OUTLOOK 2021: Battle lines form for a U.S. regulatory showdown in cryptocurrencies

NEW YORK(Thomson Reuters Regulatory Intelligence) – *To read more by the Thomson Reuters Regulatory Intelligence team click here: bit.ly/TR-RegIntel

The new year and new administration in Washington has brought uncertainty over what many see as potentially one of the most revolutionary developments in financial services, the broader acceptance and regulatory framework for cryptocurrencies.

Digital assets or currencies such as bitcoin have exploded in popularity. Some values increased nearly four-fold last year as the use cases for cryptocurrency and wider acceptance by traditional banks and financial institutions have gained traction. Many former skeptics, including regulators, have now flipped from a prior blanket opposition and are now beginning to test the crypto waters.

Despite the public’s growing interest and appetite and a new desire by some institutions to begin providing services such as custodial safekeeping and trading, the regulatory landscape took on new uncertainty as a result of the power shift in Washington to President Joe Biden and a Democratically controlled Congress.

One certainty is that 2021 will see a new and significant regulatory and political debate and possibly proposed rules and regulations for the rapidly evolving crypto marketplace. A significant lawsuit also will take center stage as current regulators square off against lawyers including a former chair of the Securities and Exchange Commission (SEC) and a former SEC enforcement chief.

NEW FACES AND UNCERTAINTY

Biden’s pick to head the SEC, Gary Gensler, is well known on Wall Street as a former partner at Goldman Sachs and from his previous stint as chair of the U.S. Commodity Futures Trading Commission (CFTC) during former President Barack Obama’s administration.

Gensler has a professional understanding of cryptocurrencies, as evidenced by his testimony before Congress and other public speeches on the subject. Gensler also taught courses on blockchain and digital currencies at the Massachusetts Institute of Technology Sloan School of Management.

Gensler gained a reputation for his overhaul of the derivatives and swaps markets while at the CFTC following the financial crisis. He is known for his efforts at the CFTC to implement the Dodd-Frank regulatory overhaul, in which he helped repair and restore participant confidence in the crisis-damaged swaps and derivatives market. His work at the CFTC could be beneficial if he seeks to do the same with a highly fragmented, mysterious, and often misunderstood marketplace for crypto assets.

Janet Yellen, the incoming Biden administration’s choice to lead the U.S. Treasury, began her confirmation process on Tuesday. In remarks to senators, Yellen, a former Federal Reserve chair, sounded a warning about the potential for crime and terrorism and financing through cryptocurrencies. She said it was “a particular concern.”

“We need to make sure that our methods for dealing with … terrorist financing change along with changing technology. Cryptocurrencies are of particular concern. I think many are used, at least in the transactions sense, mainly for illicit financing. We really need to examine ways in which we can curtail their use and make sure that (money laundering) doesn’t occur through those channels.”

Since Yellen’s testimony Tuesday, bitcoin and other cryptocurrencies plunged nearly 15 percent, a decline many participants attributed to the prospect of tighter regulation as suggested by Yellen’s testimony.

THE LEGAL BATTLE BETWEEN XRP-RIPPLE AND THE SEC

In late December, the SEC charged Ripple, the blockchain payments company associated with the cryptocurrency XRP, with improperly conducting a $1.3 billion unregistered securities offering. The SEC also charged two executives of Ripple for personal gains they received from the offering. Ripple created and sold XRP, the third-biggest cryptocurrency by market value.

According to the SEC complaint(go-ri.tr.com/ADoCz1), beginning in 2013, Ripple’s former chief executive, Christian Larsen, and its current CEO, Bradley Garlinghouse, raised capital through the sale of digital assets in an unregistered offering and also “distributed billions of XRP in exchange for non-cash consideration, such as labor and market-making services.” The SEC added that Larsen and Garlinghouse personally profited by approximately $600 million from their unregistered sales of XRP.

Ripple has contended XRP is a currency and does not have to be registered as an investment contract. “The SEC is fundamentally wrong as a matter of law and fact,” the company said in response to the SEC charges. Larsen and Garlinghouse criticized the agency’s “lack of a clear regulatory framework,” adding that they would fight the action.

“We are right and will aggressively fight – and win – this battle in the courts to get clear rules of the road for the entire industry in the U.S.,” Garlinghouse said in an emailed statement to Reuters.

Since the announcement, XRP has plunged in price, with many exchanges delisting or halting trading in the cryptocurrency.

At the heart of the legal challenge is whether XRP is a security or currency. Facing a pretrial date of February 22, XRP and the executives have engaged the legal services of former SEC Chair Mary Jo White and former SEC enforcement director, Andrew Ceresney, both with the law firm Debevoise & Plimpton.

XRP’s defense might include the fact in 2015, the Financial Crimes Enforcement Network (FinCEN) assessed a civil monetary penalty of $700,000 related to AML violations of the Bank Secrecy Act. In the enforcement action(go-ri.tr.com/zrqAz2), XRP was deemed by FinCEN to be a digital currency and required the firm to take steps to bolster its compliance program. Ripple Labs “cooperated extensively with the government during its investigation and has taken a number of important steps over the years to build and strengthen our compliance programs,” Ripple Labs spokeswoman Monica Long said in a statement emailed to Thomson Reuters at the time.

Ceresney and White are respected former SEC veterans who served at the same time Gensler headed the CFTC. With Gensler soon to take the helm of the SEC, there is uncertainty whether the case brought by the enforcement division under his predecessor will make it to a courtroom.

What is certain is that the legal, regulatory, and crypto communities will be watching very closely at the outcome of the case, which may offer a glimpse of the regulatory approach and framework to come under Gensler’s leadership at the SEC.

(This article is part of a series on the State of Regulatory Reform 2021. A SPECIAL REPORT via PDF will become available in February.)

(Todd Ehret is a Senior Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, based in New York.)

*To read more by the Thomson Reuters Regulatory Intelligence team click here: bit.ly/TR-RegIntel