Source: Coindesk
Author: Partner at Troutman Pepper Law Firm
Translation: LianGuaiBitpushNews Mary Liu
Cryptocurrencies have become “non-compliant,” especially in terms of their “business models,” at least according to Gary Gensler, the chairman of the U.S. Securities and Exchange Commission (SEC).
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Given that this view is widespread among the regulatory agencies responsible for securities regulation in the United States, it is not surprising that enforcement actions involving cryptocurrencies have reached historic levels.
In just a few years, we have witnessed the so-called unregulated “Wild West” transform into a “target” for the SEC. In addition to the SEC, the Commodity Futures Trading Commission (CFTC) and the Department of Justice (DOJ) also frequently join in the enforcement actions.
There is no doubt that these regulatory agencies are not keeping their interests in enforcement work a secret. They have taken measures, including investigating what they perceive as potential misleading of investors or illegal promotion of cryptocurrencies by key participants. These enforcement actions have attracted mainstream media attention, and some of them have been resolved through multimillion-dollar settlements.
However, the most surprising aspect of these enforcement actions is how they are carried out. One might expect a new wave of legislation aimed at regulating cryptocurrencies and other digital assets, but you would be wrong. The enforcement actions tell us that they are still sticking to the old laws that have been in place for some cases for 90 years.
As regulatory agencies increase their enforcement efforts by relying on strained interpretations of existing laws, two questions arise: 1) What is the SEC’s next target? 2) Which one will be phased out first, outdated securities laws or the cryptocurrency industry?
What is the next target? Cryptocurrency Wallets
After closely observing the actions of regulatory agencies, we anticipate that cryptocurrency wallets and certain digital asset exchanges will be the next targets.
Based on previous federal enforcement actions and signals issued by these agencies in notifications, we expect digital asset enforcement to take place in two ways: the 1934 Securities Exchange Act (“Exchange Act”) may be interpreted to cover the regulation of cryptocurrency wallets as brokers subject to anti-money laundering and know-your-customer (AML/KYC) regulations, and mixers and other tools will face compliance challenges in the digital asset field.
We predict that the next area of regulation by the SEC will involve the regulation of cryptocurrency wallets operating as brokers.
This concept was first raised by the SEC in its Wells notice issued to Coinbase, a cryptocurrency exchange, before the lawsuit was filed. In the notice and subsequent allegations and statements in the lawsuit, the SEC accuses Coinbase Wallet (a product that provides users with self-custody services for digital assets) of operating as an unregistered broker, in violation of the Exchange Act.
In response to Wells’ notification, Coinbase argued that its wallet product is just software and does not perform any traditional functions typically associated with brokerage activities. Specifically, the “Exchange Act” defines a “broker” as “any platform engaged in securities trading activities for others.”
Coinbase’s argument is that the wallet can only interface with secondary market transactions, and from Coinbase’s perspective, these secondary market transactions do not involve investment contracts and therefore are not securities. Coinbase further argued that it used to charge a 1% fee for each use of the “wallet swap” feature (which has now been discontinued), but this does not change the SEC’s analysis.
The SEC does not believe this. The agency has sued Coinbase and Binance, accusing both companies’ wallet services of operating as unregistered broker-dealers.
TradFi Trading
We predict that the second area where the SEC’s enforcement scope will expand is the increased regulation of traditional financial institutions engaged in digital asset trading. As people pay more attention to new cryptographic tools and services, we expect the design, implementation, and maintenance of compliance systems to comply with AML/KYC laws will pose significant challenges for these institutions, making them a target for regulatory agencies.
In particular, enforcing AML/KYC laws in the field of digital assets will require these institutions to rely heavily on information they cannot control. Take the internal policies for proposed token transactions, where over 10% of the value can be traced back to proceeds from stolen assets.
In practice, compliance programs that can carry out such markings will require the cooperation of third parties, which is far beyond the capabilities of most companies in and outside the cryptocurrency industry.
First, whether it is a government entity or a private investigative organization, theft behavior must be understood, and the wallets/tokens involved must be tracked and identified. Then a repository must be created to maintain that information. To some extent, multiple such repositories are needed to track the flow of currencies associated with many theft and hacking activities, which only increases the cost of solving the problem. Finally, once a company wants to screen for illegal and problematic transactions, it must screen the data for each transaction and mark the problematic ones.
Except for the last step, financial institutions have to rely on the work of others to generate inputs that contribute to driving compliance programs. This decentralization makes compliance costly in terms of both time and money.
Rapid Expansion of Enforcement Scope
The scope of encryption enforcement is expanding rapidly, causing some participants to start thinking about what’s next.
Coinbase CEO Brian Armstrong said during London Fintech Week that due to a lack of “regulatory clarity,” “any direction can be considered, including leaving the United States or any necessary action.” It is not difficult to imagine that most participants in the encryption market agree with Armstrong’s statement, “We just want a clear rulebook.”
However, the various federal agencies responsible for regulation have not established a clear set of rules to govern the cryptocurrency field, but instead rely on legal provisions from decades ago, which could not have anticipated the technology on which digital assets rely.
In some respects, it raises a question: do participants in the crypto market actually structure their business models as “non-compliant,” or is non-compliance simply a byproduct of regulatory confusion?
While we await regulatory compliance handbooks, investors and exchanges should collaborate with legal compliance teams to ensure that their transactions comply with federal securities laws, banking regulations, and the ever-evolving interpretations of their application in the cryptocurrency industry. Each transaction brings unique regulatory hurdles, which are a result of federal agencies insisting on applying decades-old regulations to a rapidly evolving industry.
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