Background

Today the US Senate Banking Committee met with the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) to discuss what regulatory role each organization should have in regards to the exchange of cryptocurrencies. Previously, no one organization commanded governance over the exchange of cryptocurrencies and the legality of such transactions has long been controversial. On December 11, 2017 SEC Chairman, Jay Clayton, issued the following public statement to address cryptocurrencies and initial coin offerings (ICOs) in which, the opening paragraph alluded to the common tulip bulb-esque hype in cryptocurrencies, warning that this time would not be different. In particular, he had this to say to Main Street investors:

“A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.”

Clayton went on to state that to date, no ICO or listing/trading exchanges have been registered with or approved by the SEC. The ultimate takeaway from this statement is that the SEC wishes for investors to be wary and to understand the risks—nowhere did it mention that exchanging cryptocurrencies within or outside of the United States is illegal and even stated that the SEC was unsure on its own role in governing the exchange of cryptocurrencies:

“It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction. Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset.”

Clayton did however make it clear that US participation in ICOs is something that needs to be registered with and overseen by the SEC:

“I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws.”

For those unfamiliar, on January 30, the SEC froze a $600 million AriseCoin ICO and has purportedly had four actions so far this year on cryptocurrency exchanges.

A full synopsis of today's Senate Banking Committee hearing is below:

February 6, 2018 Senate Banking Committee Hearing with the SEC & CFTC

SEC Chairman, Jay Clayton:

The Senate Banking Committee began with opening remarks which seemed critical of the SEC's enforcement of actions taken by large corporations and Wall Street investors, especially repeat offenders. SEC Chairman, Jay Clayton then shared his opening remarks about cryptocurrencies and ICOs and overall seemed supportive of blockchain technology while firm in his belief that both cryptocurrencies and ICOs ARE securities and must follow the law and register with the SEC. Clayton said:

“You can call it a coin, but if it functions as a security, it is a security.”

He also warned Main Street investors that ICOs and coins were not synonymous with distributed ledger technology:

“An ICO may have nothing to do with distributed ledger technology, beyond the coin itself. Buying an ICO does not mean you are investing in blockchain related ventures.”

Clayton was very firm in his assertion that ICOs are being conducted 100% illegally and warned companies to stop playing semantics in calling cryptocurrencies coins that are not securities. He said:

“ICOs are being conducted illegally. Their promoters and other participants are not following our securities laws. Some say this is because the law is not clear. I do not buy that for a moment. The analysis is simple. Are you offering a security? If so, you have a choice, follow our private placement rules or conduct a public offering registered with the SEC.”

In closing he mentioned the issue of the infancy of cryptocurrencies and the lack of definite governance over their exchange, highlighting that neither the SEC of CFTC had clear guidelines:

“We, the SEC and the CFTC, do not have direct jurisdiction over the popular markets that trade true cryptocurrencies…a result of a new product and market…Cryptocurrencies have no sovereign backing or oversight, and again to be blunt are currently operating as assets for trading and investment much more than as mediums for exchange.”

CFTC Chairman, Christopher Giancarlo:

Giancarlo opened with expressing his concern for America's youth, including his own children, who are now becoming increasingly interested in cryptocurrencies. He made it clear that the CFTC believes strongly that this begins with educating the public and stated:

“The CFTC has produced a large amount of consumer education materials on virtual currencies including written statements, podcasts, webinars and a dedicated Bitcoin website. We’ve even scheduled visits to libraries and briefings for seniors. We’ve never conducted this much outreach for any other financial product.”

He went on to warn that like the SEC, the CFTC is currently handcuffed in how it approached the regulation of cryptocurrencies:

“To be clear, the CFTC does not regulate the dozens of virtual currency trading platforms here and abroad. We cannot require them to meet requirements like trade reporting, market surveillance, standards for conduct, capital requirements, or even cyber protections or platform safeguards.”

He did however explain that the CFTC is not powerless:

“Yet through our authority over commodity derivative markets, we do have enforcement power over spot coin markets and with newly launched Bitcoin futures, the CFTC can now obtain trading data and analyze it for fraud and manipulation in five underlying spot markets.”

Also stressing that the CFTC is taking action and will continue to increase its role within its current limitations:

“Led by the CFTC’s Virtual Currency Enforcement Task Force, we’ve launched several civil actions over the past few weeks, cracking down on fraudsters and manipulators and more will follow.”

It is clear that both the SEC and CFTC are tactfully engaging the cryptocurrency market through ICOs and those who would seek to take advantage of investors, the so-called "fraudsters" and "manipulators;" however, the U.S. Senate Banking Committee was plentiful with questions and concerns.

