Gary Gensler, the chairman of the Securities and Exchange Commission, stated on September 15 that digital currencies and intermediaries that permit users to “stake” their coins may be able to satisfy a crucial test used by courts to assess whether an asset is a security. The Howey test looks at whether or not investors anticipate receiving a return from the labour of third parties.
At a congressional hearing, Mr. Gensler told reporters, “From the coin’s perspective, another indication that under the Howey test, the investing public is anticipating rewards based on the work of others.” He said he wasn’t making any specific reference to a cryptocurrency.
Under rules implemented in the 1930s, issuers of securities—a class of asset that includes stocks and bonds—are required to submit thorough disclosures to the SEC. Strict regulations that are intended to safeguard investors from conflicts of interest must be followed by exchanges and brokers that enable the trading of securities. If they sell any assets that the SEC or courts judge to be securities, crypto issuers and trading platforms will be held strictly liable.
One of the two ways that bitcoin networks validate transactions is by staking. It enables investors to lock up their tokens for a set period of time in order to obtain a return. It is used by some of the biggest cryptocurrencies, like Solana, Cardano, and, as of this week, Ether. According to Mr. Gensler, if a middleman like a crypto exchange provides staking services to its clients, it “looks quite similar—with some variations of labeling—to lending.” BlockFi Lending was ordered to pay $100 million by the SEC in February for failing to register with the agency, as the SEC has frequently warned companies selling crypto-lending products that they must do so.
CFTC vs SEC: Who will control crypto?
There is a heated debate about which government agencies and the congressional committees they report to have authority over crypto. The Senate Banking Committee, which controls the SEC, conducted a meeting Thursday in parallel with the Senate Agriculture Committee, which oversees the Commodity Futures Trading Commission, to allow senators to interview Mr. Gensler.
Leaders of the agriculture group last month suggested a crypto law that would expressly classify bitcoin and ether as digital commodities rather than securities. These assets are not currently regulated by the federal government. The law would give the CFTC, which is in charge of managing the derivatives markets, the power to control digital commodities. Exchanges like Coinbase and FTX would be required, among other requirements, to register with the CFTC, supervise trading, safeguard investors from abuse, and only provide assets that are immune to market manipulation. Additionally, they would have to provide certain disclosures on the assets they list, such as operating procedures and any conflicts of interest.
Advocates for consumer protection are concerned that the CFTC is underequipped to safeguard small investors in a sector that Mr. Gensler has compared to the Wild West. The CFTC has a small workforce compared to the SEC, and businesses, banks, and sophisticated hedge funds dominate the markets it regulates rather than retirees who are putting money down for their future.
The SEC has a strict disclosure framework that crypto advocates claim is expensive and impracticable, and the sector has made it clear that it prefers to be regulated by the CFTC. Millions of dollars have been spent by cryptocurrency companies lobbying legislators on their behalf.
Ether formerly depended on a different model, known as proof-of-work, which is the model used by bitcoin, before switching to the proof-of-stake model this week. Because miners devote enormous amounts of computational power to the network, the approach is sometimes criticised for its excessive energy use.
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