The conviction of Sam Bankman-Fried for the fraud that destroyed the once mighty digital asset exchange FTX may have been a low point for public opinion on the cryptocurrency industry. But a potentially game-changing upside event for crypto could be coming soon which could bring trillions of dollars in reliable capital into the emerging industry. Bloomberg’s James Seyffart reports a high likelihood that the first spot exchange-traded fund (ETF) for cryptocurrencies in the United States could be approved by January.
This story of two extremes is reflexive of the federal agency tasked with regulating it and calls into question whether the Securities and Exchange Commission (SEC) can act appropriately and carry out its mission under current leadership.
SEC Chairman Gary Gensler, according to his public schedule, met with Bankman-Fried and his top brass several times to discuss regulation. Rep. Tom Emmer (R-MN), a senior Republican on the House Financial Services Committee, said his office has received reports that Gensler “was helping SBF and FTX work on legal loopholes to obtain a regulatory monopoly.” According to the court record, Bankman-Fried’s fraud and theft of customer funds was in full bloom at the time of those meetings. But Gensler was too busy at the time waging an all-out war on crypto companies like LBRY, Ripple, and Coinbase, none of whom are accused of fraud.
The Ripple case was the first major SEC crypto lawsuit, and in July the agency lost on the central question that a cryptocurrency is always a “digital asset security” that it has unlimited power to regulate. The Southern District of New York threw out that legal theory, stating that the XRP token that Ripple had sold was almost entirely traded on public exchanges through blind bid/ask transactions, something the SEC has no authority to regulate. Ripple’s victory points to an even bigger and more humiliating defeat coming for Gensler against Coinbase, the largest U.S. crypto exchange by volume.
Gensler inherited an SEC that was covered in doubts on its crypto regulation in the previous administration. The agency under his predecessor, Jay Clayton, put out guidance on crypto trading that gave a free regulatory pass for the trading of Ethereum’s native token, ether. William Hinman, Clayton’s director of corporation finance, gave a high-profile speech in 2018 laying out the SEC’s reasoning why “we believe that current offers and sales of ether are not securities transactions”. But on his last day in office, Clayton filed the Ripple lawsuit despite Hinman’s guidance applying to XRP as well as ether. Instead of clarity, it caused confusion and fear.
Internal SEC emails and documents obtained by Ripple during its case, as well as a DC-based government watchdog organization, Empower Oversight, showed Hinman ignored explicit legal advice from the SEC General Counsel that his guidance on ether had no foundations in securities law, and that Hinman had financial conflicts of interest that should have prevented him mentioning the token. This points to an agency picking winners and losers rather than regulating properly.
Despite the SEC’s regulatory failures and the harmful effects of the FTX fraud, digital assets are remarkably resilient, and markets are bouncing back with the anticipation of decisions on spot ETFs. Blackrock, the world’s largest asset management firm, has pending applications for spot ETFs in both bitcoin and ether.
Gensler appears less able to prevent one of the dozens of applications from being approved, given that Grayscale Investments won a lawsuit against the SEC before the U.S. Court of Appeals in D.C. over the agency’s earlier rejection of theirs. The court found the SEC’s rationale “arbitrary and capricious” and ordered the agency to review it again, giving Gensler little wiggle room to reject the growing number of applications coming in.
But it appears that nothing has changed about the SEC’s larger regulatory approach on crypto, and Gensler seems to refuse to learn anything from Clayton’s market-confusing actions, the conflicts of interest around Hinman, the failure to scrutinize Bankman-Fried or the failed case against XRP. Worst of all, as two federal judges have pointed, Gensler’s SEC is failing to follow the law when it comes to crypto. The accumulating failures have real world consequences for markets and investors, along with the credibility of the U.S. as a destination for innovation capital.
What is going to happen when the SEC approves crypto spot ETFs and then starts suing market participants, like it did when the agency approved Coinbase’s 2021 IPO and then sued it in 2023 claiming its core business model was illegal from the start? It’s a broad hypothetical, but entirely in line with the SEC’s erratic and incoherent record. Moreover, will the SEC ethics office or Inspector General ever investigate the conflicts of interest during Clayton’s tenure, where the pronouncements from him and Hinman continue to affect market perceptions of ether as spot ETFs are on the horizon?
These are fundamental doubts about the SEC’s credibility that should have been addressed before the upside comes, not after. Otherwise, more millions of investors will continue to be harmed, more winners and losers will be arbitrarily picked by conflicted SEC officials. If there isn’t a change in leadership then there must be a clarifying legislative framework for crypto imposed on the SEC by Congress that leaves no doubt what it can and cannot do. If not, the U.S. markets will lose confidence at the hands of an arbitrary and capricious regulator no one is holding accountable.
