The need for sweeping US legislation in response to massive market events around cryptocurrencies has not been met. Unlike the 1929 crash, the dot-com bubble collapsed from 2000 to 2002, and the 1987 Black Monday stock market crash, which led to the nation’s first national securities laws, the Sarbanes-Oxley Act, and the adoption of circuit-breaker rules, respectively, failures around the Terra-Luna stablecoin ecosystem, the current crypto market’s “crypto winter,” and FTX’s implosion have not resulted in significant regulatory action. Instead, the Securities and Exchange Commission (SEC) has abruptly altered longstanding positions and brought actions alleging that digital assets are subject to securities regulations since December 2022.
Although the SEC has forced Kraken, Terraform Labs, and Nexo to pay fines in January and February 2023 alone over various services and offerings, and has sued Coinbase and Binance.US for securities violations this month, it is bringing more heat than light to crypto regulation through one-off enforcement actions. Coinbase has pointed out in a May 2023 court filing that the SEC should issue regulations through the notice-and-comment procedures under the Administrative Procedure Act (APA).
The SEC is also pursuing “enforcement by regulation” amid jurisdictional fights among regulators over whether to define cryptocurrencies as “securities” and whether the SEC has enforcement authority over them. The Commodities and Futures Trading Commission’s commissioner, which believes cryptocurrencies should be regulated as “commodities,” has described the SEC’s tactics as “regulation by enforcement” in a recent statement. The CFTC has even filed an action against Binance for running an unauthorized derivatives marketplace and failing to comply with anti-money laundering provisions.
While Congress could enact legislation for cryptocurrencies, none are close to passage, including the Securities Clarity Act and the Token Taxonomy Act. Therefore, the SEC should act using the notice-and-comment process instead of a series of confounding one-off regulatory actions. Coinbase’s lawsuit seeks to compel the agency to follow this process.
A Different Approach to Cryptocurrency Regulation
In the United States, government agencies have two ways to regulate an industry. The first approach is to use current regulatory regimes and existing rules to define acceptable conduct in a new sector, in which the SEC and the CFTC are pursuing cryptocurrencies. Under this approach, administrative agencies can issue opinion letters, initiate investigations, and commence enforcement actions to penalize organizations and force them into agreements that align with the agency’s preferred positions. However, courts may undo all of the SEC’s actions, either by rejecting its enforcement actions as ultra vires or by holding that the digital assets it is targeting are not securities.
On the other hand, the second regulation strategy, APA rulemaking, offers a more intuitive approach to autonomous vehicle standards and other emerging issues. Under this approach, a federal agency can analyze a new sector’s inner workings, customs, and practices in-depth, gaining a better understanding of its emerging legal issues. The agency can then announce proposed rules for the industry and receive feedback from the public through a “notice-and-comment period,” refining the rules with this feedback incorporated. The SEC could issue regulations with as little as 60 days’ notice or even without notice at all, provided it makes certain findings.
Coinbase notes that over 1,700 comments were received on its July 2022 rulemaking request. These regulations could also adopt the format of any legislative proposals Congress is considering. Such rulemaking could be done in parallel with CFTC rulemaking.
While it remains to be seen whether the SEC’s piecemeal regulatory action will succeed in obtaining regulatory authority over the industry, a well-thought-out, public, and collaborative regulatory regime consistent with the APA is far superior to the SEC’s “regulation-by-enforcement” approach.