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| Jeremiah Williams |
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| Helen Gugel |
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| Stefan Schropp |
According to a recent Fidelity survey, 27% of institutional investors in the U.S. hold crypto assets and 60% of investors across the U.S. and Europe "believe digital assets have a place in their investment portfolio."[1]
The trend toward acceptance of digital assets as an asset class is particularly notable given the continued uncertainty in a regulatory landscape in which the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission, with an assist from the U.S. Department of Justice, have primarily adopted an ad hoc regulation-through-enforcement approach in lieu of clear and binding rules to guide market participants.[2]
And despite several pending legislative proposals, Congress has not stepped in to fill the gap by statute. Against this backdrop, the change in administration — and the ensuing impact on law, policy and regulatory activity — presents a crossroads of sorts for the treatment and perception of digital assets in the U.S.
This article discusses some of the factors that may influence the direction of this burgeoning industry as the country transitions toward a new administration.
Regulatory Environment
Since announcing that digital assets may in certain circumstances be securities subject to its jurisdiction,[3] the SEC has established itself as perhaps the primary regulator of this space. In 2020 alone, the agency brought almost 20 enforcement actions involving sales of digital assets.[4] A number of these involved no indicia of fraud and imposed steep monetary penalties predicated solely on the failure to register the sale as a securities offering under Section 5 of the Securities Exchange Act, a move that some commentators — including SEC Commissioner Hester Peirce — perceived to be unduly aggressive and stifling to innovation.
Indeed, in a rare public dissent in one such case, Peirce noted that the analysis of whether a digital asset is properly classified as a security is "idiosyncratic by its very nature" and "does not produce clear guideposts for entrepreneurs and others to follow," thus resulting in a Hobson's choice for market participants whereby they must either expend "their limited capital on costly legal consultation and compliance or [forgo] their pursuit of innovation due to fear of becoming subject to an enforcement action."[5]
The SEC's lack of formal binding guidance regarding the treatment of digital assets — and the ensuing dilemma Peirce alluded to in her dissent — has been construed by some commentators as an extension of SEC Chairman Jay Clayton's perceived skepticism toward the industry.
Under his watch, the SEC has rejected every single proposal aimed at launching an exchange-traded fund, or ETF, based on bitcoin,[6] cleared only one full registration statement for a public offering of digital assets,[7] and otherwise advanced a cautious approach that focused more on the challenges of price discovery and custody services for digital assets than their potential to revolutionize modern day financial systems.
In this context, Clayton's anticipated departure from the agency in December[8] presents an opportunity to recalibrate the agency's approach toward digital assets and create a more hospitable environment for innovators and, by extension, institutional investors.
Depending on who fills his seat, Clayton's departure may increase the influence of Peirce, the so-called "crypto mom," who was recently confirmed to a second term running through June 2025 and will remain in her post under the new administration,[9] or at least open the door for some of her favored policy adjustments to broaden market assess to digital assets.
Peirce has been a vocal advocate for a three-year regulatory safe harbor that would allow market participants to work on developing a functional or decentralized network for digital assets and testing any novel ideas along the way without registering with the SEC and subjecting their nascent business endeavors to regulatory scrutiny, as long as certain conditions are met.[10]
Broadly speaking, the proposed safe harbor would exempt (1) the offer and sale of tokens from the provisions of the Securities Act of 1933, other than the antifraud provisions, (2) the tokens from registration under the Securities Exchange Act of 1934, and (3) persons engaged in certain token transactions from the definitions of "exchange," "broker," and "dealer" under the 1934 Act.[11]
The concept for the safe harbor is driven by Peirce's recognition that "[i]t is important to write rules that well-intentioned people can follow"[12] and is animated by the same principles that led her to speak out against the agency's enforcement of Unikrn.[13] Not surprisingly, Peirce's proposal has broad support outside the SEC and could be a game changer for the industry if it gains traction within the agency.
Clayton's departure may also accelerate the SEC's timetable for approving bitcoin ETFs, which has stalled in part due to his view that even the most stable tokens will need to be better regulated before receiving approval to be traded on a major exchange. In particular, the SEC has expressed concerns about how funds with significant digital asset positions could satisfy the requirements of the Investment Company Act, questioning their ability to determine a daily net asset value, ensure adequate liquidity, maintain holdings with qualified custodians, and limit arbitrage opportunities.[14]
As the market continues to explore these important questions, Peirce's influence may be instrumental in changing the regulatory landscape to enable broader investment opportunities relating to digital assets.
