A New Prologue for Crypto – A Practical Analysis and Proposal in the Name of Efficiency and Sound Regulatory Policy

"The United States, with its history of welcoming innovators, has a large reserve of good will. In a country that ever aspires to improve with time, people are hopeful that bad policy approaches can change. This hope is not misplaced. Particularly as more people see potential for crypto technology to solve problems across society, interest in improving how it is regulated is likely to grow."

SEC Commissioner Hester Peirce
Wharton FinTech Lecture
November 1, 2024

There is no question that the election results that we are still digesting will cause a fundamental, tectonic shift in the part of the regulatory ecosystem concerned with digital assets and blockchain. President-elect Trump has made it clear that he will support the advancement of digital assets, and the crypto world was the largest single industry supporter to Republican efforts in the cycle (approximately $200 million raised). There is no question that this will result in significant influence in the new Administration, and one should not be surprised to find thoughtful crypto executives (Charles Hoskinson of Cardano has indicated an interest, and Caitlin Long of Avanti also comes to mind) taking up positions within the new Administration. In fact, one of the SEC's staunchest supporters, John Reed Stark, posted on X on November 7 that in his view "the SEC's war on crypto will now grind to a screeching halt."

Whatever staffing and policy decisions are made, however, one thing is crystal clear: the effort by the incumbents in the existing U.S. centralized financial system to "kill crypto" have failed. Digital assets and blockchain will survive and, with the right legislative and regulatory framework, may well thrive. There is a little question that with: (A) Republican majorities in the Senate and (seemingly likely) in the House; (B) the major opponents of crypto being defeated (Sen. Sherrod Brown) or relegated to the back benches (Sen. Elizabeth Warren); and (C) the expected departure of SEC Chair Gary Gensler, the field has been cleared for existing legislation to advance and for actual rulemaking to begin. Indeed, this is a natural part of the quadrennial transfer or renewal of power in the Executive Branch as we have discussed in our earlier post.

Moreover, supporters of digital assets will not be writing on a clean slate. There are ample bills currently in various stages of advancement that can be reintroduced, marked up, and voted upon, two of the most prominent of which would be the Lummis-Gillibrand Responsible Financial Innovation Act as well as the Lummis-Gillibrand Payment Stablecoin Act (this Congress's versions are hyperlinked). Indeed, the Financial Innovation and Technology for the 21st Century Act ("Fit 21") already passed the House in May 2024 with bi-partisan support. And the demonstrated political strength of the industry in this election cycle (54 out of 58 candidates supported by crypto industry PACs won their races) makes it likely that these, or similar, bills will be reintroduced and prioritized. Of course, if passed, they will have a friendly audience in the White House eager to affix a Presidential signature.

In addition, unlike the image of crypto portrayed by the current Administration, this is not the digital asset industry of 2021. The industry has made thoughtful, responsible, and detailed efforts to engage with the SEC and the CFTC to promote workable rulemaking. Coinbase has publicly discussed its efforts to engage with the SEC to propose different forms of rulemaking and went so far as to petition the SEC to commence rulemaking. And one only has to go to the website of any major crypto exchange and/or issuer to find substantial efforts both at enhancing consumer education and making regulatory proposals. In fact, crypto is an industry that wants the market integrity and financial stability that regulation (such as MiCA in the EU) can provide. Its reward, unfortunately, often has come in the form of an enforcement lawsuit. To quote Commissioner Peirce's Wharton remarks again: "Rather than working with crypto market intermediaries and token issuers to facilitate registration, [the SEC has] brought enforcement actions for failure to do the impossible: register with a Commission that has failed willfully to articulate a viable path to registration. ... [and has] neither clarified its jurisdictional boundaries nor set out commercially feasible compliance pathways." CFTC Commissioners Pham and Mersinger have leveled similar critiques against their agency, with Commissioner Pham in particular advocating for notice and comment rulemaking under the Administrative Procedure Act, noting that "regulatory clarity comes from being out in the open, not in the dark." Remarks of Commissioner Carolyn D. Pham on SEC v. Wahi, July 21, 2022.

That is all about to change. With an open-minded SEC and CFTC and a Congress eager to legislate, the construction of a sensible regulatory framework should not be a daunting task. This certainly would be a more productive path than the current one in which industry participants have been told to comply with a regulatory framework that requires the fitting of a square peg into a round hole. Indeed, many of the judges involved in those pieces of litigation have decried the fact that they have no true guidance from the agency or from Congress, which clearly defines terms and sets standards for disclosure that would accommodate this new technology and decentralized markets, leaving them with the difficult task of breaking new judicial ground. Thus, it is a safe assumption that legislative and regulatory clarity would be welcomed by all courts grappling with these issues. Moreover, the new Administration is highly likely to revive a series of Executive Orders, which were all revoked by the Biden Administration on its first day. Executive Order 13892, titled "Promoting the Rule of Law Through Transparency and Fairness in Civil Administrative Enforcement and Adjudication" (October 9, 2019), stated among other things that "guidance documents may not be used to impose new standards of conduct on persons outside the executive branch except as expressly authorized by law … [t]he agency may not treat noncompliance with a standard of conduct announced solely in a guidance document as itself a violation of applicable statutes or regulations." Assuming that this standard will be revived, it would severely undercut the SEC's position that it had given fair notice to the market through guidance documents such as the DAO Report. Armistice talks would seem to be in order.

