Approval of the ETF encryption market will usher in the era of strong supervision by the US SEC?
On September 7, 2021, without giving any explanation, the SEC issued a litigation warning against Coinbase’s loan product Lend, stating that it has been identified as a securities investment contract, which means that this product must go through the securities approval process.
Brian , the founder of Coinbase, was completely angry and sent a “soul question” to the SEC through “21 Questions” on Twitter. The SEC’s rapid and unrelenting action reminds people of the stern investigation of the DAO initiated by the SEC in 2017 on the identification of DAO as a security.
But it is undeniable that the SEC’s determination to vigorously strengthen supervision is evident. At the same time, it is reported that just today, ETF issuer Volt Equity’s crypto industry ETF was approved by the SEC and will be listed on the New York Stock Exchange.
To this end, in this article, we mainly focus on the SEC’s supervision of the Token market.
Regulators of the U.S. Token market:
SEC, CFTC, IRS, FinCEN
The US regulatory system is composed of the state and the federal, generally speaking, they are equal and independent of each other. Today, we will focus on popularizing science with the main regulators at the federal level.
1. The United States Securities and Exchange Commission (SEC)
The SEC is the highest regulatory authority in the U.S. securities industry, with legislative powers, judicial powers, and independent law enforcement powers.
The issuance and circulation of securities products defined in the Securities Exchange Act of 1934, such as stocks, bonds, debt instruments, and other investment contracts, fall under the supervision of the SEC.
2. Commodity Futures Trading Commission (CFTC)
The scope of the CFTC is mainly for the U.S. commodity futures, options, and financial futures options markets. It is responsible for protecting the public and market participants from related fraud. At the same time, it passes legislation to ensure the openness, competitiveness and financial reliability of the futures and options markets.
The functions jointly formed by the SEC and CFTC are equivalent to the domestic securities regulatory commission and are also the main department for overseeing the crypto market.
3. Internal Revenue Service (IRS)
The IRS mainly supervises the crypto market from the perspective of tax policy. On the issue of how to characterize the attributes of encrypted assets, the IRS classifies them as broad property, which means that the tax provisions for property are also applicable to crypto asset transactions. The main consideration of IRS is to prevent taxpayers from evading tax liability through encrypted assets.
Therefore, the IRS has the right to require individuals and institutions to file tax returns on encrypted asset transactions, and from time to time requires trading platforms or individuals to provide transaction information for encrypted accounts.
4. Financial Crime Enforcement Network Agency (FinCEN)
The issues that FinCEN targets are mainly about anti-money laundering, preventing illegal transactions and preventing the financing of terrorist activities. Its law enforcement is based on the “Bank Secrecy Law”. In terms of the qualitative nature of encrypted asset service providers, FinCEN believes that they are fund transfer intermediaries in the capital service business chain and therefore need to be included in supervision.
According to the “Bank Secrecy Act”, the most basic regulatory requirements are: within 24 hours, for a one-time cash transaction, or the total amount of related transactions exceeds 10,000 US dollars, the institution needs to be licensed and declare the transaction.
SEC’s regulatory changes on the crypto marketIssuance
financing, trading, borrowing, derivatives, platforms
1. Issuance financing
The SEC does not supervise all financing activities. In most cases, it only needs to be registered with the SEC to operate. Looking at all the links in the life cycle of the securities market, the SEC sees most closely the compliance of the issuance and financing phase.
Since 2014, when it comes to Token financing in the United States or for U.S. residents, project parties and all service providers need to obtain SEC approval or registration, otherwise they will have to bear huge fines.
As of September this year, the SEC has issued more than 12 fines, mainly for non-compliant Token financing and fraudulent projects.
The SEC’s review and punishment of “unlicensed operations” and “fake projects” has never been relaxed, because the crypto market is changing too fast, investors may not have sufficient knowledge reserves and judgment, and regulators must perform better to protect market order. Responsibilities.
There are many standards for the SEC to intervene in supervision, but once a “securities” investment contract is involved, it must be included in the scope of the securities law. Therefore, after 2018, centralized trading platforms must comply with strict license regulations and compliance requirements in order to provide trading services.
Moreover, the trading platform must have strict KYC regulations and practical KYC implementation plans, and the review of customer identities and sources of funds must be strictly implemented.
Not long ago, the new chairman of the SEC said that crypto asset custody service providers and trading platforms should pay attention, because acts that may soon provide loan and pledge services may need to be regulated by the US Securities Law, and regulators are formulating targeted regulatory rules.