In another notable public dissent earlier this year, she denounced the SEC's repeated disapprovals of proposed rule changes that would allow access to exchange-traded products by noting that the agency's approach "interfered with the continued institutionalization of the market and thus delayed improvements in market structure and investor protections" and threatened to drive innovation away from the United States to more receptive jurisdictions.[15]
Thus, irrespective of Clayton's accomplishments at the SEC, it is perhaps not surprising that proponents of digital assets are hopeful that the opportunities for investment and engagement with this asset class will increase under different leadership. Indeed, given the open admiration that CFTC Chairman Heath Tarbert has expressed for digital asset initiatives,[16] a changing of the guard at the SEC may well herald a new regulatory regime that is more conducive to experimentation and innovation while continuing to call out fraud across the board.
Legislative Review
When the 116th Congress adjourns just after the New Year, it will do so having concluded the most active legislative session for digital assets and blockchain issues in the branch's history, highlighted by the introduction of more than 40 pieces of legislation on the topic.[17]
While a number of those bills focused on nefarious uses of digital assets — including terrorism, money laundering and human or sex trafficking — many sought to clarify the regulatory and tax treatment of cryptocurrencies, to encourage or study the use of blockchain technology by U.S. government agencies, and to consider the potential adoption of a digital dollar, antithetical as that may be to proponents of decentralized cryptocurrencies.[18] These developments are encouraging for the continued incorporation of digital assets into mainstream finance.
Of particular note, the bipartisan Virtual Currency Tax Fairness Act, introduced in January, could markedly improve the chances for widespread adoption of cryptocurrency. Although it has subsequently stalled following referral to the House Committee on Ways and Means, the bill would exempt virtual currency transactions of $200 or less from the calculation of capital gains,[19] thereby allowing users to spend or exchange virtual coins for everyday transactions without maintaining records of those gains in a market that often sees wild fluctuations.
It would also put cryptocurrency on more equal footing with transactions involving foreign fiat currencies, which currently benefit from a similar exception to capital gains calculations. Given the extent to which Congress' overall makeup remains unchanged, the success of this effort and others like it may well turn on the extent to which the incoming administration is willing to take a lead on this issue.
From this perspective, several of the individuals President-elect Joe Biden has appointed to his transition team or floated as permanent members of his administration have generated cautious optimism that a Biden administration will be more receptive to digital assets than that of his predecessor, who once famously declared himself "not a fan of Bitcoin and other cryptocurrencies."[20]
For example, Biden has tapped Gary Gensler — CFTC chairman under President Barack Obama, a U.S. Department of the Treasury official under President Bill Clinton and a Wall Street veteran — to lead the agency review team for the Federal Reserve as well as banking and securities regulators.[21]
Gensler is currently a professor of blockchain, digital currency, financial technology and public policy at the Massachusetts Institute of Technology, and senior adviser to the influential Digital Currency Initiative of the MIT Media Lab.[22]
Although his public comments have been a mixed bag, including criticism and defenses of various developments in the digital asset space, he is by virtually all accounts an expert in the area and has the appropriate experience and knowledge to make informed policy judgments.[23]
As another example, Biden is said to have seriously considered Lael Brainard for the post of Treasury secretary before settling on former Federal Reserve Chair Janet Yellen.[24] In her current role on the Federal Reserve Board of Governors, Brainard has spearheaded the Fed's efforts into research and experimentation related to distributed ledger technologies and use cases, including the potential for a central bank digital currency.[25]
With the addition or promotion of these and other like-minded individuals in a Biden administration, the potential for regulators to drive innovation in this area, and to push Congress to act by developing proofs of concept, is perhaps for the first time a real possibility.
Conclusion
In short, the outlook for a number of digital assets and blockchain technologies, including the proliferation of decentralized tokens, the creation and acceptance of platforms on which to trade those assets, and a tax and regulatory structure that would make all of that possible, has never been brighter.
As a new administration brings increased expertise to a regulatory regime that has already taken a lead in setting the rules of the game, institutional investors, traders and other adopters of digital assets should prepare to engage in continued advocacy to ensure a fair and open market for all participants.
Jeremiah Williams is a partner at Ropes & Gray LLP. Previously, he was senior counsel in the SEC's Division of Enforcement, and a member of its Asset Management Unit.
Helen Gugel is counsel at the firm.
Stefan Schropp is an associate at the firm.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Olga Kharif, Fidelity Says a Third of Big Institutions Own Crypto Assets, Bloomberg.Com (June 9, 2020), https://www.bloomberg.com/news/articles/2020-06-09/fidelity-says-a-third-of-large-institutions-own-crypto-assets.
[2] See, e.g., U.S. Dep't of Justice, Report of the Attorney General's Cyber Digital Task Force, Cryptocurrency: Enforcement Framework (Oct. 2020), https://www.justice.gov/ag/page/file/1326061/download.
[3] See, e.g., U.S. Securities and Exchange Commission, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017), https://www.sec.gov/litigation/investreport/34-81207.pdf.
