SEC And CFTC's Early Regulations On Cryptocurrencies Are Here: What It Means For Market Participants

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Summary

The CFTC has been validated on its stand that cryptocurrencies are 'commodities' and hence it has the power to regulate them.
The SEC will be making it mandatory for crypto platforms to register with regulators.
Bad players will make a rush to get out of the cryptocurrency market.
Existing players in the cryptocurrency space will either have to clean up their act or make way for more established players.
Investors and speculators can expect several benefits when regulations come into play.

People who have read my previous articles would be aware that I have advocated for regulations on the cryptocurrency market, calling them imminent. That's not because I am pro- or anti-cryptocurrencies, but because as a securities professional I know that for any market - with sizeable assets and participants - to survive it is crucial for it to be properly regulated. Well, my prediction regarding regulation to be imminent has come true pretty soon.

In the last two days, we have seen two big news coming from the cryptocurrency space, both related to regulators. The first was a ruling from a federal court, which agreed with Commodity Futures Trading Commission's (CFTC) assessment that cryptos are commodities and should be regulated like commodities. The second news, which also came as a shock for crypto participants, was the Securities and Exchange Commission (SEC) releasing a public statement in which it reiterated its stand and strongly advised crypto platforms to get registered if they want to continue doing business in the United States. Before getting into how these events will impact participants in the crypto market, let us take a closer look at both these stories.

CFTC Is Validated

Back in 2015, in a case related to a Bitcoin Option trading platform that was offering derivatives on Bitcoin illegally, the CFTC had issued a press release in which it remarked, 'CFTC Holds that Bitcoin and Other Virtual Currencies Are a Commodity Covered by the Commodity Exchange Act.' In the same release Aitan Goelman, then CFTC's Director of Enforcement, had commented:

While there is a lot of excitement surrounding Bitcoin and other virtual currencies, innovation does not excuse those acting in this space from following the same rules applicable to all participants in the commodity derivatives markets.

This determination of cryptocurrencies being commodities by CFTC was validated by a federal court in Brooklyn on Tuesday. In a case concerning a New York-based cryptocurrency trading advisory company, Judge Jack Weinstein of the U.S. District Court for the Eastern District of New York upheld CFTC's view that virtual currencies are 'commodities' and hence the agency has the power to regulate them.

SEC Makes Registration Mandatory For Crypto Platforms

The SEC had already made its stand on cryptocurrencies clear in a statement it released last December. In that statement, SEC Chairman, John Clayton had said:

On cryptocurrencies, I want to emphasize two points. First, while there are cryptocurrencies that do not appear to be securities, simply calling something a “currency” or a currency-based product does not mean that it is not a security. Before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, its promoters must either (1) be able to demonstrate that the currency or product is not a security or (2) comply with applicable registration and other requirements under our securities laws.

If one goes through that whole public statement, it is clear that the SEC wanted to communicate to operators in the crypto space that either they will have to prove that the crypto product/token/coin they are offering or allowing to be traded on their platforms is not a 'security' or they will have to register with the agency and/or other regulators.

In its latest public statement that the SEC released yesterday, it has left no room for ambiguity regarding who should register with regulators. Whether a crypto company is operating as an exchange or a platform to exchange cryptocurrencies or as an ICO adviser or even just as a service provider offering digital wallets, it will have to either register with SEC or with other regulatory bodies. Check out the comments that the agency has made regarding the same:

"A platform that trades securities and operates as an "exchange," as defined by the federal securities laws, must register as a national securities exchange or operate under an exemption from registration, such as the exemption provided for ATSs under SEC Regulation ATS."
"An entity seeking to operate as an ATS is also subject to regulatory requirements, including registering with the SEC as a broker-dealer and becoming a member of an SRO."
"Some online trading platforms may not meet the definition of an exchange under the federal securities laws, but directly or indirectly offer trading or other services related to digital assets that are securities. For example, some platforms offer digital wallet services (to hold or store digital assets) or transact in digital assets that are securities. These and other services offered by platforms may trigger other registration requirements under the federal securities laws, including broker-dealer, transfer agent, or clearing agency registration, among other things."

Following the release of this public statement from the SEC, major cryptocurrencies took a big hit.

^{(Source: TradingView, Exchange: BITFINEX, BTC/USD)}

^{(Source: TradingView, Exchange: BITFINEX, ETH/USD)}

These moves reveal that a mere public statement from SEC asking for crypto companies to register with regulators is enough to send the cryptocurrency market crashing.

What is the inference we can draw from this?

The inference is simple, crypto markets currently are rigged and have a lot of 'bad actors'. Whether they are dubious exchanges, market manipulators or highly leveraged speculators, any threat of regulatory oversight makes them nervous. This nervousness results in them cashing out of the markets in a hurry, thereby punishing even the honest market participants. So, what will happen when regulators come in full force against the bad actors? Read further.

Impact on Crypto Platforms

After going through what the CFTC, SEC and the FINRA have been reiterating over the past few months, it is clear that crypto platforms will have to clean up their act. There have been too many hack attacks, malfunctionings, unfair practices and sudden crashes. All this will have to go. Here is what will happen-

Existing players, those who have been conducting their business in a reasonably fair manner, will either have to register and be accountable or they will die.
New startups in the space, especially those launching ICOs with different applications of the blockchain or distributed ledger technology (DLT) apart from cryptocurrencies will not only have to register, but they will also have the additional burden of proving that the reasons they are collecting funds from the public or private investors are valid.
Those platforms that are in the strictest sense 'cryptocurrency' platforms (and have nothing to do with other applications of the blockchain or DLT) will still have to register, if not with SEC then at least with the CFTC or FINRA.

