Only the strong will survive the avalanche of bankruptcies, layoffs and volatility now cascading through the crypto sector.
Investors burned by flimsy promises or forced to panic-sell digital assets will want evidence that companies have undergone proper licensing and due diligence. Customers who buy, sell, borrow or loan crypto will want to rest easy knowing their assets won’t be lost. Prospective buyers, lenders, partners and employees will demand similar assurances.
The crypto winter won’t last forever, but the table stakes for market entry have changed. Federal and state agencies are ramping up their enforcement efforts, legislators are putting forth new proposals and state agencies are setting rules of their own.
To seize new opportunities and stay competitive as the seasons change, regulatory clarity will be key. Answering two key questions can help lay the groundwork.
Is my digital asset going to be considered a security?
Chances are, your digital asset is one of two things: a security (i.e., a financial instrument, like a stock or bond, that represents value) or a commodity (i.e., a basic good that is interchangeable with goods of the same type).
At present, the Securities & Exchange Commission (SEC) essentially considers every digital asset aside from Bitcoin and Ethereum to be a security. Though the Commodities and Futures Trade Commission (CFTC) and many others might disagree — and proposed bipartisan legislation would effectively put most digital assets under the CFTC’s jurisdiction — critics say the CFTC isn’t equipped to manage the workload and has significantly less experience than the SEC, which nearly doubled the size of its crypto assets and cyber unit earlier this year.
For now, at least, most companies would do well to assume that their digital asset will be viewed as a security. And they should therefore register it with the SEC.
Some will continue to argue that their cryptocurrency or NFT is merely a “utility token” that can only be used within a closed ecosystem (e.g., as a ticket to specific events/access in the metaverse, to buy upgrades to particular NFTs, etc.), and therefore is not something that has value as a wider financial instrument. Yet, the bar for qualifying as such is growing ever higher, as outlined in the SEC’s 2019 guidance, which argues that a digital token will be a security so long as there is “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”
Though registering and filing with the SEC can be costly and burdensome, the potential alternative could be far more expensive: facing a fine and enforcement action. While most in the industry would prefer common sense rule-making, the SEC is currently leading by enforcement. So if the SEC considers your digital asset to be a security, you probably should too.
Even if your asset is not a security, it does not mean that it will not be regulated. If it is considered a commodity, it will be regulated by the CFTC. If your digital asset can be used as a form of payment, you may be considered a Money Services Business and will be regulated by the Financial Crimes Enforcement Network (FinCEN), along with regulators in every state within which you transact with customers.
In light of these considerations, it might be useful to consider whether registering with the SEC is the better choice, because at the very least it provides a modicum of regulatory certainty. Moreover, it may serve to inspire confidence in potential investors, customers and counterparties.
Are you aware of other regulatory vulnerabilities?
Federal and state regulators are also renewing their focus on crypto, including:
- The Consumer Financial Protection Bureau (CFPB) has said that movement on its own crypto regulations will likely happen this year, particularly with regard to stablecoins. In May, the agency also released an enforcement memo addressing deceptive claims of federal deposit insurance related to crypto assets. Executives marketing such products should take note.
- The Federal Trade Commission (FTC) is concerned about the growing number of scammers in the crypto market. In a June report, the agency found that nearly 50,000 people have reported losses of over $1 billion in crypto to scams — more than any other payment method.
- State financial regulators, commentors say, may move forward with standards of their own, such as liquidity requirements as a condition for crypto trading platforms to obtain an operating license. These regulators can move faster than the federal government.
For example, New York’s Department of Financial Services requires all virtual currency businesses to apply for a BitLicense. Their scope is broad: Even if you’re looking to launch digital assets in crypto-friendly states like Wyoming, a BitLicense may be necessary if you’re conducting business in New York.
The path forward
Though the industry already looks to be on the road to recovery, gone are the days where a splashy white paper or initial coin offering can take off without further examination. In the months to come, the focus will likely turn to crypto infrastructure applications, management solutions and security tools.
This pivot reflects the concerns investors, customers, lenders, regulators and mainstream corporations have with the budding industry. It also underscores the importance of providing these stakeholders with regulatory assurances. That starts with understanding the various agencies, frameworks, rules and enforcement actions now in play, as well as implementing professional management teams, effective internal policies and procedures, and comprehensive data privacy controls.
Today’s weather may be harsh, but the next phase of crypto is coming. Those who can inspire regulatory confidence will be better positioned to be on its leading edge.
