Turf battles are nothing new in Washington, but the one currently raging over which federal agency has authority to regulate the trading of digital assets reveals deep dysfunction in the modern administrative state. The battle goes far beyond which agency gets more power; the future of the internet may be at stake.
The United States is somewhat unusual in having different agencies to regulate securities, like stocks and bonds, and derivatives, like options, swaps, and commodity futures. The Securities and Exchange Commission (SEC) is the regulator of the former, while the Commodity Futures Trading Commission (CFTC) regulates the latter. But the jurisdictional borders are sometimes murky, thanks to overlapping mandates between the agencies, as well as with other state and federal financial regulators.
Division of labor and competition may offer some benefits, but in this case, the lack of a clear regulator has meant that digital assets have fallen into some jurisdictional cracks. The 60 million Americans who trade crypto assets do so either overseas, at the mercy of foreign law, or under state money-transfer laws designed for payday lending, not financial markets.
It turns out that which agency has jurisdiction matters a lot. While the SEC regulates through detailed rules, the CFTC more often employs a principles-based approach. The former offers certainty and rigidity, while the latter provides greater flexibility. While strict SEC enforcement might limit downside risk, the CFTC model is more likely to encourage investment in innovation.
These differing approaches also are reflected in how the agencies have approached emerging markets for digital assets. CFTC-registered exchanges have been approved to offer Bitcoin derivatives products for several years now. Indeed, the CFTC has a history of fostering and regulating financial innovations. Although originally tasked with overseeing plain-vanilla hedges on agricultural commodities, the CFTC has used its broad, principles-based approach to permit countless new derivatives on everything from interest rates to the weather.
Meanwhile, SEC staff have sat on numerous crypto exchange-traded-fund (ETF) registrations and the commission has repeatedly rejected proposals by firms to list a Bitcoin ETF product. In fact, the commission has largely chosen to regulate crypto through enforcement actions against entities it accuses of offering “unregistered crypto asset securities.” This has led to some bizarre outcomes. One project might blast ahead without consulting the SEC, raise billions of dollars, and ultimately pay only a small fine to the commission, while other projects actively seek SEC guidance prior to launch and are met with staff silence and stares, thus never getting to the starting blocks.
The SEC and CFTC have had fights about jurisdiction before. When futures on stock-market indices flourished in the late 1970s, the agencies signed the Shad-Johnson Accord, which gave each agency a bit of the action. The accord ultimately found its way into law a few years later, which is as it should be. Congress, not agencies, should determine jurisdiction.
Which is precisely what recently introduced bipartisan legislation—sponsored by Senate Agriculture Committee Chair Debbie Stabenow (D-Mich.) and Ranking Member John Boozman (R-Ark.), along with Sens. Cory Booker (D-N.J.) and John Thune (R-S.D.)—seeks to do. The Digital Commodities Consumer Protection Act of 2022 would define cryptocurrencies like Bitcoin and Ethereum as “digital commodities” subject to CFTC jurisdiction.
The logic is sound. Bitcoin, Ethereum, and most other crypto projects do not have managers, looking more like currencies or gold, which are not under SEC authority. If, however, companies issue digital “tokens” that grant the same rights and obligations to “tokenholders” that normally would pass to stockholders, then the SEC would have jurisdiction. Simply calling a stock by some other name ought not make it immune from securities regulation.
Critics of the bill argue that the SEC is the tougher cop, but it is ill-suited to encourage financial innovation. Some standards and regulations are needed to onshore investment and to protect investors, but entrepreneurs and investors cannot be left to worry that regulators may come knocking one day and claim that they’ve been violating securities laws all this time. The CFTC is the right agency to deliver on sensible regulation that balances the needs of investor protection with regulatory discretion to encourage innovation.
Crypto is in its infancy. The claims that blockchain technology will offer alternatives to government currencies, enable peer-to-peer investing, reduce transaction costs throughout the financial system, and even create a better Internet remain speculative, at this point. But the potential is there, and companies are investing billions. There will be winners and losers, and hopefully breakthroughs.
A robust trading system in the United States is essential to ensuring good ideas get funded, while fraudsters are deterred and punished. If Web 3.0 and other blockchain-based technologies are to come from American entrepreneurs and enrich American investors, crypto markets and investors need regulatory certainty.
Geoffrey A. Manne is the president and founder of the International Center for Law & Economics (ICLE). M. Todd Henderson is the Michael J. Marks Professor of Law at the University of Chicago Law School and an ICLE academic affiliate.