The lack of regulation is one of the most appealing aspects of cryptocurrencies. However, it is also an underlying risk that leaves crypto markets and investors vulnerable to fraud and other serious problems. Unsurprisingly, the Securities and Exchange Commission (SEC) and other regulators in the U.S. and internationally are taking tangible measures to regulate the crypto market.
Cryptocurrency regulation is a fierce debate with many supporters and challengers. There are many factors to consider, and it will make notable changes to how the crypto market works. It will also have benefits and disadvantages for investors and everyone else involved.
Here is a comprehensive guide on how the SEC is poised to regulate cryptocurrency markets. This guide will also discuss how regulation will impact the crypto markets and its benefits and disadvantages to investors.
The Need for Cryptocurrency Regulation
Several recent developments in the crypto markets have highlighted the need for regulation. The most notable is the collapse of FTX, one of the world’s largest crypto exchanges, and the revelation that its founder and CEO, Sam Bankman Fried, was involved in fraud.
Another notable development was the collapse of the stablecoin TerraUSD (UST), which wiped out more than $600 billion in value and triggered insolvencies. Other cryptocurrencies, altcoins, and stablecoins have also lost considerable value over the recent past and throughout the crypto market’s history.
Cryptocurrency investors have incurred significant losses during the crypto market’s turmoil. Fraudsters and other nefarious actors have also exploited the system for criminal purposes. Nevertheless, cryptocurrencies have proven that they are here to stay, despite the huge losses. Regulators and other stakeholders have proposed regulation as a way to bring stability and security to the crypto markets, and the wheels are already rolling.
Unsurprisingly, SEC chair Gary Gensler is on record saying the crypto exchanges and assets that don’t comply with SEC regulations are in breach of the law. The SEC is also cracking down on cryptocurrencies and exchanges. The most notable examples include the following:
- In October, the SEC charged and fined reality TV star Kim Kardashian $1.2 million for failing to disclose compensation she received from EthereumMax for promoting it.
- The regulator also charged Ian Balina for not disclosing compensation received from Sparkster for the unregistered sale of the crypto assets.
- It also charged The Hydrogen Technology Corp. in September for the manipulation and unregistered sale of crypto assets.
The SEC is also in an ongoing battle with Ripple (XRP). BlockFi Lending LLC also paid a $100 million settlement in February for failing to register its BlockFi Interest Accounts as securities. These are just some of the highlights of how the SEC is cracking down on the crypto market.
Is Cryptocurrency a Security?
The SEC’s plans to regulate cryptocurrencies are primarily based on the concept that cryptos qualify as securities. Securities are defined in broad detail under the Securities Act of 1933 and the Securities Exchange Act of 1934. They are also evaluated under the Howey Test, based on the 1946 Supreme Court ruling in the SEC v. W.J. Howey Co.
Under the Howey Test, an asset qualifies as a security if it meets the following requirements:
- Holders invest money.
- Investors expect to earn a profit.
- The investment is a common enterprise.
- Other people’s efforts result in profit generation.
Interestingly, most cryptocurrencies meet the four requirements listed above. For example, most people pay to buy Bitcoin expecting to profit from its hyped growth. Many cryptocurrencies’ growth is also based on projects launched and run by other people, making the generated profits a result of other people’s efforts.
The Potential Benefits of SEC Regulation
The most notable benefits of crypto regulation will include the following:
· Safety & Security
SEC chair Gensler has described cryptocurrency as the ‘Wild West’ of the finance industry. The crypto market is not subject to the standard regulations that apply to the conventional finance industry, making it vulnerable to various kinds of criminal and fraudulent actions.
Some of the common forms of fraud in the crypto market include front running, wash trading, scams, rug pulls, and market manipulation. The crypto market has experienced a steady rise in fraud. Scammers stole about $7.8 billion worth of cryptocurrencies in 2020. This figure doubled to about $14 billion in 2022, demonstrating scammers’ brazenness. Crypto regulations can help eliminate fraud, protecting crypto investors and other stakeholders.
