U.S. regulators will be weighing whether to adopt new rules that could encompass cryptocurrency as experts say more enforcement actions are on the horizon.
It’s been a busy year for both the Commodity Futures Trading Commission and the Securities and Exchange Commission from charges against some of the biggest crypto exchanges including Binance, Kraken and Coinbase to contemplating rules that could rein in the industry.
The SEC hasn’t proposed crypto-centric rules, but it is weighing two rules that could see adoption in the new year. Meanwhile, the CFTC just voted in December to propose a rule that would bolster customer protections in the wake of the collapse of crypto exchange FTX.
The Block spoke with experts to break down what rules these agencies will likely hone in on in 2024.
The SEC’s focus
SEC Chair Gary Gensler has been consistent in his messaging that most cryptocurrencies are securities, while also calling on crypto exchanges to come in and register with the agency, despite industry pushback.
“On crypto broadly, a lot of general crypto does seem to follow in the gambit of the securities laws from the SEC’s perspective, so I don’t think there are a lot of new regulations coming from the SEC on that front,” said Tyler Gellasch, CEO of the investor-focused Healthy Markets Association. “I just think they’ll keep doing what they do, which is probably bring a lot of enforcement cases.”
The SEC could adopt two rules that it recently proposed — one that puts requirements on custodians and another that broadens the definition of an exchange to loop in decentralized exchanges.
“Both of those, I expect, in some form will be finalized. We will see how much they affect crypto as they’re finalized,” Gellasch said.
Upcoming elections as well make it particularly important for SEC Chair Gensler to finalize those rules, said Linda Jeng, a Web3 advisor for the Crypto Council for Innovation. Jeng also worked previously at the Federal Reserve Board of Governors, the SEC and the Treasury Department.
The SEC’s custody rule
The SEC voted in February to propose a rule that would require registered investment advisers to keep cryptocurrencies with a qualified custodian — and those custodians would have to abide by certain requirements.
Registered investment advisers are subject to a custody rule, which requires them to maintain those assets with a qualified custodian, such as a bank or broker-dealer. The rule, which had not been updated since 2009, could now encompass crypto. SEC Chair Gensler had also warned that depending on how crypto platforms operate, investment advisers cannot rely on them as qualified custodians.
There are not that many custodians who know how to custody digital assets, Jeng said. “So then you’re forcing… the industry to use custodians that probably don’t have the requisite expertise,” Jeng said. “And that’s a problem.”
The rule could also lead to concentration to only a few registered custodians, which could lead to systemic financial stability risks, Jeng said.
The SEC’s ATS rule
The SEC also proposed a rule in January 2022, which was reopened for comments in April, that broadens the definition of an exchange to capture decentralized exchanges. The rule could ultimately require decentralized projects to register with the agency as alternative trading systems.
Under ATS, DeFi projects would have to make regular filings with the SEC, be subject to mandatory disclosures and have strict limits on how they operate, said Healthy Markets’ Gellasch.
“The industry built and grew without regard to the securities laws, so if the SEC were to adopt rules that would make them have to comply, their ability to operate would likely go very low very quickly,” Gellasch said.
The rule would probably “destroy” decentralized exchanges, in part because the only way to comply would be to become centralized, said the Crypto Councils’ Jeng.
CFTC’s latest rule proposal
A little more than a year after the collapse of the FTX crypto exchange, the CFTC voted to propose a rule in December that would bolster customer protections for those making trades through a derivatives clearing organization.
The rule, called the “Protection of clearing member funds held by derivatives clearing organizations,” would require DCOs, which are registered with the agency and clear trades, to segregate out customer funds, including money from retail investors, from their own house funds.
The agency may want to focus on the spot markets in the new year, Gellasch said.
“From the CFTC, there is quite a bit they might want to do, most notably focusing on how much they can get access to the spot markets,” Gellasch said.
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