As America stumbles toward the 2024 election, the crypto industry appears bent on getting itself a new set of rules. With a comprehensive pro-crypto restructuring of financial rules apparently stalled in the Senate, the industry is seeking passage of a narrower, though equally weak, framework.
As of June, the industry has collectively donated over $160 million to Super PACs. They’ve already successfully urged Congress to repeal Securities and Exchange Commission guidance on how banks and other firms should account for crypto on their financial statements, though they failed to get enough members to override President Biden’s veto of the repeal. Now, they’re pushing for passage of customized legislation that would pull regulation of the crypto industry away from the SEC and toward industry leaders’ strongly preferred regulator: the Commodity Futures Trading Commission (CFTC).
The CFTC’s total staffing and budget are about one-sixth of the SEC’s, which would make it harder for the agency to conduct examinations and oversee the volatile but growing crypto industry. But much more significant, and likely attractive to the industry, is that the CFTC lacks most of the rules the SEC has put in place to protect retail investors and ensure a fair marketplace.
The push for CFTC regulation comes primarily from crypto brokers, exchanges and asset managers — the intermediaries of crypto trading. It’s not impossible for these intermediaries to adhere to the SEC’s rules. They just aren’t doing it.
Compliance could derail their ability to attract retail customers, many of whom unwisely invest their savings into these highly volatile assets without information critical to sound investing. In other words, complying with SEC rules that ensure a fair marketplace could cause the crypto industry’s customer base and profit margins to shrink.
Although crypto advocates claim that the CFTC’s authorizing statute is similar in many ways to the SEC’s, this argument ignores the robust rules established over decades by the SEC and the Financial Industry Regulatory Authority (FINRA), an industry-funded independent organization that sets the rules for securities brokers and dealers.
Three key issues illustrate why these rules are so important.
First, the fundamental problem with CFTC regulation is that, by design, the agency does not focus on retail investors. It was established in 1974 to regulate complex financial contracts called derivatives, the value of which is based on an underlying asset and which are often used to hedge against risk in agricultural, oil and gas, manufacturing and other industries. Retail investors and consumers generally do not participate in derivatives markets.
Because of this, the CFTC never developed a comprehensive set of requirements to protect retail investors. By contrast, the sellers of securities are required both by law and by SEC rules to make detailed disclosures about their operations, assets, governance, risks and financials. And those disclosures must be updated regularly, as they change over time.
Even though much of crypto is marketed and sold as projects and companies looking to raise money to do things (similar to companies that sell securities), crypto firms and brokers typically have not made disclosures anywhere close to what the SEC requires. CFTC regulation could ensure that they’ll never have to make those disclosures.
Second, the SEC and FINRA have adopted and enforced extensive rules on how securities may be marketed and sold to customers by intermediaries. Regulating intermediaries in this way has profound effects on marketing and access to customers. There’s nothing like these rules at the CFTC — which probably is just the way the crypto industry likes it.
Lastly, although derivative contracts are complex instruments, the markets where they’re traded are relatively simple. For example, when a futures contract — a type of derivative contract to buy or sell assets at a fixed price to be delivered in the future — is listed and traded on the Chicago Mercantile Exchange, it is generally only tradeable there. In the securities markets, by contrast, there are more than a dozen exchanges and hundreds of other regulated trading venues for trading the same share of stock. Securities markets are a complex web, so the risks are different.
In fact, the difference between these two markets is where a lot of the money in crypto comes from. The crypto industry, including the brokers and exchanges, know how to exploit differences in prices at different venues. They also know that complex SEC rules both dramatically limit the fees they can charge and constrain their profits.
So, while the language of the law governing the CFTC may look similar to language in the foundational securities laws, the rules created by the CFTC and its self-regulator almost completely lack the framework of protections developed over 80 years for securities trading.
Attempting to recreate something like the SEC’s regulatory regime under the CFTC would not only be outside of its expertise (and way outside its budget), it would be inefficient and unnecessary. Nor is it likely to result in robust oversight of the industry or fair markets for investors, especially retail investors like the average Americans who invest in crypto assets.
The shortcomings of the CFTC as a crypto regulator, the stalling of the industry’s dream bill and the industry’s recent lobbying sure make the current rush to pass crypto-friendly rules look like a desperate election-year gambit.
Alex Thornton is the senior director for Financial Regulation Policy at the Center for American Progress.