· Greater Stability
The crypto market is inarguably the most volatile financial market. The sudden appreciation and depreciation of Bitcoin prices demonstrate this well – prices have dropped by thousands of dollars within 24 hours several times in the past. This is a double-edged sword – the few investors who can master the market’s volatility make profits, but most investors incur losses.
Crypto regulations can help bring stability to the crypto markets in several ways. Most notably, regulations can help eliminate speculation among buyers, effectively changing the current investors’ erratic buying and selling behavior. Stability can also help incentivize long-term investors to invest, expanding and further stabilizing the crypto markets.
· Investor Protection & Confidence
The crypto markets are not regulated. Some of the U.S.-based crypto exchanges willingly comply with the standard regulations, but they are not subject to formal regulation. This leaves crypto investors vulnerable to nefarious actors who know that they can get away with fraud.
Crypto regulations can help prevent this by securing all transactions and weeding out the criminal elements in the industry. Investor protection can also help inspire confidence among cautious investors, helping expand the crypto markets. The regulations can also motivate crypto founders to run better projects, further inspiring potential investors and driving innovation in the industry.
The Potential Downsides of SEC Regulation
Crypto regulations also have disadvantages for the crypto markets and all stakeholders, hence the fierce opposition against them. The most notable disadvantages include the following:
· Capital Flight
Many crypto investors are opposed to regulations. Regulations will bring radical changes to the markets with implications for everyone, including ordinary investors. This may scare off some investors, resulting in capital flight – however, this may be a short-term consequence, as regulations would also make the crypto markets appealing to other investors.
· Complicated User Experience
The crypto markets are easy to enter and navigate in their current form – investors simply find a crypto exchange platform, register, and start trading within minutes. However, this laxity is one of the reasons behind the runaway fraud plaguing the markets. Regulations will introduce strict rules governing how investors can trade, making the process and experience a bit complicated.
Notable Impacts of SEC Regulation on the Cryptocurrency Market
The current and future SEC regulations for cryptos will impact and change how the crypto markets and cryptocurrencies work and operate. Here is an overview of three of the most notable changes to expect:
· Regulation of New Tokens
Cryptocurrency coins and tokens are already facing regulation. New types of crypto assets, such as Non-Fungible Tokens (NFTs) and decentralized finance (DeFi), may also face regulation.
The SEC has been regulating cryptocurrency tokens and coins since the 2017 ICO boom. The regulator has fined many ICO issuers since then, and many have settled out of court. In 2017, the regulator issued an investigative report concluding that DAO tokens are investment securities. It also sued Ripple Labs Inc. in 2020 for violating securities laws by not complying with securities offerings disclosure and registration requirements when selling the XRP token.
The SEC is also turning its attention towards DeFi, NFTs, and other new types of blockchain tokens. In 2021, the regulator fined the founders of DeFi Money Market $125,000 each for selling unregistered tokens, and the company agreed to $12.8 million accrued from sales of its tokens. It has also subpoenaed NFT creators in its probe of these new blockchain tokens.
· Registration of Crypto Exchanges as Broker-Dealers
SEC chair Gensler recommended that cryptocurrency exchange platforms be registered and regulated as securities exchanges during a hearing before the Senate Banking Committee in 2021. He argued that these exchanges play similar roles as traditional securities exchanges. He also highlighted the theft of more than $14 billion worth of crypto assets in 2021 because of custodial issues at crypto exchanges. Many exchanges have also been accused of front running, freezing clients’ balances, and wash trading.
SEC regulations would require crypto exchanges to adopt and implement audit-compliant order books and technology systems. They would also impose strict order execution guidelines to prevent manipulation.
· Greater Scrutiny of Stablecoins
Stablecoins may also face greater scrutiny and regulation, especially after the steep declines in Terra (UST) and Tether (USDT) values. SEC chair Gensler voiced his concerns about stablecoins, questioning their stability. The SEC has not yet taken action against stablecoins, but the CFTC and the New York Attorney General have charged backers of Tether.
An Inevitable Outcome
Crypto regulations are inevitable in that crypto is here to stay. Significant changes are coming to the crypto industry, and it pays to be prepared. You can count on Crypto Signal Hub to inform you about the latest developments in the crypto industry and provide you with informed crypto signals.