The cryptocurrency industry has a difficult challenge ahead of it in the coming years: demonstrate legitimacy both to potential investors and regulators who are increasingly skeptical of the nascent technology.
It’s a tremendous burden of proof to bear, but one that those in the industry have understood since inception.
But while regulatory bodies have treated cryptocurrencies with caution, recent comments made in a meeting last week at the Security and Exchange Commissions’ (SEC) Investor Advisory Committee (IAC) seem to have shifted the tone from “skepticism” to “hostility.”
Should you be worried? Let’s take a look at those comments in context.
‘Everything Is Different’
In the meeting, Damon Silvers, director of policy at the American Federation of Labor and Congress of Industrial Organizations, had some harsh words for the cryptocurrency industry.
“As somebody who’s been around financial bubbles a [long time], my ‘alarmo-meter’ is at DEFCON 5,” said Silvers. “My sense is that most of the conversation that goes on around this is essentially designed to obscure. [It] uses big ideas and technical jargon to evade fundamental questions that should be asked in this institution about any investment product,” he said.
“I’m deeply, deeply frustrated with a conversation that appears to be designed to evade the law in the context of what appears to be obviously a bubble.”
Created in 2010 after the passing of the Dodd-Frank Act, the IAC was assembled in order to advise the SEC on matters of regulatory priorities, marketplace integrity, and investor protection.
The committee of regulators, investors and academics has recently turned its focus on cryptocurrencies and the technology continues to grow in availability and popularity.
Last week’s meeting signals a growing skepticism within the IAC that is manifesting as hostility publicly.
“Can I suggest something to you? People who come in suggesting that ‘everything is different’ [while] marketing investment contracts tend to end up looking rather badly,” Silvers said to Adam Ludwin, the CEO of the blockchain startup, Chain, in his most pointed of these comments.
The SEC’s Growing Skepticism
The SEC, unsurprisingly, shares the IAC’s skepticism. Commissioner Kara Stein said, “These investments are seen as cutting-edge opportunities for individual investors, but these investments may not be suitable for all investors because they carry such significant risk.”
But as harsh as they were, Silvers’ words represent a lengthening, broadening, and deeply skeptical SEC that has become much more hostile in its public comments on cryptocurrencies in recent months. Investors worry this growing skepticism is a signal that working with the regulatory agency is going to slowly become an uphill battle – if it hasn’t already.
Earlier this year, media began to take notice that the hottest trends in cryptocurrencies had finally caught the attention of the largest financial regulator in the world.
Last March, the SEC denied the application for the Winklevoss Bitcoin Trust ETF, in what was then considered a massive blow to its founders, the somewhat infamous Winklevoss Twins.
In the SEC’s statement, the commission found that the proposed fund was too susceptible to fraud simply due to the unregulated nature of bitcoin and cryptocurrencies like it. The Verge reported that the result was “a major setback for the fund” and a “frustrating false start for the crypto-currency at large.”
A few months later in July, the SEC published a scathing report advising that ICOs, or token sales, are subject to securities laws. The report concluded that a certain multimillion-dollar ICO last year violated securities law.
The report specifically analyzed the Decentralized Autonomous Organization’s (DAO) ICO in 2016, concluding that the DAO tokens are securities.
According to The Verge, the DAO has been described as “a new sort of venture capital fund that works without the need for human administrators.”
“According to the SEC, the DAO violated section 5 of the Securities Act by failing to register with the Commission. The SEC has declined to pursue an enforcement action against the DAO or Slock.it (a German startup that the SEC credits with ‘creating’ the DAO), but does not explain why in either its report or press release.” The press release cautions “market participants” about ICOs in general, suggesting that the Commission is keeping a suspicious eye on this space.
New York-based money manager VanEck had filed to create the VanEck Vectors Bitcoin Strategy ETF in August, stating it would “be used to invest in “U.S. exchange-traded bitcoin-linked derivative instruments…and pooled investment vehicles and exchange-traded products that provide exposure to bitcoin.”
But in a new letter addressed to the SEC’s Division of Investment Management, VanEck legal team alleged that “officials at the agency [wouldn’t] consider reviewing the firm’s request because of the nascent state of the derivatives market for cryptocurrencies like bitcoin.” VanEck then sought to pull back the filings it made that month.
According to The Verge, “Four years after the Department of the Treasury’s Financial Crimes Enforcement Network released its first guidance on bitcoin, the federal government is still struggling to keep up with the rapid evolution of cryptocurrency. Tuesday’s report comes a year after the DAO’s token sale, but it’s arriving just in time to cast a chill on the craze around ICOs.”
A New Cyber Unit
This report, coupled with the SEC’s growing public admonishment, is just one prong in its growing willingness to take down certain actors within the cryptocurrency industry. And that has many cryptocurrency investors worried; last month SEC created its own internal task force—the Cyber Unit—to deal with digital currency trading.
And the Cyber Unit are no amateurs. Its chief, Robert Cohen, led the SEC’s Market Abuse Unit for the past two years.
News about the Cyber Unit came less than a week after the SEC disclosed to the public that its own database of corporate filings had been hacked even though the SEC’s Cyber Unit had “been in the planning stages for months.”
The SEC announced that same week it had created a retail strategy task force that will “develop proactive, targeted initiatives to identify misconduct impacting retail investors.” And while this task force is not said to be targeting cryptocurrency companies specifically, the SEC did say that the new team will “apply the lessons learned from [past securities fraud] cases and leverage data analytics and technology to identify large-scale misconduct affecting retail investors.”
These actions from the SEC simply reveal that the regulatory organization is unimpressed with many of the tech-driven arguments that ICOs can transform traditional investing. Those in the cryptocurrency game worry that this skepticism is already starting to have an adverse impact on investor confidence in the new technology.
That’s a lot to parse, and if growing skepticism and hostility to the cryptocurrency industry alarms you, you’re certainly not alone. Still, with any new technology and the complexity of financial regulation in general, none of this comes as a huge surprise.
Here are some key things to consider about how these regulatory bodies do things, and what all of this news means for you.
Yes, regulators are likely to continue building tasks forces and other cases against cryptocurrency companies (we called the SEC’s “cease and desist” letter campaign, the first arrow in their quiver). But the evolution of the SEC’d regulatory practices concerning cryptocurrencies is likely to be glacial in pace; different rules for startups and registration will likely create double standards within the industry until solid regulations are implemented.
Time is on the side of the cryptocurrency industry to evolve. Those in the SEC will remain skeptical of cryptocurrencies unless the industry itself can prove legitimacy, which will be the primary challenge of the industry in the coming years.
Other companies do this by participating in trade unions or industry-specific organization that seek to educate both the public and industry regulators on best practices, lessons learned, and the future of the industry itself. It’s all to be expected with the growth of a new industry. Call it growing pains.