There's a storm brewing between the booming cryptocurrency sector and regulators charged with overseeing a white-hot industry, where potential risks to investors are proliferating almost as fast as new products.
Tuesday's Senate testimony by newly appointed Securities and Exchange Commission Chairman Gary Gensler did little to shed light on a number of crypto-related controversies — including an evolving battle with Coinbase (COIN), the premier crypto trading platform trying to offer a new lending product.
However, the SEC chief faced pointed questions on how far the agency was willing to go to impose order on the Wild West of trading and product creation in a digital currency sector that prides itself on decentralization, efficiency and the empowerment of small investors.
For his part, Gensler said "this asset class is rife with fraud, scams, and abuse in certain applications. We can do better." That point was illustrated on Monday, when a fraudulent press release touting a partnership between Walmart (WMT) and Litecoin (LTC-USD) moved the market before the retail giant shot it down.
The SEC is set up to promote investor protection, facilitate capital formation and anything else in between, according to Gensler. In recent months, the SEC has gone on the offensive to pursue alleged bad actors in the crypto space.
Regulators "are coming aggressively after cryptocurrency businesses using enforcement cases and sending a signal that they are watching the sector very carefully," Reena Aggarwal, director of Georgetown's Center for Financial Markets and Policy, told Yahoo Finance.
Coinbase and 'regulation by litigation'
Employees of Coinbase Global Inc, the biggest U.S. cryptocurrency exchange, watch as their listing is displayed on the Nasdaq MarketSite jumbotron at Times Square in New York, U.S., April 14, 2021. REUTERS/Shannon Stapleton ·Shannon Stapleton / reuters
However, tensions between regulators and industry players are rising, as a viral Twitter post by Coinbase CEO Brian Armstrong illustrated last week. The friction brewing between Armstrong and the SEC centers on Coinbase's plans to launch a crypto lending product, Coinbase Lend, later this year.
With a proposal offering a 4% annual percentage yield (APY) on USD coin (USDC) — a stablecoin pegged to the U.S. dollar — the lending product is lower than other crypto lending businesses according to what Armstrong revealed over Twitter. However, the SEC still classified the product as a security.
Coinbase's chief isn't alone in taking issue with regulators. Other crypto market players have publicly expressed frustration with the SEC, which is also reportedly probing the popular decentralized finance (DeFi) platform UniSwap.
“This is how the SEC regulates,” Caitlin Long, a Wall Street veteran who's currently CEO of crypto bank startup Avanti Financial, told Yahoo Finance in an interview.
“They will try to move a whole market by picking an example. What’s interesting and frustrating to us in the [crypto] industry is that the industry has been collectively asking the SEC for clarity on some of these very issues for years," she added.
They aren’t providing much in the way of proactive guidance but rather leaving founders to read the tea leaves based on enforcements... But the enforcements are patchy and scattered.Nic Carter, crypto investor
Long and others have criticized this approach, calling it "regulation by litigation." Georgetown's Aggarwal and those on Capitol Hill have pointed out that it isn't clear whether the SEC has the authority or resources to regulate other parts of the market, such as the fees associated with crypto exchanges.
"Funding-wise we could use a lot more people," Gensler admitted on Tuesday. "There's 6,000 projects. Some of those are commodities, many of them are securities under the laws and many of the platforms are."
While pinning down the SEC's next moves in the crypto sector remains difficult, the larger concern expressed by advocates, and the policy-minded in Washington who disagree with Gensler, is that the commission's current approach lacks clarity.
Jennifer Schulp, a former FINRA attorney and current Director of Financial Regulation Studies at the Cato Institute, said that one key problem Gensler put on display this week is that determining whether a digital asset is a security remains far from clear.
Gensler's "assertion of authority is based on a lot of assumptions about the facts and circumstances of a myriad assets," Schulp told Yahoo Finance.
"This lack of clarity, coupled with the SEC’s insistence at bringing these assets within an ill-fitting securities regulation framework, risks hampering innovation at the expense of so-called investor protection," she added.
Representations of cryptocurrencies Bitcoin, Ethereum, DogeCoin, Ripple, Litecoin are placed on PC motherboard in this illustration taken, June 29, 2021. REUTERS/Dado Ruvic/Illustration ·Dado Ruvic / reuters
Nic Carter, partner at the crypto-focused venture capital firm, Castle Island Partners, said the SEC's current regulatory framework for crypto assets is completely fair, but there's a lot more to be desired.
"They aren’t providing much in the way of proactive guidance but rather leaving founders to read the tea leaves based on enforcements... But the enforcements are patchy and scattered," Carter explained.
Other companies with a crypto lending business, such as crypto wealth management firm Abra, avoids regulatory scrutiny by using a "bank trust based model for offering yield on crypto custody," CEO Bill Barhydt told Yahoo Finance in an interview this week.
This safer approach includes Know Your Customer (KYC) protocols through a Nevada-based chartered trust company called Prime Trust.
"All users go through Onboarding for those trust accounts via the Abra App. Interest (yield) on crypto holdings, including Bitcoin, Ethereum and USD stablecoins is paid via Prime Trust," said an Abra spokesperson.
Prime Trust is a chartered trust company regulated by the banking commissioner’s office at the Financial Institutions Division. Their clients also include crypto exchanges such as Kraken and Binance.US.
Abra faced its own brush with the SEC more than a year ago, when the regulator fined the firm $300,000 for offering clients tokens that mirrored the performance of stocks and shares of exchange traded funds (ETFs). Large exchanges such as FTX have managed to offer tokenized equities by not making them available to U.S. investors.
Now with $1 billion in assets under management, Abra appears to have recovered, thanks to success in their private client services business that has expanded dramatically over the past six months, according to Barhydt.
"Generally these are wealthy clients looking for a very high touch experience," he added.
At the close of its latest funding round, Abra raised $55 million with backing from venture investors including Blockchain Capital and Amex Ventures.
David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.