The main basis of the SEC is the securities law, because the mortgage and return pledge contracts are close to the creditor’s rights agreement and can be included in the scope of supervision. The decentralized loan market is extremely active in 2020, with a loan scale approaching US$3.7 billion, which has attracted the attention of the Financial Action Task Force (FATF), including the Anti-Money Laundering Financial Action Task Force (FATF), and is advancing the comprehensive KYC supervision of users participating in Defi transactions.
The current trend is that the SEC is gradually focusing its supervision on the platform. In the crypto market ecological chain, the role of the platform is very critical, because this is the entrance for most investors to participate in market transactions. Therefore, both the SEC and state-level regulatory agencies have been strengthening the compliance review of the platform.
Therefore, even though it is the top centralized trading platform globally, Coinbase has always been a key regulatory object of the SEC . In fact, nearly half of the fines issued by the SEC this year for the crypto market were unregistered platforms or traded unregistered securities tokens.
SEC’s regulatory purposes
systemic risks, off-balance sheet liabilities, unknown risks
1. Beware of systemic risks in outbreaks
Recently, the new chairman of the SEC talked about the Evergrande debt incident in an interview. Perhaps it was stimulated by this incident, or because he did not want to repeat the 2008 financial crisis. The SEC is intentionally or unintentionally strengthening the supervision of listed companies. This explains why Coinbase was suddenly launched a “lawsuit warning.”
The warning is sudden, but the logic is correct, because Coinbase is already a listed company, and it is expected that the launch of crypto-asset-based loan products will inevitably face stricter approvals.
Coinbase Lend is an encrypted asset loan product. Considering the huge number of Coinbase users, the SEC is worried that if the Token market collapses, a wide range of investors will be implicated.
Therefore, the SEC is concerned about whether this product should be classified as a securities product, and if it is, it must be registered. Although Lend is more like a savings product, it is clear that the SEC insists on classifying it as a securities investment.
In fact, many financial institutions provide similar financial products, such as Square and Fidelitys Fidelity Investment. They all comply with the requirements and register with the SEC or obtain permission.
2. Beware of the surge in off-balance sheet liabilities caused by the encryption business of listed companies
Excessively high debt ratios of listed companies will increase the risk of bankruptcy and liquidation, especially convertible bonds, which are often overlooked. From this, it can be inferred that the next key regulatory object of the SEC is likely to be MicroStrategy (MS).
MS raised huge debts to buy BTC . Although convertible bonds were used, they were still interest-bearing liabilities of the company before the creditors were formally converted into shares, so it also increased the debt burden of the company. Therefore, it was immediately downgraded by the rating agency. .
MS indirectly triggered a wave of BTC buying by global listed companies. Today, about 25 listed companies hold BTC, most of which are US companies. Of course, the SEC cannot ignore it. The purpose of the SEC is to protect investors.
If other listed companies follow the example of MS, if BTC depreciates sharply, companies will have to redeem the bonds in full, which will bring immediate and huge cash outflow pressure. This is something investors and the SEC can’t imagine.
3. Unknown risks: leverage, data fraud, asset safety
The SEC often has puzzling regulatory measures, which are mainly aimed at potential unknown risks in the crypto market. These unknown risks are closely related to technology, and it is difficult to achieve supervision by rules and regulations alone, which is a huge challenge to supervision.
Because the crypto market is different from the traditional financial ecology, such as the project subject is not clear, the location of the operating agency is difficult to define, the trading platform plugging problem, and so on. The rapid development of this field makes it easy for regulators to fall into a state of little understanding. Therefore, in terms of supervision, it is necessary to follow the existing legal framework and to conduct experimental supervision attempts.
The risk of leveraged trading is mainly concentrated on the trading platform, especially the forward contract transactions. The number of participants far exceeds that of spot transactions, because it can create profitability regardless of the ups and downs. The higher the leverage, it stimulates price fluctuations.
Some factors outside the rules can easily lead to infinitely magnified trading gains or losses. For example, the platform system has a “fault”, or the system has set transaction restrictions and so on. The appearance of these factors is very likely to cause users to be unable to stop loss reasonably. And trading platforms or platforms often have sufficient reasons to exclude their own responsibilities. These problems have given the SEC a great headache.
- Information asymmetry
Another issue that the SEC has been trying to solve is the information disclosure issue of encryption service providers. Take the trading platform as an example. Regarding the actual situation of assets, there is asymmetric information between users and the trading platform.
