Even after the FTX scandal, Washington is bamboozled over how to regulate crypto

Confusion and finger-pointing about regulating cryptocurrency far predate the fall of FTX. Cryptocurrency has existed for over a decade, and Washington remains at a loss over how to regulate the industry, which at its peak last year was valued at $3 trillion. Bankman-Fried is scheduled to testify in front of Congress on Tuesday about his company’s failure, but don’t expect Congress to leap to action with new remedies for the crypto industry’s ills.

Washington hasn’t passed new laws or issued new rules guiding cryptocurrency since the industry started a decade ago, frustrating both consumer advocates who say new rules would help protect investors and cryptocurrency companies themselves. And it isn’t getting much closer, lobbyists and industry officials told Grid: Despite widespread calls for change that followed FTX’s dramatic November downfall, Congress and federal regulators are at a series of impasses that are unlikely to get resolved any time soon.

Cryptocurrency has become mired in a series of policymaking problems that are in many ways endemic to Washington. There are turf wars between federal agencies and committees, confusion among lawmakers over how digital currency works and myopic debates over how cryptocurrency should fit into the broader financial system.

Ultimately, everyone seems to be outwardly jockeying to take control of the cryptocurrency debate, but no one wants to take the wrong step and take responsibility for the next blowup like that at FTX, said Joseph Hall, an attorney and former SEC official who advises cryptocurrency companies.

“Every time there’s a scandal, the SEC gets hauled up in front of Congress and excoriated,” Hall said. “If you decide that what you’re going to do is create a brand new regulatory scheme for crypto, then the inevitable scandal occurs, you’re going to be roasted on a spit.”

Hall said he doesn’t blame the SEC. “Where the buck stops is with Congress,” he said. “Anyone could have predicted that there would have been a scandal. There’s always scandals in the financial services world. And shame on Congress for not getting ahead of this.”

Cryptocurrency’s problems are only compounded by lawmakers’ general confusion about the industry. While some lawmakers and regulators have embraced cryptocurrency and even independently invested in it, many either don’t have a great understanding of what the industry is or plead ignorance.

“This asset class is rife with fraud, scams and abuses in certain applications,” SEC Chairman Gary Gensler said last year. “There’s a great deal of hype and spin about how crypto assets work.”

Who’s in charge here?

Much debate over cryptocurrency revolves around whether it should be treated as a security (like stocks) or a commodity (like oil futures). The answer to that question determines which congressional committees must pass laws about cryptocurrency, which government agencies will oversee it and which investor protections will be set up for consumers.

For example, if a cryptocurrency is regulated like a stock, then it would fall under the purview of the Securities and Exchange Commission. And the SEC requires companies under its purview to file detailed public disclosures for investors.

Financial disclosures could give significant new information to investors and penalize companies that misrepresent their finances, adding a valuable layer of protection. But right now, it’s nearly impossible for a digital currency to register with the SEC, cryptocurrency companies say. Though the SEC has publicly said it has authority over cryptocurrency, it hasn’t issued new rules modifying its existing financial regulations for digital assets, instead asking cryptocurrency companies to fit themselves into the existing framework for stocks. Cryptocurrency companies say the SEC’s current rule book is impossible to use for their business and have largely avoided registering their products as securities, so they don’t file disclosures like 10-K reports that public companies do.

The alternative to SEC regulation is to treat all or some of cryptocurrency like a commodity, like futures that are traded under the purview of a different federal agency, the Commodity Futures Trading Commission. The CFTC is a smaller agency with less stringent regulations. Many people who work for cryptocurrency companies assert their products are more similar to commodities than stocks, and thus are a better fit for the CFTC.

Just like the SEC, the CFTC has asserted that cryptocurrency should be under its purview. “The CFTC’s expertise and experience make it the right regulator for the digital asset commodity market,” the agency’s chairman, Rostin Behnam, told congressional lawmakers in September.

