarify the jurisdictional boundaries between the securities and commodities legal and regulatory frameworks, by a margin of 279-136, including 71 Democrats in support. Former President Trump has recently embraced crypto and Vice President Harris may be considering a less hostile approach than that of the current Biden administration.
No one knows the federal political configuration next year will bring. Congress should use some of the remaining legislative time available this year to pass crypto legislation that will help the U.S. to retain its leadership as the world’s most innovative financial center.
Pat Toomey is a former Republican senator from Pennsylvania. He is a member of Paradigm’s Policy Council and a member of Coinbase Global Advisory Council.