The SEC's Crypto "Clarification" Is Out — But Does It Actually Help Institutional Players?
This article will discuss what the SEC actually stated, the concerns of critics that it fell well short of expectations and most importantly, what this means for anyone involved in the institutions.
The SEC just released another set of crypto guidelines, but despite what regulators say, the statement isn't necessarily a clarification and most institutions find themselves confused about its true implications.
Key Points
- The SEC published a statement to clarify how securities law applies to crypto assets
- Experts claim the new guidelines leave room for ambiguity in certain cases
- There are compliance challenges for institutional investors that the guidelines don't cover
- Confusion about the term "digital asset securities" remains a problem
- Without intervention from Congress, institutions might have no choice but to hire lawyers
Introduction
Creating a business on a street with a variable speed limit is a frustrating position for many institutional participants in the crypto space as it relates to the SEC and their recent "clarification" does little to reduce this frustration.
On paper, it would seem that the SEC has made advancements since they are now providing some guidance, which would be a blessing to the market. However, once you dig beyond the surface, it becomes obvious that it is much more complicated than that. Many legal teams continue to be confused; compliance personnel continue to be concerned about the lack of guidance, and institutions attempting to follow the regulations do not know what the regulations are.
This article will discuss what the SEC actually stated, the concerns of critics that it fell well short of expectations and most importantly, what this means for anyone involved in the institutional crypto space.
What the SEC Actually Said
SEC's statement could have been perceived as nothing out of the ordinary since it was an effort aimed at clarifying how current federal securities regulations apply to digital assets. Nevertheless, the agency did not step back from its traditional position stating that all digital assets that exhibit behavior of securities need to be registered and regulated as such.
As far as the criteria are concerned, SEC refers to the Howey Test, which is the legal framework that has been used for decades to establish whether some asset may be considered a security.
Howey Test was developed back in 1946 - way before blockchain technology became popular
Application of Howey Test to cryptocurrencies is like drawing with your hands when you have a smartphone
In the mentioned statement, the SEC didn't develop any framework for regulating digital assets
According to securities attorney Jake Chervinsky, "There really isn't much in the statement that brings any real clarity. It restates the status quo without explaining anything about the unique structures of crypto."
Why Institutional Players Are Still Stuck
Institutions differ greatly from typical retail traders. Banks, hedge funds, asset managers, and companies (that are publicly traded) operate under completely distinct scrutiny levels compared with the retail trader. The uncertainty of regulation is not an annoyance for an institution; it is a significant risk.
Institutions are trying to figure out a number of things right now; here are three major challenges they have identified.
STEP ONE: What is the Asset Class?
Before an institution can sell, offer or purchase/hold a digital asset product, it must first assess if that digital asset is a security. The SEC has not given a simple 'yes' or 'no' answer regarding the definition of a security but is forcing institutions to attempt to classify the asset in a case by case method of evaluation instead of providing institutions with a more definitive source for legal guidance for every token.
STEP TWO: Custodial Guidance
If it is determined that the asset is a security, then the security must be maintained by a "qualified custodian." Determining who is qualified to provide custodial services for a digital asset is very unclear. The SEC has put forth custodial regulatory guidance with a series of proposals that have required them to rethink the custodial standard of service and then propose those standards again, but many of the proposed rules have been withdrawn and resubmitted.
STEP THREE: Build a Compliance Program Without Operational Guidelines
Compliance personnel are unable to construct the appropriate systems to develop and enforce compliance due to the SEC's vague guidance. Instead of having specific guidance in the areas of reporting format, semi-annual filings, examination requirements, etc., the SEC has communicated its intentions to develop operational guidelines, but has failed to supply the detail that institutions so desperately need.
Did You Know?
According to a survey conducted by Fidelity Digital Assets, published in 2023, 58 percent of institutional investors reported regulatory uncertainty as their biggest hindrance to increasing investments in cryptocurrency. Recently, The SEC's latest guidance will not change that figure.
The Criticism Isn't Coming From Crypto Rebels
This is important to know – the fiercest opponents of this guidance are not the crypto anarchists or DeFi proponents but financial firms, legal firms, and even former commissioners of the SEC themselves.
According to Paul Atkins, former SEC Commissioner, the regulatory body’s methodology in handling matters tends to emphasize enforcing laws rather than educating the public on them. “You cannot regulate an industry into clarity,” he stated. “At some point, you need to define the parameters.”
This is true across the board. This reflects another problem – the SEC does not wish to define clearly because clarity restricts its enforcement capability.
Risks and Benefits: A Balanced Look
Preventive Measures: What Institutions Should Do Right Now
One cannot afford to wait for full regulation before crafting a sound strategy. Here is what one needs to do until then:
- Bring on board dedicated crypto legal advisors — not generic securities lawyers
- Track the rationale behind each decision to classify assets
- Interact with regulators directly via comments and industry associations
- Keep tabs on SEC enforcement cases as they are clear indication of priorities
- Construct modular compliance solutions that can swiftly change as rules change
Special Cases: What If You're Already Operating?
If your institution is engaged in cryptocurrency or other cryptocurrencies, the calculations change slightly.
If you are already in the system with the SEC or FINRA, the new statement is likely to create greater scrutiny over your offerings of digital assets, so perform an audit of your operations before the regulatory agency performs one for you.
If you operate in DeFi applications, the statement has little to say about decentralized finance, and that void is risk on its own; it indicates that the SEC is still determining how to approach DeFi and may deliver a sudden enforcement.
If you are holding cryptocurrency for customers, you need to re-evaluate your custody contracts and disclosure language.
Conclusion: The Promise Was Clarity — The Delivery Was Fog
But recall what we mentioned initially: establishing your business in an area where traffic laws keep changing?
What should have been the definitive guidance on what the number is turned out to be a link to a book on a subject which has not existed back when this document was written.
That is unacceptable for institutions handling billions in their clients' money. That is unacceptable for compliance teams aiming to develop scalable solutions. And quite frankly, it is unacceptable for the whole integrity of the regulatory framework.
So what is to be done now? Prepare for the worst-case scenario. Assemble your team. Put in place all the necessary infrastructure. Stay on top of regulatory developments. Lobby for clear legislation through your industry associations.
You won't get any clarity out of this statement. You will need to act strategically yourself until Congress equips the SEC with legislative authority necessary to define clear rules.
Now what? Send this piece to your compliance department, your general counsel, or even your CFO. Because in such a rapidly evolving regulatory environment, the only mistake you can make is assuming that someone else takes care of following the changes.