U.S. Senate Banking Committee Concerns:

Chairman Crapo opened with his concerns that neither agency seemed to have complete jurisdiction and asked if either had sufficient jurisdiction to do its job. He followed up by asking:

“Should Congress address refining and revising our law?”

Clayton responded very carefully by stating that there needs to be a collaborative effort across all governing agencies and they must first convene before remarking on any requests for additional regulatory power. This resounds with his early statement where he said the SEC was not requesting additional authority at this time but will if asked, step up its game. Giancarlo concurred.

The issue of the international nature of the cryptocurrency market and the illicit use of cryptocurrencies was also addressed as an issue in regulation.

Senator Brown came down even harder on the SEC and referenced that there are hundreds of consumer complaints on file with the Consumer Financial Protection Bureau (CFPB) and asked what was being done to address this. Clayton seemed to skirt the question and state that it was outside the realm of the SEC. Brown also returned to the issue that the SEC has not been hard enough on repeat offenders on Wall Street and combined with recent employee retention issues questioned if the SEC was up to the task at all. Clayton responded that personnel was his biggest issue and that due to the hiring freeze was handicapped.

Senator Reed raised the concern that the SEC and CFTC needed experts in cryptocurrencies and both Clayton and Giancarlo stressed that they had special teams devoted to this area. Senator Rounds also discussed the issues with a lack of knowledge in this area and wanted to know in what a cryptocurrencies was a security. Clayton boiled it down to offering a coin in hopes of a return gave it value and made it a security. Rounds went further by asking if cryptocurrencies were of more interest to the SEC or CFTC based on its status as a commodity or a security:

"Is Bitcoin or are these [cryptocurrencies] as currently being traded, are they a commodity or are they a security, or are they both?"

Giancarlo said they could be both. He referenced HODL and said that cryptocurrencies can be held onto as a store of value making it a commodity. If there is a derivative on this, the CFTC can regulate it and wishes to protect investors from fraud.

Senator Warren raised issues with the SEC blocking investor lawsuits referencing a Bloomberg article. Clayton responded by saying the issue will take a long time to address and has yet to see light. Warren came down hard:

"I'll tell you what, Chairman Clayton, I'm going to let you get away with that. Because what I'm reading is real skepticism about a rule like this. The SEC's mission is to protect investors, not throw them under the bus and I can't think of anything that would do more harm to investors than saying they have to pre-waive their rights to sue a company in a class action when that company cheats them."

Senator Perdue brought the issue back to cryptocurrencies and took Clayton/the SEC out of the spotlight for a moment, asking about arbitrage and if it applied to this market, referencing recent actions taken by China and South Korea. Clayton said that there certainly is regulatory arbitrage as it was a largely unregulated space across the world but said that it is beyond the understanding of the average investor. Giancarlo replied that there were two types of arbitrage occurring: price and regulatory. Perdue wanted to know what needed to be done to combat this. Giancarlo believes that the reason the price of cryptocurrencies is stabilizing is due to the SEC and CFTC cracking down on fraud. Perdue then continued the discussion with the pump and dump technique to which both Clayton and Giancarlo replied that investors were blind and more class actions were coming to protect them.

Senator Donnelly wanted to know what else the SEC and CFTC were doing to educate investors. Giancarlo announced a partnership between the CFTC and CFPB and the use of libraries to educate consumers as well as the CFTC's podcasts. Giancarlo went on to state that seniors were the most vulnerable and preyed upon across all marketing schemes. Donnelly then referenced a Washington Post article about hardworking Americans that invested in Bitcoin as a pension and asked:

"What would you say to them to help protect them from winding up in a situation a few years from now where it didn't quite work out the way they were hoping?"

Giancarlo responded:

"What I would say to them is, it's the same advice I'd give my children: if it sounds too good to be true, it is. If they're promising ridiculous returns, they're ridiculous. If you're going to give them money you better be prepared to lose it."

Clayton added, referring to cryptocurrencies as "disruptive technology":

"There are things like disruptive technologies that come along but they shouldn't disrupt the way you look at markets, for us, or the way that you look in investing. Pumping all of your money into a disruptive technology has a very high likelihood of not working out for you as an individual...there will be winners but there will be many losers."

Referring to a company's Prospectus or White Papers, Senator Kennedy alluded to the fact that no one reads them and asked:

"What's the point of all this over disclosure, if nobody's reading it? And why do we want to do the same thing with Bitcoin?"