Generally speaking, after recharging, the user’s Token will be concentrated in the dedicated address of the trading platform, and the assets will be transferred to the user’s address only when “withdrawing”. All transaction behaviors of the user will not cause the actual transfer of Token, and are only recorded in the server of the trading platform.
In other words, in case the trading platform transfers funds to another address, the user does not know. The greater risk comes from service providers’ use of customer assets for price manipulation and other behaviors. Therefore, the SEC and regulatory agencies in many countries require service providers to provide sufficient evidence to prove that they have rules and systems to ensure the transparency of information.
- Asset safety
The SEC’s supervision mainly focuses on investor protection. For the traditional securities industry market, there is no major asset safety issue. But for digital assets, there is no absolutely safe custody mechanism. Because of the centralized asset custody scheme and the decentralized network protocol, both have a large number of cases of user assets being transferred or network theft.
When the encrypted assets are not completely isolated from the network through the cold wallet, they will be exposed to the chain. If the centralized organization has moral problems or the platform is hacked, the assets are at risk of loss.
Therefore, before the SEC and other regulatory agencies approve the qualifications of operators, they will evaluate their strength and willingness for asset security protection. On the one hand, they are concerned about whether they have complete processes and technical support, and on the other hand, they are concerned about their capital adequacy.
These factors together constitute a relatively large unknown risk, which is the key research direction of regulatory agencies.
Those cases challenged by the SEC:
Libra , Ripple, Coinbase
1. Libra: Never get the “Like” of the SEC
The launch of Libra started in 2019 and has not yet been approved for issuance. Facebook can only reluctantly change its name to Diem and reformulate its electronic cash issuance plan. In fact, the SEC has always maintained a prudential attitude towards stablecoins anchored to fiat currencies, and the new SEC chairman has recently reiterated his remarks on strengthening the supervision of stablecoins.
In fact, the SEC’s prudence is not unreasonable. As early as 2017, there was widespread doubt that TEDA did not have a US dollar reserve equivalent to the USDT issuance.
If the stable currency anchored to the US dollar appears to be falsified, it may be a potential risk for the huge US dollar economy. Therefore, with regard to stablecoins, perhaps a better form is a CBDC endorsed by regulatory authorities or national credit.
2. Ripple: Seven years later, the SEC filed a lawsuit
Since December last year, the SEC filed a lawsuit against Ripple. The SEC believes that Ripple’s issuance of XRP is not registered in accordance with the Securities Law, while Ripple believes that XRP is not a security, but a digital commodity, just like BTC and ETH. Same.
Although RippleToken has been on the market for about 8 years, it still needs to face the new requirements of regulation. Regardless of the final result, XRP’s market reputation has been greatly affected, and more than 50 trading platforms have removed XRP trading pairs.
3. Coinbase: None of the income products are spared?
Regarding Coinbase’s previous warnings, the SEC believes that it may have false statements, so it requires the provision of information about all investors in order to further understand the truth of the matter. However, Coinbase disagreed and believed that investor information was not related to whether the product was approved. In addition, Coinbase also opposed the SEC’s use of the Howe test as a standard for qualitative securities, and failed to keep up with the times.
Investigating through information disclosure is the SEC’s normal practice. In 2018, the SEC required nearly 80 projects to provide information on all investors, as well as consulting companies and firms participating in the issuance. Therefore, although the SEC’s approach seems to overturn all previous communications with Coinbase, it may be a signal that a substantial problem has been investigated.
In 2019, at the kick-off meeting of the Block Technology Research Award Program led by Tsinghua University, some scholars asked Professor Xu Wei of the Institute of Interdisciplinary Information of Tsinghua University: Is supervision necessarily centralized? Is there a distributed supervision method? The situation is complicated, and Professor Xu did not give a clear view at the moment.
Judging from the current stage, the SEC seems to have returned to the one-size-fits-all strictness of 2017, but this does not mean a retrogression in supervision. On the contrary, in the face of more new types of encryption products, such as stablecoins, DeFi, and NFTs that have emerged this year, regulators need to be more actively involved and consider the safety and soundness of the investment ecosystem.
I believe that with the deepening of research, a regulatory model suitable for the blockchain ecology will emerge in various countries. In recent years, government agencies and market participants have invested more and more in compliance talents.
In the future, embracing supervision is the right path of development.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/approval-of-the-etf-encryption-market-will-usher-in-the-era-of-strong-supervision-by-the-us-sec/
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