Analyzing the SEC's regulatory changes in the encryption market: With the approval of ETF, will the US SEC usher in an era of strong regulation?

Produced | Vernacular Blockchain (ID: hellobtc)
Produced | Vernacular Blockchain (ID: hellobtc)

On September 7, 2021, without giving any explanation, the SEC issued a lawsuit warning against Coinbase’s lending product Lend, stating that it has identified it as an investment contract of securities category, which means that this product must go through the securities approval process.

Coinbase founder BrianCompletely angry, he sent a "soul question" to the SEC through "21 Questions" on Twitter.The SEC’s quick and merciless action reminds people of the serious investigation of the DAO launched by the SEC in 2017 on the “identification of DAO as a security”.

But it is undeniable that the determination of the SEC to vigorously strengthen supervision can be seen. At the same time, it was reported that just today, ETF issuer Volt Equity’s encryption industry ETF was approved by the SEC and will be listed on the New York Stock Exchange.

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01 
Regulator of the US Token market
SEC、 CFTC、IRS、FinCEN

The U.S. regulatory system is composed of states and the federal government. Generally speaking, they are equal and independent of each other. Today we mainly popularize science on the main regulators at the federal level.

1. US Securities and Exchange Commission (SEC)

The SEC is the highest regulatory authority in the U.S. securities industry, with legislative, judicial and independent law enforcement powers.
The issuance and circulation of securities products as defined in the 1934 Securities Exchange Act, such as stocks, bonds, debt instruments and other investment contracts, fall under the supervision of the SEC.

2. Commodity Futures Trading Commission (CFTC)

The scope of the CFTC is mainly for the commodity futures, options, and financial futures and options markets in the United States. It is responsible for protecting the public and market participants from related fraud, and at the same time passing legislation to ensure the openness, competitiveness, and financial reliability of the futures and options markets.

The function composed of SEC and CFTC is equivalent to the domestic Securities Regulatory Commission, and it is also the main department that supervises the encryption market.

3. Internal Revenue Service (IRS)

The IRS mainly supervises the encryption market from the perspective of tax policy. On the issue of how to characterize the attributes of encrypted assets, the IRS classifies them as generalized property, which means that the tax provisions for property are also applicable to encrypted asset transactions.The IRS’ consideration is mainly to prevent taxpayers from evading tax responsibilities through encrypted assets.

Therefore, the IRS has the right to require individuals and institutions to file tax returns on encrypted asset transactions, and from time to time require trading platforms or individuals to provide transaction information on encrypted accounts.

4. Financial Crimes Enforcement Network (FinCEN)

FinCEN's main focus is on anti-money laundering, preventing illicit transactions and preventing the financing of terrorist activities. Its law enforcement is based on the Bank Secrecy Act. In terms of the characterization of encrypted asset service providers, FinCEN believes that they are fund transfer intermediaries in the fund service business chain, so they need to be included in the supervision.

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The SEC’s regulatory changes to the crypto market
Issuance financing, trading, lending, derivatives, platforms

1. Issue financing

The SEC will not supervise all financing activities. In most cases, it only needs to be registered with the SEC to operate.Looking at all links in the life cycle of the securities market, the SEC is most concerned with the compliance of the issuance and financing stage.

Since 2014, when it comes to Token financing in the United States or for US residents, the project party and all service providers need to obtain SEC approval or registration, otherwise they will have to bear huge fines.

As of September this year, the SEC has issued more than 12 fines, mainly for non-compliant Token financing and fraudulent projects.

The SEC has never relaxed the review and punishment of "unlicensed operations" and "false projects", because the encryption market is changing too fast, investors may not have enough knowledge and judgment, and regulators must fulfill their duties of protecting market order. duty.

2. Transaction

There are many standards for the SEC to intervene in supervision, but once it involves "securities" investment contracts, it must be included in the scope of the securities law. Therefore, after 2018, centralized trading platforms must comply with strict license regulations and compliance requirements in order to provide trading services.

Moreover, the trading platform must have strict KYC rules and regulations and a practical KYC implementation plan, and the review of customer identity and source of funds must be strictly implemented.

3. Borrowing

Not long ago, the new chairman of the SEC said that encrypted asset custody service providers and trading platforms should pay attention, because the provision of lending and pledge services may soon be subject to the supervision of US securities laws, and regulators are formulating targeted regulatory rules.

The main basis of the SEC is still the securities law, because the loan and return pledge contract are close to the debt agreement and can be included in the scope of supervision.In 2020, the decentralized lending market is extremely active, with a borrowing scale close to 3.7 billion US dollars, which has attracted the attention of the Financial Action Task Force (FATF), and is promoting comprehensive KYC supervision of users participating in Defi transactions.

4. Platform

so,

so,Despite being the top-ranked centralized trading platform in the world, Coinbase has always been a key regulatory target of the SEC.first level title

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Regulatory Purposes of the SEC
Systemic risk, off-balance sheet liabilities, unknown risk

1. Beware of outbreaks of systemic risks

Recently, the new chairman of the SEC talked about the Evergrande debt incident in an interview. Maybe it was stimulated by this incident, or he did not want to repeat the financial crisis in 2008.The SEC is intentionally or unintentionally strengthening the supervision of listed companies. This explains why Coinbase was suddenly issued a "lawsuit warning".

The warning is sudden, but the logic is correct, because Coinbase is already a listed company, and it is expected that the launch of encrypted asset-based lending products will inevitably face stricter approval.

Coinbase Lend is an encrypted asset lending product. Considering the huge number of users of Coinbase, the SEC is worried that if the Token market collapses, a wide range of investors will be implicated.