That is the good news. The more challenging question, though, is how to manage the current overhang of regulatory opposition, as seen in the two dozen or so cases filed by the SEC against digital asset exchanges, issuers, NFT creators, etc. Put another way, how might the government act in a responsible manner to limit the potential market damage and conserve resources of all parties between now and the early development of a legislative/regulatory framework? It would seem to make no sense to go through the pain of forcing courts to decide on complex issues of first impression, which will inevitably be appealed, when legislative and regulatory solutions are likely on the near horizon.

On the other hand, the agencies cannot guarantee that such legislative or regulatory solutions will come to pass, and until then they have their duties to perform within their understanding of the law as it exists today, and in obedience to the orders of the courts where the claims are being litigated.

Thus, this modest proposal below is made in the spirit of efficiency and transparency and in an effort to balance both interests pragmatically. New legislation and existing proposed rulemaking solutions may render moot many of the claims which the SEC has made with respect of the nature of digital assets and the disclosure of their risks. Furthermore, once new agency heads are confirmed, the trial lawyers conducting these matters are likely to be faced with a client which has "changed its mind" about the need for aggressive, implacable enforcement, which in some cases, such the LBRY case, has amounted to "destroying the village in order to save it." It would be a signal waste of resources to continue to litigate a battle which may be rendered moot by a client who would prefer to regulate through rulemaking rather by enforcement. It would seem sensible, therefore, for such ongoing litigation to pause until further direction from Congress and/or new agency management can be clearly assessed, provided that the rights of the agency can be preserved throughout the pause. To draw an analogy, this would be no different from a litigation matter in which one of the parties was acquired by a second party which did not intend to continue to pursue the litigation.

These following elements may provide a pragmatic way forward:

1. A clear statement issued by the SEC (perhaps in conjunction with the CFTC), or at least by certain commissioners, that the Commission will reevaluate its crypto litigation portfolio, and also will: (a) begin the rulemaking process; and (b) collaborate with the new House and Senate with respect to the prompt reintroduction and passage of crypto legislation. Similar statements by members of Congress who have authored prior legislation could be to a similar effect.

2. This could be followed by a Joint Motion for Stay filed by both parties in each pending piece of litigation. In the event, however, that the SEC would not participate in or would oppose such a motion, it could be filed by the defendant. The motion would seek a stay for 120 days conditioned upon legislation and/or rulemaking to move forward by the end of that window. This could be thought of as a "cooling off period." In the event that a rulemaking or legislation has not advanced within that time frame, the parties could decide whether they wish to extend the cooling off period, or let the litigation proceed.

3. The Motion for Stay could be accompanied by a request that the court convene a settlement conference to determine if a negotiated resolution would be possible prior to any rulemakings or legislative efforts.

4. At the end of the cooling off period, and after consideration of the status of the development of both legislation and rulemakings, the SEC could decide whether it wishes to move forward with each case.

Unquestionably, such an effort would be out of the ordinary, but it also would be a pragmatic approach to the unusual "sea change" situation in which the digital asset industry and the regulatory community now find themselves. No one can be blind to that fact that litigation costs have now advanced well into the hundreds of millions of dollars and consume enormous amounts of agency staff time. It would appear to be unproductive to spend significant additional funds in light of a predictable change in approach by the party which has instituted the litigation. Moreover, some parties (such as Bitnomial Exchange, Jonathan Mann, and the DeFi Education Fund) have sued the SEC to stave off various enforcement matters. That litigation, as well, could benefit from a pragmatic delay. Indeed, the redirection of economic and intellectual capital from litigating to building a safer, more inclusive, and more innovative digital economy has obvious benefits.

Some will say that it will take many more months for new agency heads and senior staff to be in place. While that is true to an extent, the new Congress will be sworn in on January 3, 2025, and reintroduced digital asset bills would be ripe for swift advancement. Thus, waiting for the confirmation of a new agency management team could lead to an additional unneeded expenditure of time and resources.

Of course, each case is different based on its facts. Some cases simply may not be suitable for efforts at resolution or efforts to comply with a rulemaking and some defendants may wish to continue the fight, believing that an aggressive approach will ultimately lead to favorable decisions. In such cases, a delay of 3 to 4 months is not likely to substantially damage the administration of justice, and the case could restart with the benefit of whatever insights can be provided by legislation and rulemaking. And, given the unique nature of the issues, any actions by Congress, the SEC, and CFTC should be a welcome guide for the trial courts that are struggling with these issues.

The multi-year enforcement battles over digital assets have generated an enormous amount of heat but very little light, and all at a very great expense. It has created a hole for the American digital asset industry with which competitors in other countries do not have to contend. It is time to level the playing field. Thus, this small proposal thinks that is would be both wise and prudent to adhere closely to the "First Law of Holes": when you find yourself in one, stop digging.

The president-elect has declared that he wants the U.S. to be the "crypto capital of the planet." All parties need to readjust their thinking in line with that intention and push forward to build a new digital asset framework that works for all.