SEC chief Gary Gensler braces for clash with crypto traders

Mr. Gensler outlined his desire to regulate digital assets such as bitcoin and other crypto products to the same extent as stocks, bonds and commodity-related trading instruments. He told the Aspen Security Forum on Tuesday that his priorities include newer innovations such as stablecoins and decentralized finance, products that are beginning to draw more mainstream investors.

The impulse to regulate these markets is growing more evident around the globe. Japan’s top financial regulator said Wednesday that plans to combat money laundering would also include digital currencies.

Mr. Gensler’s mission faces several obstacles, including the cryptocurrency industry’s historical resistance to following SEC rules. Because so many crypto developers have bypassed the SEC’s front door, the agency has tried to rein them in through enforcement, a slow process that requires investigating a particular product and either suing the team behind it or convincing them to settle and adopt the SEC’s requirements.

“There is going to be a more aggressive enforcement posture, and I think that is one way to bring order to chaos," said Lee Schneider, a securities lawyer who has worked at several broker-dealers and cryptocurrency firms. “That is one way, but perhaps not the most effective or the most evenly distributed way."

One of the biggest problems for Mr. Gensler is bitcoin, a cryptocurrency with a market capitalization of $710 billion and one that Washington has acknowledged is a commodity. Market regulators don’t have authority to write rules for how commodities are bought and sold—only for financial products such as futures whose value is tied to the real-world products.

Mr. Gensler has said Congress should create an investor-protection regime for bitcoin trading. But lawmakers tend to move slowly on financial-regulation overhauls, and typically write laws only after a crisis.

That means Mr. Gensler must use the SEC’s existing powers, which limit him to policing crypto assets that qualify as securities. Many are, but crypto developers insist SEC oversight doesn’t fit their technology and trading protocols.

To date, the SEC’s strategy has centered on suing token sellers on a case-by-case basis. The SEC has prevailed—through settlement or trial verdicts—in every such enforcement action it has filed. As a result, public sales of crypto tokens largely stopped, with startups limiting the deals only to private investors.

Late last year, the SEC sued Ripple Labs Inc. and two of its executives, Chris Larsen and Brad Garlinghouse, accusing them of raising $1.3 billion by selling an unregulated cryptocurrency, XRP, that should have been registered with the SEC.

Larger U.S. crypto exchanges reacted by halting trading in XRP. More crypto exchanges should reckon with whether they are dealing in unlicensed securities, the SEC chairman told CNBC on Wednesday.

“They’ve got to come in and let’s talk to them," Mr. Gensler said. “Many of them right now are trying to say, ‘you know, well, well, we’re not going to come in.’"

Newer crypto innovations, such as stablecoins and decentralized finance, or DeFi, could form the next wave of enforcement targets, according to securities lawyers. Some stablecoins may meet the definition of mutual funds, while certain DeFi applications could be investments that should be registered with federal regulators, Mr. Gensler said.

Stablecoins, which seek to track the value of national currencies such as the U.S. dollar, are used by traders to shift value between exchanges and move between strategies. Total stablecoin supply is about $113 billion, more than triple the level from the start of the year, according to The Block, a news and data provider.

Forcing stablecoin issuers to register the assets as securities could be painful for some players, said Charles Cascarilla, chief executive of Paxos, a blockchain company that developed Binance USD, a dollar-backed stablecoin. But the industry would ultimately benefit from transparency into the reserves that underpin the coins’ value, he added. “Oversight creates trust, and trust can lead to widespread adoption," Mr. Cascarilla said.

DeFi encompasses a range of projects that seek to replicate traditional financial activities, such as trading and lending, using cryptocurrencies and the internet. DeFi has boomed during the past year, with many projects avoiding the most basic regulation such as anti-money-laundering controls.

Regulators may have trouble applying securities laws to DeFi, where projects are often set up as automated peer-to-peer networks with no central entity operating them. In contrast, the SEC and other federal agencies largely focus on people and companies. Mr. Gensler suggested that legislation might be needed to impose investor protections on DeFi.

“The problem is that regulation applies to entities," said Lee Reiners, executive director of the Duke University’s Global Financial Markets Center. “But with a decentralized trading or lending platform, it’s not clear who that entity is."

The industry could potentially avoid an enforcement blitz by agreeing to follow SEC rules or pursuing exemptions on a case-by-case basis. The SEC has exempted a few digital assets from oversight. In those cases, the token wasn’t sold to raise capital and was used for purposes such as videogames or flights on business jets.

Some still argue Mr. Gensler should stop enforcing old rules and propose an updated code tailored to how crypto works. But Mr. Gensler and other regulators have shown little interest in that.

“Many in the crypto industry are saying that the SEC should come up with new rules," said Michael Didiuk, a former SEC lawyer and now a partner at Perkins Coie LLP. “The SEC, on the other hand, has repeatedly said that, for the most part, the rules are there."

This story has been published from a wire agency feed without modifications to the text