Giancarlo said that adequacy of full disclosure is a foundation and that most people only study the Prospectus to know when to sue a company. Kennedy questioned how far we need to go to protect people from themselves and stressed that currently disclosure laws are only good for the financial advisors and lawyers, stating,

"I think we over-disclose."

He then referenced outlawing cryptocurrencies all together or just disclosing and going after the shysters. Clayton seemed unsure but definitely believed that investors needed to be protected especially in ICOs. Kennedy ultimately said that only more meaningful disclosure will be useful and that current laws being applied to cryptocurrencies would not suffice.

Senator Warner asked if cryptocurrencies would become so large in the future that it should become an Financial Stability Oversight Council (FSOC) issue and Clayton agreed that it was a systemic issue that may need greater oversight in the future. Warner also went on to question if all cryptoassets were a commodity/security and how they should be regulated to which Clayton did not truly address beyond ICOs, as he already had many times before.

Senator Cotton wanted to know the value of blockchain technology to companies and consumers. Giancarlo reported that it has enormous potential in the financial service industry as well as several others. He added that:

"Most importantly, the potential of distributed ledger technology for regulators to be able to do really close market surveillance and if it had been available in 2008, if we had been able to see the counter party credit exposure of one bank to another bank in real time with precision, that would have enabled much more precise policy choices that were had to be made in a rush with no real good data."

Clayton agreed that the potential was extraordinary and stated that:

"I hope people pursue it vigorously."

Senator Cotton then asked about the factors driving the extreme volatility of Bitcoin. Giancarlo said that in the commodity world, one is used to volatility and Bitcoin was not unique. Clayton stated:

"I don't really know what is driving the volatility in Bitcoin and cryptocurrencies...that's one of the issues before us, there does appear to be a lot of volatility there."

Clayton then went on to state that a highly volatile means of exchange is not a useful one and that a price needs to be agreed upon so that an investor knows what he/she is getting.

Senator Menendez wanted to know about the CFTC and SEC's role in foreign cryptocurrencies being created. Giancarlo said that they would not have authority but would on any fraud that may occur. Menendez was concerned with the manipulation of a foreign nation using a cryptocurrency to avoid U.S. sanctions, such as Russia. Menendez also wanted to know what the SEC can do to prevent celebrities and other high status personnel from persuading investors into participating in ICOs without fully understanding the risks, referencing previous actions taken by the Kardashians and Floyd Mayweather. Clayton said that the SEC has already issued statements which clearly define that taking on the promotion of ICOs subjects the person to securities laws.

Senator Moran raised issues about IT security and referred to the Modernizing Government Technology (MGT) Act encouraging the CFTC and SEC to protect themselves from a hack.

Senator Cortez was concerned with companies utilizing blockchain to pump their stocks referencing Kodak, Long Island Ice Tea and Burger King. Clayton said he put out a public warning that companies should not be doing this. Cortez also referenced Mt. Gox and other sites vulnerable to hacking and asked what buyers can do to get their money back if they are subject to a hack. Clayton replied:

"This is a very good point and one that we have emphasized in our investor alerts. If you engage in investing online with an offshore entity, the chances that we can do anything practical to get your money back, are very very low."

TLDR:

The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) met with the U.S. Senate Banking Committee to discuss what regulatory role each organization should have in regards to the exchange of cryptocurrencies and initial coin offerings (ICOs). Both the SEC and CFTC made it clear that blockchain technology was essential to the future and encouraged its use. Both mentioned that they did not have clear jurisdiction over the regulation of the cryptocurrency market and must reconvene to address seeking further authority from Congress. The SEC stated that it would protect investors from fraud via cracking down on ICOs while the CFTC stated it would continue to educate the public and work with the SEC to treat cryptocurrencies as both a security and a commodity, taking class action against the "fraudsters." The Senate had many concerns ranging from if cryptocurrencies should be banned or if the CFTC/SEC needed more regulatory power to what role they played in politics and international affairs.

The meeting ran for 2:11:51 and felt more like an introduction to the issue than a sentencing. The SEC and CFTC have agreed to get together to discuss what actions needed to be taken moving forward before reconvening with the Senate. It is unclear how further regulation may shape the cryptocurrency market but it was agreed that it was necessary for the future.

The Future:

The CFTC is set to meet with The U.S. Senate Committee on Agriculture, Nutrition, and Forestry on February 15 at 09:30 AM and can be watched live here.

In Closing:

If you enjoyed this post and would like to see more like them, please let me know. Please comment, up-vote and or resteem if this interests you as I am trying to discover my worth within this community and how I can best contribute to the interests of the people.

Best,
Christian