On February 6, 2018, Securities and Exchange Commission (SEC) chairman Jay Clayton and Commodity Futures Trading Commission (CFTC) chairman J. Christopher Giancarlo gave testimony before the Senate Banking Committee in a hearing on virtual currencies. ETHNews reported on the event and the prepared remarks, which were published ahead of the meeting.
The hearing provided valuable insight into the SEC and CFTC's regulatory jurisdiction and enforcement actions, but it also demonstrated each agency's weaknesses (namely, not having enough cryptocurrency experts). While the meeting was fruitful, it ultimately failed to address several key areas.
Looking ahead, here are four topics that should be considered by the SEC and CFTC in greater detail:
1. Systemic Risk
In light of the sudden dip in the Dow Jones Industrial Average, several senators expressed concern about the "systemic risk" that could be posed by cryptocurrency. Essentially, what would happen to the broader economy if bitcoin (or other cryptocurrencies) became the dominant medium of exchange in the US or across the globe? Or perhaps, what would happen if cryptocurrency prices came crashing down to earth?
With regard to the financial risks of cryptocurrency, price fluctuations are just one piece of the puzzle. As we've seen over the last year, bitcoin's price explosion and the rise of alt-coins aren't really all that worrisome. Sure, there's a nominal value of $400 billion tied up in cryptocurrency, but could that threaten the global economy? What percentage of outstanding coins are actually in circulation?
The "hodl" mentality means that many project founders – and investors – aren't engaged in a liquid market. If I were to suddenly create 800 trillion Matt Tokens, and I traded one of those Matt Tokens for $1, that doesn't magically mean that we've exposed the economy to an extra $800 trillion of risk.
To understand the financial risks of cryptocurrency, it's critical to examine individual projects and the markets in which their tokens trade. How many dollars and cents have actually gone into exchanges? It's certainly a lot of money, but the market caps that we see online are significantly overstated.
More pressing is the conversation about cryptocurrency-based financial products, like bitcoin futures and proposed cryptocurrency exchange-traded funds (ETFs). These are of real concern because they are (or could be) cleared by the same institutions that manage the conventional economy. Exposing the normal economy to crypto volatility seems tremendously unwise, especially if cryptocurrency-based financial products are leveraged to multiply the value of price movements.
2. What is a commodity? Do issuance mechanisms matter?
Since the CFTC declared in 2015 that bitcoin is a commodity, that's just become convention. But, does it make sense? With bitcoin, the PoW scheme has not materially changed, so the commodity designation seems acceptable.
However, there are many projects implementing – or seeking to implement – different mining algorithms and issuance mechanisms. What happens if and when Ethereum shifts to PoS? Although we don't yet know what PoS will look like, that could potentially alter the digital asset's classification.
3. Is self-certification appropriate for cryptocurrency derivatives?
This is something that the CFTC has been reevaluating, but apart from Senator Warner (D-VA) questioning the hastiness of bitcoin derivatives, it didn't come up during the hearing.
What was the CFTC's purpose in allowing self-certification? Perhaps, as Chairman Giancarlo noted, it enabled oversight of the cryptocurrency spot markets. Although the existing cryptocurrency derivatives are cash-settled, were the CBOE and CME bitcoin futures contracts truly robust enough to withstand potential manipulative efforts? I've certainly got my doubts.
4. Are there any tokens that aren't securities?
Personally, I was left wondering whether Ether is a commodity, a security, both, or neither. At this stage, I think it's a commodity, but I'm not certain. In his eagerness to protect investors, Chairman Clayton might have overlooked vital development opportunities. Ether is certainly more than a simple currency, but who knows what it will eventually become. During Tuesday's hearing, there was no mention of smart contracts and little mention of Ethereum, except for Senator Warner's momentary allusion to Filecoin.
One question that came up (but wasn't answered) is how the SEC will address token offerings that have already taken place. Even though the agency cracked down on Munchee, what about other projects (and those that aren't US-based)? It's not clear how the SEC will address this matter, and I'm sure we'd all like some clarification.
Taken as a whole, it's incredible that the CFTC and SEC have gotten up to speed on cryptocurrency markets so quickly. It's a real credit to the leaders of the agencies and their hardworking staff. However, the questions we're faced with about the CFTC and SEC's jurisdiction are complex. It's clear that traditional definitions might not apply to cryptocurrency, and it's important that neither agency stifles development. Perhaps, one day, we will have a Cryptocurrency Commission.