February 25, 2024

Crypto Queens, Trojan Horses, the SEC and CFTC, Lawmakers Need To Act on Bipartisan Bill to Create Regulatory Framework for Cryptocurrencies

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Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) have recently introduced a groundbreaking bipartisan bill in June, 2022 that aims to establish a comprehensive regulatory framework for cryptocurrencies. The bill, known as the Responsible Financial Innovation Act, proposes assigning primary jurisdiction over most digital assets to the Commodity Futures Trading Commission (CFTC), while the Securities and Exchange Commission (SEC) would retain jurisdiction over specific types of digital assets, including initial coin offerings (ICOs). This bill represents a significant milestone in the cryptocurrency industry and could reshape how cryptocurrencies are regulated in the United States if it is passed.

The bill also includes the creation of a dedicated office within the Treasury Department that would oversee cryptocurrency matters. This office would be responsible for formulating policies, developing regulations, and providing guidance to businesses and consumers involved in the cryptocurrency space. By establishing a clear regulatory structure, the bill aims to bring more certainty and clarity to businesses offering cryptocurrency products and services, while also promoting growth and facilitating access to capital within the industry.

 

Impact on the CFTC and SEC

If passed, the bill would grant the CFTC enhanced authority to regulate cryptocurrency exchanges and other market participants. As the CFTC has a history of regulating derivatives markets, it is often viewed as a more favorable regulator for the cryptocurrency industry compared to the SEC. This shift in jurisdiction could lead to a more crypto-friendly regulatory approach, providing additional opportunities for innovation and development within the sector.

The Lummis-Gillibrand bill is also likely to influence the SEC’s stance on cryptocurrencies. Historically, the SEC has been cautious in approving cryptocurrency-related products and services. However, the bill would provide the SEC with clearer guidance on how to regulate the industry, potentially leading to a more constructive and informed approach to cryptocurrency regulation. Read the article titled Exploring the Distinction Between Cryptocurrency Commodities and Security Tokens for more information.

 

Industry Reactions and Potential Impact

The introduction of the Lummis-Gillibrand bill has garnered positive responses from the cryptocurrency industry, which sees it as a significant step towards legitimizing the sector. By creating a comprehensive regulatory framework, the bill could attract more investment to the cryptocurrency industry and encourage its growth. It also has the potential to promote financial inclusion by making it easier for businesses to offer cryptocurrency-related services.

The bill’s impact extends beyond the cryptocurrency industry itself. The regulatory clarity provided by the legislation would level the playing field for businesses operating in the cryptocurrency space, replacing the current patchwork of regulations that can impede their operations.

Both Senator Lummis and Senator Gillibrand have been staunch supporters of cryptocurrencies. Lummis, a Republican Senator from Wyoming, has voiced her belief in the transformative potential of cryptocurrencies and has actively advocated for their adoption. Gillibrand, a Democratic Senator from New York and a former trial lawyer, shares a similar vision, emphasizing the potential of cryptocurrencies to provide financial inclusion on a global scale.

The introduction of the Responsible Financial Innovation Act by Senators Lummis and Gillibrand represents a significant milestone in cryptocurrency regulation. This bipartisan bill seeks to create a comprehensive regulatory framework, with the CFTC taking primary jurisdiction over most digital assets and the SEC retaining oversight of specific types of digital assets. If enacted, the bill could provide clarity and certainty to businesses, attract investment, and help legitimize the cryptocurrency industry. It also has the potential to influence the SEC’s approach to regulating cryptocurrencies, leading to a more informed and constructive regulatory landscape.

 

The Trojan Horse

Amidst the ongoing debate over regulatory clarity in the cryptocurrency industry, a potential breakthrough is emerging on the fringes of the market. The Financial Industry Regulatory Authority (FINRA), an oversight arm backed by the Securities and Exchange Commission (SEC), has very quietly granted significant approvals to companies seeking to adhere to securities regulations. These recent developments include the approval of the first broker-dealer with custody rights for digital asset securities, Prometheum Ember Capital LLC, and the authorization of OTC Markets Group to facilitate trading for crypto securities. These milestones could signal the early stages of a fully compliant crypto infrastructure in the United States.

The question is why wasn’t this option put in front of any other cryptocurrency exchange such as Coinbase, Binance, Kraken and others?