[4] U.S. Securities and Exchange Commission, Cyber Enforcement Actions (last visited Nov. 30, 2020), https://www.sec.gov/spotlight/cybersecurity-enforcement-actions.
[5] U.S. Securities and Exchange Commissioner Hester M. Peirce, Statement on SEC Settlement Charging Token Issuer with Violation of Registration Provisions of the Securities Act of 1933 (Sept. 15, 2020), https://www.sec.gov/news/public-statement/peirce-statement-settlement-charging-token-issuer.
[6] Kevin Helms, Jay Clayton Leaves SEC: Crypto Industry Hopeful for Bitcoin ETF Approval, Bitcoin.Com (June 21, 2020), https://news.bitcoin.com/jay-clayton-cryptocurrency-bitcoin-etf/.
[7] INX Limited, INX Limited Announces Effectiveness of Security Token IPO (Aug, 24, 2020), https://www.inx.co/news/inx-limited-announces-effectiveness-of-security-token-ipo.
[8] U.S. Securities and Exchange Commission, SEC Chairman Jay Clayton Confirms Plans to Conclude Tenure at Year End (Nov. 16, 2020), https://www.sec.gov/news/press-release/2020-284.
[9] Jason Brett, U.S. Senate Votes in "Crypto Mom" Hester Peirce at SEC through 2025, Forbes.Com (Aug. 2, 2020), https://www.forbes.com/sites/jasonbrett/2020/08/06/us-senate-votes-in-crypto-mom-hester-peirce-at-sec-through-2025/.
[10] U.S. Securities and Exchange Commissioner Hester Peirce, Running on Empty: A Proposal to Fill the Gap Between Regulation and Decentralization (Feb. 6, 2020), https://www.sec.gov/news/speech/peirce-remarks-blockress-2020-02-06.
[11] Id.
[12] Id.
[13] See supra note 5.
[14] See U.S. Securities and Exchange Commission Chairman Jay Clayton, Testimony Before the Committee on Banking, Housing, and Urban Affairs, United States Senate (Feb. 6, 2018), https://www.sec.gov/news/testimony/testimony-virtual-currencies-oversight-role-us-securities-and-exchange-commission; see also U.S. Securities and Exchange Commission, Division of Investment Management, Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings (Jan. 18, 2018), https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm.
[15] U.S. Securities and Exchange Commissioner Hester Peirce, Dissenting Statement in Response to Release No. 34-88284 (Feb. 26, 2020), https://www.sec.gov/news/public-statement/peirce-dissenting-statement-34-88284.
[16] See, e.g., Nikhilesh De, CFTC Chairman Heath Tarbert Talks Ethereum, DeFi and the Next BitMEX, CoinDesk.Com (Oct. 14, 2020), https://www.coindesk.com/heath-tarbert-invest-eth-fireside.
[17] Jason Brett, In 2019-2020, Congress Introduced 40 Crypto And Blockchain Bills, Forbes.Com (Oct. 17, 2020), https://www.forbes.com/sites/jasonbrett/2020/10/17/in-2019-2020-congress-introduced-40-crypto-and-blockchain-bills/?sh=22e563c46213.
[18] Id.
[19] H. Res.5635, Virtual Currency Tax Fairness Act of 2020 (Introduced Jan. 16, 2020), https://www.congress.gov/bill/116th-congress/house-bill/5635/all-info.
[20] See, e.g., Brett Molina, Trump on Bitcoin, other cryptocurrencies: "I am not a fan," USAToday.Com (July 12, 2019), https://www.usatoday.com/story/money/2019/07/12/trump-says-hes-not-fan-bitcoin-cryptocurrencies/1712784001/.
[21] Jaspreet Kalra and Nikhilesh De, Biden Confirms Crypto-Savvy Gary Gensler Will Lead Financial Policy Transition Team, Nasdaq.Com (Nov. 10, 2020), https://www.nasdaq.com/articles/biden-confirms-crypto-savvy-gary-gensler-will-lead-financial-policy-transition-team-2020.
[22] Gary Gensler, Faculty Bio, MIT Management Sloan School (last visited Nov. 20, 2020), https://mitsloan.mit.edu/faculty/directory/gary-gensler.
[23] See Kalra and De, supra note 21.
[24] See, e.g., Shalini Nagarajan, What Janet Yellen's Appointment as US Treasury Secretary Would Mean for Markets, BusinessInsider.Com (Nov. 28, 2020), https://markets.businessinsider.com/news/stocks/janet-yellen-appointment-treasury-secretary-means-for-markets-2020-11-1029846210.
[25] Daniel Palmer, Fed Reserve Governor Brainard Said to Be Biden's Choice for Treasury Secretary, CoinDesk.Com (Sept. 25, 2020), https://www.coindesk.com/fed-reserve-governor-brainard-said-to-be-bidens-choice-for-treasury-secretary.
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