Behnam told Congress that his agency was preparing to become the main regulator of cryptocurrency, in anticipation of lawmakers passing a bill giving it authority. For both agencies, getting a nod from Congress could lead to bigger budgets and more employees to enforce the law.

“We need clarity,” said Jarrod Loadholt, partner at the law and lobbying firm Ice Miller and former counsel for the House Committee on Financial Services. “Where does the CFTC’s jurisdiction begin and end versus the SEC? There is a gray area in the law because the tests that are used to determine that something’s a commodity versus a security are dated, and they did not envision a world of blockchain and digital assets.”

It’s not clear Congress will bite. Lawmakers are also stuck in their own turf wars that mirror the one at play between the SEC and the CFTC. Commodities and securities are regulated by different committees, so there are multiple lawmakers who could take the lead on drafting cryptocurrency legislation. Right now, both the Senate Agriculture Committee and the Senate Banking Committee have indicated they plan to play a role.

While the Senate Agriculture Committee worked closely with Bankman-Fried to develop a bill that was widely seen as a leading contender to pass Congress, in the wake of the FTX collapse, the chairman of a different committee, the Senate Banking Committee’s Sherrod Brown (D-Ohio), said the bill put out by the Agriculture Committee has “too much lean to the crypto industry.” Brown, a proponent for stricter regulation for cryptocurrency housed under the SEC, said he plans to be more aggressive during the next Congress on the issue.

Hot potato problem

Lawmakers and regulators are sparring over who gets to regulate cryptocurrency. But whoever regulates cryptocurrency will also likely take blame for industry problems in the future — a little-discussed reality that’s slowed progress and sewn hesitancy across Washington.

Congress first held a hearing on cryptocurrency regulation in 2013, and the Obama administration held meetings with cryptocurrency industry leaders that year. In 2014, New York state released its first proposed rules for how cryptocurrency companies need to register with the state.

Nearly a decade later, Congress hasn’t voted on a bill to regulate the cryptocurrency industry. The SEC or the CFTC could propose their own rules that give cryptocurrency companies clear, reasonable ways to register their digital assets — but those, too, have not arrived, despite both agencies’ plans to become more involved in cryptocurrency.

“People just don’t want to make the wrong move or make a mistake. It’s a new technology. Trying to understand it and trying to figure out how it fits into the securities laws hasn’t been easy,” said Keith Miller, a former SEC enforcement lawyer who is representing the blockchain startup LBRY in a high-profile digital asset court case against the SEC. “For that reason, I think the commissioners have always taken a very conservative approach, and hence what we’ve seen is regulation through enforcement.”

The court system is increasingly playing its own role. Both the LBRY case and another attention-grabbing suit filed by the SEC against the company Ripple Labs could set precedent around what crypto offerings are, and aren’t, securities. The SEC alleges that Ripple misled investors by not registering a digital token with the SEC.

If the SEC wins either case, it could push more cryptocurrency offerings to register their offerings as securities with the agency. Industry experts argue that following the SEC’s existing rules is virtually impossible, and new rules or legislation is needed.

How companies makes sense of the mess

If Washington can’t act on cryptocurrency, then companies will increasingly take their cues on what is legal and not by watching who the SEC investigates, how judges are ruling and what public officials, like Gensler and President Joe Biden, say about the industry. It’s not an ideal way to do policy — but with Congress returning to divided control next year and lawmakers at odds over how to proceed, it might be the only option.

Ultimately, a lack of action from Washington on cryptocurrency could not only harm investors in the short term but also damage the industry’s bottom line. The more the cryptocurrency industry gains a reputation for bad actors and losing investor money, the more investors will take their money elsewhere.

“The reality is at some point, when there’s not really clear regulatory standards, you may see some folks take liberties that ultimately cause them to lose their shirts,” Loadholt said. “I think if anything, you could see trust in the marketplace spiral. Consumers could say, ‘You know what, I’m taking my money out of this stuff.’”