Prometheum Capital has received two significant approvals from FINRA. Firstly, they have been approved as a “special purpose broker-dealer” with custody rights over customer crypto assets since May 17. Secondly, they have gained recognition as an alternative trading system (ATS) for digital asset securities, positioning them as one of the first ATSs in the market.

Prometheum Capital, purpose-built to comply with SEC regulations, received the broker-dealer approval, marking a significant milestone for the industry. Aaron Kaplan, founder and co-CEO of Prometheum Inc., the parent company, emphasized that the approval demonstrates a viable path to compliance in the U.S. Contrary to claims of regulatory uncertainty, Kaplan stated, “There is obviously a way forward for crypto in the United States.” He dismissed previous complaints, noting that some were attempting to fit square pegs into round holes.

 

And Enters The Pink Sheet King OTC Markets Group

OTC Markets Group, a reputable player in trading securities outside major exchanges, has also aligned itself with the SEC’s regulations. The company’s deputy general counsel, Cass Sanford, expressed their commitment to operating within the existing rules rather than pushing back against them. This doesn’t mean that it makes sense for OTC Markets to jump into the crypto space, they are focused on OTC Securities. It may serve the public interest better for an exchange that is compliant with any potential regulations and laser focused on the cryptocurrency space to hold that crown. Mixing of the two will only give a muted view of the markets and put traditional market makers in place, which would potentially usher in the likes of Citadel Securities, GTS, Jane Street, StoneX, Susquehanna and Virtu.  This could potentially knock out the interest of major players such as Goldman Sachs, Blackstone, Morgan Stanley and other major firms that are jockeying for position if certain cryptocurrencies begin trading on the OTC Market. This may lead such firms just to focus on digital assets that are seen more as commodities such as Bitcoin, Ethereum, Pecu Novus, Litecoin and once XRP is resolved they may enter that group.

One of the key difficulties with the OTC Market lies in the lack of centralized regulation compared to traditional exchanges. While the OTC market is subject to general securities laws, the absence of specific rules and oversight tailored to OTC trading can create uncertainties and potential risks for participants. This regulatory ambiguity often leads to concerns about transparency, investor protection, and market integrity, as the decentralized nature of the OTC market can make it more susceptible to fraud and manipulation.

Another challenge facing the OTC market is liquidity. Unlike major exchanges where trading volumes are high and liquidity is abundant, the OTC market often struggles with lower liquidity levels, making it more difficult to buy or sell securities quickly at desired prices. The absence of centralized order books and the fragmentation of trading across various market makers and broker-dealers further contribute to liquidity challenges. This lack of liquidity can result in wider bid-ask spreads, making it costlier for investors to execute trades and potentially affecting the overall efficiency of price discovery in the OTC market. Market participants, particularly smaller companies and less-established securities, may find it harder to attract investor interest and access capital due to these liquidity limitations. Now how would this impact the cryptocurrency industry if this should move forward?, that should be the question that comes up on this point.

 

Could The SEC Have Created a Path to Compliance Away From Existing Crypto Exchanges?

Kaplan dismissed the notion of major companies like Coinbase abandoning the U.S. market, asserting that the cost of giving up the largest portion of their revenues would be prohibitive. While he hopes for a middle path forward, he warned that companies failing to evolve and comply with federal securities laws may face dire consequences. Kaplan concluded that compliance, investor protection, and secure asset management should be the industry’s top priorities.

The recent approvals by FINRA for a broker-dealer with custody rights and OTC trading platforms for crypto securities signal the formation of a potentially compliant crypto infrastructure in the United States. These milestones provide hope for companies seeking to navigate the securities rulebook and establish clear regulatory frameworks. While challenges persist, the developments indicate progress towards a more regulated and secure crypto ecosystem. The ongoing dialogue between industry stakeholders and regulatory authorities will shape the future of digital asset markets, determining what falls under SEC guidelines and what falls under CFTC guidelines, in the end it all comes down to how best to protect investors and foster growth in a rapidly evolving landscape.

The adoption of the Responsible Financial Innovation Act along with recent developments by FINRA could finally provide that regulation that is required and it could spark innovation while protecting investors and setting the example for the world to follow.

James Cullen
Technology/Digital Assets Desk

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