SEC Chair Gary Gensler Reiterates Active Regulatory Stance On DeFi Platforms And Crypto Tokens – Technology

On April 4, 2022, Securities and Exchange Commission (SEC) Chair
Gary Gensler presented his views on decentralized finance (DeFi)
platforms and crypto tokens, which reiterated the active stance the
SEC is prepared to take on the nascent industry. In his prepared
remarks addressed to the Penn Law Capital Markets Association,
Gensler expressed his determination to use existing regulatory
tools to supervise crypto platforms, stablecoins, and other crypto
tokens.¹In Gensler’s view, the SEC already has
sufficient means to protect investors from crypto platforms and
crypto issuers. This is consistent with the positions previously
taken by Gensler and the SEC in asserting jurisdiction over crypto
markets. Gensler also unveiled several projects that the SEC is
planning to prod the crypto industry into the regulatory frameworks
already in place.

Regulation of Crypto Platforms

Gensler first remarked that the crypto platforms are currently
highly concentrated, with only two platforms making up 80% of all
trading by crypto-only exchanges. To protect investors, Gensler
stated that he directed the SEC to consider three projects. First,
the SEC is examining whether crypto platforms should register and
be regulated as securities exchanges. While acknowledging that
there have been arguments that exemptions from registration for
alternative trading systems (ATSs) should also be available to
crypto platforms, Gensler did not agree with the analogy. In his
view, ATSs are generally inhabited by large institutional
investors. Crypto platforms, on the other hand, have “millions
and sometimes tens of millions of retail customers directly buying
and selling on the platform without going through a broker.”
The presence of retail customers has compelled the SEC to step in
and assess how to provide customers of crypto exchanges with the
protections retail investors have on traditional exchanges.

Second, Gensler announced that he has directed the staff to
collaborate with the Commodity Futures Trading Commission (CFTC) on
how to jointly regulate crypto platforms. Since many crypto
platforms list both crypto commodity tokens and crypto security
tokens, Gensler finds that coordination between the two regulatory
agencies would establish a comprehensive regulatory regime for
these platforms.

Third, Gensler finds it appropriate for crypto platforms to
insulate their custodial services and market-making functions from
their trading services. Gensler noted that most crypto platforms,
unlike traditional exchanges, take custody of their customers’
assets and that “more than $14 billion in value was
stolen” last year. To address this concern, he has directed
the SEC to consider whether custody should be segregated as a means
to protect customers’ assets. Moreover, many crypto platforms
act as market makers, hence they are often counterparties to their
own customers. This, according to Gensler, is troublesome for such
a highly concentrated industry, particularly raising market
integrity questions, as mentioned below. 

Regulation of Stablecoins

In addition to his reservations over crypto platforms, Gensler
also expressed his concerns about stablecoins. According to
Gensler, stablecoins pose a risk to the financial stability of the
general market. Gensler discussed the importance of regulation and
oversight over the peg that stablecoins claim to ensure so that a
failure of one stablecoin does not “reverberate across the
wider crypto ecosystem.” Stablecoins’ potential for use in
illicit activities and potential for conflicts of interest were
also points of concern. Specifically, Gensler mentioned that many
crypto platforms actually own the stablecoins that are heavily
traded on their platforms. Hence, those crypto platforms become
counterparties to many of their customers. This fact, along with
the fact that many retail investors do not have direct rights of
redemption for the stablecoins, can create an issue of market
integrity for the platforms.

Reiteration of the Authority of the Howey Test

Finally, Gensler reminded his audience that he believes most
crypto tokens are securities because they meet the definition of
“investment contracts” as defined by the U.S. Supreme
Court’s decision in SEC v. Howey.²Under the
Howey test, an investment contract involves an investment
of money by entrepreneurs in a common enterprise with an
expectation of profits from the efforts of others. Such an
investment contract comes under the jurisdiction of the SEC.
According to Gensler’s view, most crypto tokens carry this
hallmark of an investment contract: “Without prejudicing any
one token, most crypto tokens are investment contracts under the
Howey Test.” Gensler warned that issuers of such crypto tokens
must register with the SEC and comply with its rules.

Conclusion

Gensler mentioned in his prepared remarks that the Super Bowl
this year showcased numerous ads for crypto platforms and services.
This “hype” reminded him of subprime lender
AmeriQuest’s ad in the 2006 Super Bowl, before going defunct
during the financial crisis, and of the “dotcom
companies” advertised in the 2000 Super Bowl, many of which
have also disappeared since. “Ads, thus, don’t equal
credibility.” Gensler was careful to note that the SEC is
willing to work with crypto platforms to help them comply with the
SEC, raising the recent settlement with BlockFi as an example
(discussed in a previous article here). Since joining the SEC, Gensler has
emphasized his determination that existing legislations and
regulations already confer the SEC ample authority to oversee the
crypto industry. He had told Congress in October 2021, for example,
that “the SEC’s authorities in [the crypto space] are
clear” and that “Congress painted with a broad brush for
the definition of security.”³ Although
Gensler’s view has been coherent, his detailed remarks about
crypto platforms and stablecoins and his plans for upcoming
projects at the SEC should alert the crypto industry. It would be
prudent for crypto platforms and issuers to prepare for the several
projects that Gensler has in mind for the SEC. 

Winston & Strawn Law Clerk Jeremy Chu also
contributed to this blog post.

Footnotes

1. Gary Gensler, Prepared Remarks of Gary Gensler on
Crypto Markets, U.S. Securities and Exchange Commission (Apr.
4, 2022),
https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422.

2. 328 U.S. 293 (1946).

3.Oversight of the U.S. Securities and Exchange
Commission: Wall Street’s Cop Is Finally Back On the Beat,
117th Cong. No. 117-51, at 8 (2021).

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