While all the above points are for companies and startups that have only been working in the crypto space, there is also a case to be made for established companies that are planning to or have already entered the space.

At the end of January this year, Square Inc (SQ) launched a service for users of its Cash app (barring those in New York, Georgia, Hawaii, or Wyoming) which allows them to trade in Bitcoins. A month later, free stock trading platform Robinhood released 'Robinhood Crypto' for a select group of customers, a service that currently gives them access to buy and sell Bitcoin and Ethereum. They are not alone. In my last article, I discussed how Paypal Holdings Inc (PYPL)'s recent patent suggests that it is actively working on entering the crypto space and the benefits it will derive by doing so. Now, all these players are credible names in their respective industries. They all are financial firms with established track records, so compliance and regulations are not new to them. It is obvious that when a reliable regulatory framework is established in the crypto space, these firms will have an upper hand over lesser-known or nonestablished players.

Impact on Crypto Investors and Speculators

Whether someone is a crypto investor or speculator, I don't see how regulations can negatively impact them. Yes, I know that one of the hallmarks of cryptocurrencies, something that is touted often, is that they are free from the control of governments and central bankers and thus can't be manipulated with. However, as I have made clear earlier, the government or more specifically the US government and regulatory bodies like SEC, CFTC, FINRA are not proposing a control over cryptocurrencies. All they are interested in is to make sure that the crypto market, like any other financial market, is robust and is free of bad actors. There are several benefits that regulations will bring including, but not limited to:

Less Volatility - With bad actors and manipulators out, the crypto market will become less volatile than what we have seen recently. This actually will help in increasing the user base of cryptocurrencies as more and more merchants will feel comfortable in accepting payments in cryptocurrencies.
Higher prices - This is a continuation of the first point. When the user base of cryptocurrencies will increase, it will lead to an increase in demand. As we all know, or have been told by crypto enthusiasts, the supply is limited. So, the chances of cryptocurrencies rising in value are more when they are subject to a regulatory framework than when they are not.
Safer environment to transact - Hack attacks, thefts etc. will become less common as regulations will ensure that any platform providing cryptocurrency services (exchanges, digital wallets, and others) have a suitable infrastructure to safeguard customers from such attacks.
Right to collect damages - Even when hack attacks, theft, manipulation or unfair practices are encountered, regulations will ensure that the aggrieved party has a chance to collect compensatory or punitive damages for the losses suffered, which is presently not possible.

This article was written by

Rian Insights

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Often fooled by randomness, yet driven by curiosity, trying to find needles in a haystack.My investment philosophy can best be summarized by this quote from James 'Jim' Grant, founder of Grant's Interest Rate Observer:"To suppose that the value of a common stock is determined purely by a corporation's earnings discounted by the relevant interest rate and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed." I post my analysis here on Seeking Alpha primarily to keep a journal that records my thoughts about a company (industry) as I am learning about it, and secondarily to avoid hindsight bias in the future. Writing helps me to deepen my understanding of companies and industries. It also helps me to process my thoughts and keep a track of the industry (or stock) I might find worthy of investment. I am not on Seeking Alpha to sell or promote any stock, product or service. Any article or blog post I publish is not an investment recommendation and should not be relied upon when making investment decisions - investors should conduct their own research.

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First, government regulation in any form adds significant operating (especially accounting and reporting) expenses and associated other legal and tax liabilities. The economic and legal playing field for private cryptocurrencies is becoming more level with all other payment platforms. The US government in their typical methodology has laid out their interpretation of the laws they will use to force compliance of all cryptocurrency exchange with US currency. Economically, this is a disaster for private cryptocurrencies because it means that their greed trade will become non-existent as their ability to compete with other regulated and established payment becomes obviously non-existent as well. The only good news is that blockchain will eventually be basis of all payment platforms, at least for larger transactions and those transactions will be more secure. Unfortunately, these benefits support established payment platforms that already dominate the market far more than newer startups like cryptocurrencies.

Cryptocurrencies have essentially become legally recognized for what they technically always were (without their quasi-legal greed trade) - just another technological electronic payment platform option using the blockchain technology base. If you look at the use of BitCoin and most other current cryptocurrencies - their use as a retail payment devices is still a fraction of a percent of other methods. Their acceptance as a retail payment method has not and is not growing significantly. Removing their greed trade attraction essentially leaves them with only their competitive economics as payment platform - which is next to nothing competitively with other major payment companies.

As major payment platforms such as credit card companies, PayPal, banks and others deploy blockchain technology in their own payment platforms - and regulatory requirements are the same for all of them - those major payment platforms gain even more control of the payment market of which they already totally and absolutely dominate. Once the greed trade disappears from private cryptocurrencies, as is inevitable as their regulation ensues, and the mythical nature of private cryptocurrency anonymity becomes more broadly recognized - there is really nothing left to warrant private cryptocurrency economic existence.

The nature of the private currency (including cryptocurrency) economic evolutionary path has always been historically (3,000 years without deviation) obvious to those who were historically informed of the associated economic limitations to private currencies of all types. As cryptocurrencies have become significant in the equity markets their regulation became inevitable and their economic fates - assured.