Chairman of the US SEC: Encrypted businesses are often non-compliant and full of opacity and risks

During a question-and-answer session at the Federal Reserve Bank of Atlanta's 27th Annual Financial Markets Conference yesterday, when asked about the SEC's controversies with Coinbase and the regulation of cryptocurrencies in general, SEC Chairman Gensler commented on the entire crypto economy. The legal situation in China gives a pessimistic assessment:

●Their business models, often built on non-compliance, built on client money, mixed it up, full of conflicts.

●In contrast, the SEC will never let the NYSE operate like a crypto platform, an exchange may trade its own ledger on its own platform, act as a market maker or hedge fund, or borrow its own token without publicly disclosing what it does.

● Gensler also noted that three of the last four U.S. bank failures had “substantial exposure to cryptocurrencies,” a comment intended to highlight the potential for “financial market risk” as the worlds of traditional finance and crypto become more closely linked bigger.

On Coinbase and the “generally non-compliant” crypto market

The conference kicked off with a presentation on the SEC's role in preventing systemic contagion in traditional banking. When talking about digital banking, Gensler said: "I'm not talking about a generally non-compliant crypto market."

Then, Tom Barkin, president and CEO of the Federal Reserve Bank of Richmond, asked him to comment on the controversy with Coinbase. The SEC has issued a Wells Notice to Coinbase (possibly based on suspicions that Coinbase may be marketing unregistered securities), and in response, Coinbase has sued the agency in an attempt to force it to create new rules for the cryptocurrency industry.

Barkin: "Why is the SEC reluctant to issue rules for this market?"

“Because the rules have been issued, and to be clear, this is an area where most of the operations are not compliant. Our agency has issued guidelines on how exchanges, broker-dealers, custody advisors and how to register securities offerings rules. Those rules already exist, and new technology doesn’t make them inconsistent with public policy established by Congress.”

'They're full of conflict'

“We have reviewed the intermediaries in the middle,” he said. “Financial intermediaries act as nodes in this, and if they have securities on their platform, then they need to comply with compliance requirements.”

“We stand ready to help those intermediaries achieve compliance. But I must say that their business model is often built on non-compliance. Their business model tends to pool client funds and there are many conflicts of interest issues. Tom, If the NYSE were a market maker, hedge funds operating directly on the exchange and conflating all of these things and raising capital through tokens, leverage and borrowing without public disclosure in a proper manner, we would absolutely not Allowed. The only thing we require in terms of tokens is registration and full, fair and truthful disclosure, and intermediaries need to be registered. Deal with conflicts of interest and make sure they have time-tested anti-fraud and anti-manipulation aspects the rule of."

Gensler then elaborated on the SEC's philosophy on how securities regulation relates to cryptocurrencies, summarizing a legal principle known as the Howey test. "If the public invests money in the expectation of profiting in a common enterprise by the efforts of others, that is a security, an investment contract."

"We don't know who Satoshi Nakamoto is yet"

He also spoke extensively about the disconnect between crypto-natives and how governments view their industry, arguing that most “decentralized” platforms or protocols are actually centralized in some way around a small number of operators.

“We still don’t know who Satoshi Nakamoto is, she, he, or they? This is a field built on the concept of not using centralization, even though finance has tended to be centralized since ancient times. Decentralization requires a lack of authority, anti-commercial banks, anti-central banks, and an off-grid approach on a global scale. However, when they fail and go to bankruptcy court, it is very dependent on the law. You know what we saw.”

"But there's an area emerging where the investing public is investing 24/7, globally -- and it's not just the U.S. market but mostly international markets -- investing their hard-earned money in the hope of something better. The future, and that's what securities are at their core...to say that these things are very decentralized is a false statement, they tend to be centralized."

“The last three bank failures in the U.S. have been linked to cryptocurrencies”

Towards the end of his talk, Gensler spoke about the growing connection between cryptocurrencies and traditional finance, against the backdrop of considering whether there could be a "fire" in a potentially out-of-control space.

The collapses of First Republic Bank, Silicon Valley Bank and Signature Bank were the second, third and fourth largest bank failures in U.S. history. Another smaller bank, Silvergate, also went bankrupt. SVB, Signature, and Silvergate all have substantial exposure to crypto clients and assets.

“The recent bank problems, where two of the four failed banks had significant cryptocurrency businesses, one of which was also a stablecoin issuer put their deposits into the account, and caused the stablecoin USDC to briefly de-anchor. So at least there are 3 of these banks are somewhat interconnected in the cryptocurrency market and crypto players,” Gensler said.