Therefore, the SEC is concerned about whether this product should be classified as a securities product, and if so, it must be registered. Although Lend is more like a savings product, it is clear that the SEC insists on its characterization as a securities investment.

In fact, many financial institutions provide similar financial products, such as Square and Fidelity's Fidelity Investments. They all comply with the requirements and register with the SEC or obtain a license.

2. Beware of the surge in off-balance sheet liabilities of listed companies due to encryption business

The debt ratio of listed companies is too high, which will increase the risk of bankruptcy and liquidation. Special attention should be paid to convertible bonds, which are often overlooked.exist

exist"Twitter, Tesla, Paypal and other major companies have entered the game, short-term hype or long-term layout? "We have analyzed in the article that MS borrowed huge debts to buy BTC. Although it uses convertible bonds, it is still an interest-bearing liability of the company before the creditor officially converts it into shares, so it also increases the debt burden of the company, so it was immediately rated Institutions lowered their buy ratings.

MS indirectly set off a wave of BTC buying by listed companies around the world. Today, about 25 listed companies hold BTC, most of which are US companies.Of course, it is impossible for the SEC to ignore it. The purpose of the SEC is to protect investors.

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Source: COINGECKO

3. Unknown risks: leverage, data falsification, asset security

The SEC often has puzzling regulatory measures, which are mainly aimed at the potential unknown risks of the encryption market. These unknown risks are closely related to technology, and it is difficult to achieve supervision only by rules and regulations, which is a huge challenge for supervision.

lever

• lever

The risk of leveraged trading is mainly concentrated on the trading platform, especially the transactions of forward contracts. The number of participants far exceeds that of spot transactions, because no matter whether it rises or falls, it can create profit margins. The higher the leverage ratio, the more it stimulates price fluctuations.

Some factors outside the rules can easily lead to infinite amplification of trading gains or losses.Information asymmetry

• Information asymmetry

Another issue the SEC has been grappling with is the disclosure of encryption service providers. Taking the trading platform as an example, there is an information asymmetry between users and the trading platform regarding the actual situation of assets.

Generally speaking, after recharging, the user's Token will be concentrated in the dedicated address of the trading platform, and the assets will be transferred to the user's address only when "withdrawing". All transactions of users will not lead to the actual transfer of Token, but will only be recorded in the server of the trading platform.

asset security

• asset security

The SEC's supervision mainly focuses on investor protection. For the traditional securities market, there is no major asset security problem. But for digital assets, there is no absolutely safe custody mechanism. Because of the centralized asset custody scheme and the decentralized network protocol, there are a large number of cases of user assets being transferred or network theft occurring in both.

When the encrypted assets are not completely isolated by the cold wallet, they will be exposed on the chain. If there is a moral problem in the centralized organization, or the platform is hacked, the assets will be at risk of loss.

Therefore, regulatory agencies such as the SEC will evaluate their strength and willingness for asset security protection before approving their qualifications. On the one hand, they focus on whether they have perfect processes and technical support, and on the other hand, they focus on their financial adequacy.

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Cases that were challenged by the SEC
Libra、Ripple、Coinbase

1. Libra: Never get the SEC's "Like"

The launch of Libra began in 2019, and it has not yet been approved for distribution. Facebook had no choice but to change the name to Diem and re-establish the distribution plan for electronic cash. In fact, the SEC has always held a prudent regulatory attitude towards stablecoins anchored to fiat currencies, and the new SEC chairman has recently reiterated his remarks on strengthening the supervision of stablecoins.

In fact, the SEC’s prudence is not unreasonable. As early as 2017, there were widespread doubts that TEDA did not have US dollar reserves equivalent to USDT issuance.

If data falsification occurs in stablecoins anchored to the U.S. dollar, it may be a potential risk to the huge U.S. dollar economy. Therefore, with regard to stablecoins, perhaps a better form is a CBDC endorsed by regulatory authorities or national credit.

2. Ripple: After 7 years, the SEC sued

Since December last year, the SEC has filed a lawsuit against Ripple that has continued to this day. The SEC believes that Ripple’s issuance of XRP has not been registered in accordance with the securities law, while Ripple believes that XRP is not a security, but a digital commodity, just like BTC and ETH. Same.

Although RippleToken has been on the market for about 8 years, it still needs to face new regulatory requirements. Regardless of the final result, the market reputation of XRP has been greatly affected, and more than 50 trading platforms have delisted XRP trading pairs.

3. Coinbase: No income products are spared?

With regard to Coinbase’s warning that it was sued some time ago, the SEC believes that it may have made false statements, so it requires information on all investors in order to further understand the truth of the matter. However, Coinbase disagrees, arguing that investor information has nothing to do with product approval. In addition, Coinbase also opposes the SEC’s use of the Howey test as a standard for qualitative securities, failing to keep pace with the times.

summary

05 
summary

In 2019, at the kick-off meeting of the Block Technology Research Incentive Program led by Tsinghua University, some scholars asked Professor Xu Wei of the Institute of Interdisciplinary Information at Tsinghua University: Is supervision necessarily centralized? Is there a distributed form of supervision? The situation is complicated, and Professor Xu did not give a clear view at the moment.

Judging from the current stage, the SEC seems to have returned to the one-size-fits-all strictness in 2017, but this does not mean that the supervision has gone backwards.On the contrary, in the face of more new types of encrypted products, such as stablecoins, DeFi and NFT, which have emerged in succession this year, regulators need to intervene more actively and consider the safety and stability of the investment ecosystem.

It is believed that with the deepening of research, a regulatory model suitable for the blockchain ecology will emerge as the times require. In recent years, government agencies and market participants have invested more and more in compliance personnel.

In the future, embracing regulation is the right way to develop.