By Jay Clayton and J. Christopher Giancarlo
(Mr. Clayton is chairman of the Securities and Exchange Commission. Mr. Giancarlo is chairman of the Commodity Futures Trading Commission.)
Distributed ledger technology, or DLT, is the advancement that underpins an array of new financial products, including cryptocurrencies and digital payment services. Many have identified DLT as the next great driver of economic efficiency. Some have even compared it to productivity-driving innovations such as the steam engine and personal computer.
Our task, as market regulators, is to set and enforce rules that foster innovation while promoting market integrity and confidence. In recent months we have seen a wide range of market participants, including retail investors, seeking to invest in DLT initiatives, including through cryptocurrencies and so-called ICOs, initial coin offerings. Experience tells us that while some market participants may make fortunes, the risks to all investors are high. Caution is merited.
For perspective, look to the 1990s. Countless companies chased the dot-com promise, yet only a fraction survived. Fewer still provided their investors with life-changing returns.
This is not a statement against investments in innovation. The willingness to pursue the commercialization of innovation is one of America’s great strengths. Together Americans embrace new technology and contribute resources to developing it. Through great human effort and competition, strong companies emerge. Some of the dot-com survivors are the among the world’s leading companies today. This longstanding, uniquely American characteristic is the envy of the world. Our regulatory efforts should embrace it.
History also has proved that transparency, investor protection and market integrity are critical to ensuring that innovation continues. But today we are seeing substantial DLT-related market activity that shows little or no regard to our proven regulatory approach. This concerns us.
Earlier this month, the collective market capitalization of cryptocurrencies topped $700 billion. Direct participation by U.S. investors in cryptocurrencies is significant. The prices for these currencies are set by trading on “spot” platforms. Many of these platforms are based offshore — and none are registered with the Commodity Futures Trading Commission or the Securities and Exchange Commission.
Advocates and investors initially promoted cryptocurrencies as a payment-facilitation alternative to traditional currencies such as the dollar and the euro. But cryptocurrencies lack a fundamental characteristic of traditional currencies, namely sovereign backing. They also lack other hallmarks of traditional currencies, such as governance standards, accountability and oversight, and regular and reliable reporting of trading and related financial data. Significantly, cryptocurrencies are now being promoted, pursued and traded as investment assets, with their purported utility as an efficient medium of exchange being a distant secondary characteristic.
A key issue before market regulators is whether our historical approach to the regulation of currency transactions is appropriate for the cryptocurrency markets. Check-cashing and money-transmission services that operate in the U.S. are primarily regulated by states. Many of the internet-based cryptocurrency-trading platforms have registered as payment services and are not subject to direct oversight by the SEC or the CFTC. We would support policy efforts to revisit these frameworks and ensure they are effective and efficient for the digital era.
In some areas, federal authority to police cryptocurrencies is clear. The Bank Secrecy Act and its implementing regulations establish federal anti-money-laundering obligations that apply to most people engaged in the business of accepting and transmitting, selling or storing cryptocurrencies. In other areas, some say, federal authority is murkier. Some proponents of cryptocurrencies note that the jurisdiction of the CFTC and SEC over cryptocurrency transactions is limited and cite the absence of U.S. and other government market regulation as an investment attribute. Such claims should give prospective investors pause.
Recently, two of the largest CFTC-regulated exchanges listed Bitcoin futures products. Although the exchanges are permitted to “self-certify” and commence trading futures products without CFTC approval, for Bitcoin futures they spent significant time engaging with CFTC staff and agreed to implement risk-mitigation and oversight measures, including heightened margin requirements and a requirement that the exchanges have information-sharing agreements in place with underlying Bitcoin trading platforms. As a result, the CFTC gained oversight over the U.S. Bitcoin futures market and access to data that can facilitate the detection and pursuit of bad actors in underlying spot markets.
The SEC does not have direct oversight of transactions in currencies or commodities. Yet some products that are labeled cryptocurrencies have characteristics that make them securities. The offer, sale and trading of such products must be carried out in compliance with securities law. The SEC will vigorously pursue those who seek to evade the registration, disclosure and anti-fraud requirements of our securities laws. In addition, the SEC is monitoring the cryptocurrency-related activities of the market participants it regulates, including broker-dealers, investment advisers and trading platforms.
The SEC is devoting a significant portion of its resources to the ICO market. Through statements, reports and enforcement actions the SEC has made it clear that federal securities laws apply regardless of whether the offered security — a purposefully broad and flexible term — is labeled a “coin” or “utility token” rather than a stock, bond or investment contract. Market participants, including lawyers, trading venues and financial services firms, should be aware that we are disturbed by many examples of form being elevated over substance, with form-based arguments depriving investors of mandatory protections.
The CFTC and SEC, along with other federal and state regulators and criminal authorities, will continue to work together to bring transparency and integrity to these markets and, importantly, to deter and prosecute fraud and abuse. These markets are new, evolving and international. As such they require us to be nimble and forward-looking; coordinated with our state, federal and international colleagues; and engaged with important stakeholders, including Congress.
Distributed ledger technology may in fact be the next great disruptive and productivity-enhancing economic development. If history is any guide, DLT is likely to be followed by many more life-changing innovations. But we will not allow it or any other advancement to disrupt our commitment to fair and sound markets.