By Jack Horrigan
Throughout the world, and perhaps more acutely in America, recent politics have played out as pantomime. A reality star president, posturing politicians, and culture wars over gas stoves and cow farts have proved more fodder for late-night television hosts than the substance of meaningful debate. In light of this, perhaps the rise of meme cryptocurrencies and decentralised finance (DeFi) should come as no surprise – and their predictable collapse has vindicated an oft-criticised institution. The Securities and Exchange Commision (SEC) has set ambitious aims in the past year. The crypto collapse may provide it with the political capital it needs to accomplish them.
The SEC was created following the Great Depression to regulate the type of reckless trading that crashed the stock market in 1929. Its mandate is simple: “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation”. It usually does this by mandating certain transparency and risk-mitigating measures in the securities market, and enforcing these rules through civil suits. It is understandable why it is the frequent target of Wall Street’s ire. The SEC is meant to insulate investors from avoidable busts like Ponzi schemes, securities fraud, or subprime mortgage-backed securities. The issue: financial institutions make a lot of money on risky, or even illegal, trades. Before the bust is the boom, and the boom is a bacchanale of profits for both investors and traders. The SEC’s job is to stop the revelry before the hangover – and no one likes a killjoy. Here, cryptocurrency investors have found a rare common ground with their institutional counterparts. They, too, have been the target of finance’s top cop.
The world of finance has always been slightly tinged by the ridiculous. The world of crypto, however, monetised comedy – Dogecoin, funny-looking apes, and “MetaBirkin” bags were attempts to cash-in on what amounted to the internet’s inside joke.
But the joke came at the expense of the majority of DeFi investors. Following the popping of the NFT bubble, and the collapse of many fraudulent crypto exchanges, the SEC has received a new breath of life. Crypto enthusiasts previously painted the SEC as, at best, meddlesome worrywarts, too archaic to understand or permit crypto’s innovation, and at worst, a more insidious body controlled by the very entrenched powers DeFi set out to disrupt. But in the post-FTX era, the SEC suddenly seems more wise than wizened. The question is: what happens now?
It is understandable that a flood of new financial toys like cryptocurrencies, NFTS, or SPACs would correspond with a new tide of SEC scrutiny. But SEC boss Gary Gensler, after two years on the job, has taken matters to another level. He is on pace to craft more rules than either of his previous two predecessors, and has already given more speeches in two years than his immediate predecessor had in four. Two of his proposals: forcing publicly traded companies to disclose both climate change risks and employee benefits. These regulations are favoured by the left, but unlikely to come to fruition. Much more realistic, however, are his plans for crypto. The arguments the SEC ordinarily makes when bringing suits against crypto firms is that they represent a dangerous unregistered security that could prove ruinous for everyday investors. Before the collapse of FTX, the usual arguments applied – charitable observers may say the SEC sued out of an abundance of caution; crypto advocates may accuse the SEC of regulatory zeal.
Besides, the SEC’s authority remained (indeed, remains) murky. When the SEC was created nearly a century ago, its powers were broad but well-defined – it had the authority to regulate and enforce rules regarding securities. But it is unclear if crypto qualifies. The Howey Test, named for US Supreme Court Case SEC v. W.J. Howey Co., defines a product as a security if “there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others”. The SEC’s stance, understandably, is that crypto meets this definition. Crypto enthusiasts, understandably, disagree.
It is up to a judge to decide whether cryptocurrencies count as securities, and this occurs on a case-by-case basis. The bankruptcy of FTX and the media surrounding its founder, accused fraudster Sam Bankman-Fried, will help the SEC prove its argument in court. FTX convinced many that cryptocurrencies need regulation, and the SEC is the obvious choice to do it.
The world of crypto has been referred to as the “Wild West”. It is, depending on who you ask, either a compliment or criticism. But, just as the American frontier, crypto could never remain “wild” for long. The SEC is perhaps the least of its issues – a run on crypto banks and a slew of new KYC-AML policies have caused many crypto currencies to fall in value. Crypto firms no longer enjoy the privilege – or at least, the benefit of the doubt – that they once did in the court of public opinion. It is yet to be seen if they still enjoy it in the court of law.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.