The Securities and Exchange Commission (SEC) is planning a series of changes that could aggressively step up its regulation of the cryptocurrency industry, most notably in the oversight and functioning of both centralized and decentralized exchanges.
In a speech at the University of Pennsylvania’s law school Monday (April 4), SEC Chairman Gary Gensler cited the need to offer greater investor protections on “crypto asset platforms, which have millions and sometimes tens of millions of retail customers directly buying and selling on the platform without going through a broker.”
The commission, he announced, is planning to regulate both centralized and decentralized exchanges involved in trading or lending cryptocurrencies by requiring them to register with the agency.
See also: Gensler: SEC Is Coming for Crypto Exchanges
The SEC chairman also suggested that he’s heard the central message of President Biden’s executive order on the regulation of cryptocurrency: The various competing government agencies must work together to come up with a common regulatory framework for digital assets.
Gensler revealed that he has ordered his agency to make peace with the Commodity Futures Trading Commission (CFTC), which the SEC has been at odds with for the past six months over whether cryptocurrencies are securities or commodities.
Share and Share Alike
The two regulatory agencies with a strong case for control of the cryptocurrency business have been disputing the question for years. Gensler, like his predecessor Jay Clayton, argues that virtually all “crypto tokens are investment contracts” as defined under the law.
However, in his speech on Monday, Gensler said something that just might mark a sea change in the SEC’s outlook on the matter.
“Crypto platforms currently list both crypto commodity tokens and crypto security tokens,” he said, “including crypto tokens that are investment contracts and/or notes.”
As a result of this, Gensler said that he’d asked the SEC staff to figure out how “we jointly might address such platforms that might trade both crypto-based security tokens and some commodity tokens, using our respective authorities.”
By and large, Gensler’s SEC has had the upper hand in the battle for control of crypto: It can, and frequently does, take enforcement actions against cryptocurrency issuers and exchanges for illegally selling unregistered securities. It recently expanded that to include crypto lending programs, forcing BlockFi to cough up a $100 million settlement over its lending offering.
Related: BlockFi’s $100 Million Settlement With SEC Raises Internal Discussion
The CFTC doesn’t really have reason to do that if a cryptocurrency is a commodity token — so the SEC, by dint of what the crypto industry lambasts as “regulation by enforcement,” is setting precedents — although none have yet been tested in court.
Last month, CFTC Chairman Rostin Behnam made an aggressive pitch for more crypto authority in front of a clearly supportive Senate Agricultural Committee, pointing to what he said is a “noticeable gap” in the law about “what constitutes a security and what constitutes a commodity.”
Read more: At Senate Hearing, CFTC Chair Behnam Steps Up Battle With SEC for Crypto Oversight
Behnam also requested more resources to build an enforcement and oversight division.
Real Control
On the other hand, by seeking control of crypto exchanges, Gensler would make the CFTC a de facto junior partner, at best.
As far as registering and regulating exchanges, Gensler suggested that this might not be too hard to accomplish, noting that the top five crypto-only trading platforms account for 99% of the market. He added that the top five exchanges with crypto-to-fiat on- and off-ramping account for 80% of the market, and the top five decentralized exchanges (DEXs) also account for 80% of that market’s activity.
Two changes could have a substantial impact on the way cryptocurrency is bought and sold. First, the SEC is looking at forcing exchanges to separate custody of crypto assets — something virtually all do through “hosted” wallets.
But with more than $14 billion stolen last year, Gensler said that the SEC is looking at how “best ensure the protection of customers’ assets, in particular, whether it would be appropriate to segregate out custody.”
Second, Gensler said the agency was considering ordering both lending and trading exchanges to “segregate out market-making functions” — something that could have a profound impact on decentralized finance (DeFi). DEXs function via automated market makers, generally called AMMs.
AMMs substitute pools of investors who lock cryptocurrency into lending pools that provide the liquidity that traditional exchanges bring via market making firms. It isn’t clear if Gensler was specifically including DeFi AMMs in that proposal, but it would be difficult to operate DEXs without them.
See also: PYMNTS DeFi Series: What is Yield Farming and Liquidity Mining?
Those AMM liquidity pools are also a primary source of DeFi investments, in the form of liquidity mining.
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