According to leading technology investors the blockchain is one of five major innovation platforms. While the blockchain is already more than 10 years old regulators have been slow to adapt so far. The technology was ignored as a niche phenomenon that would not impact the mainstream. However, after the blockchain industry grew to over 3 trillion USD market capitalization in 2021

regulators started to pay more attention. The quest for the approval of a Bitcoin spot ETF turned out as one of the main battlefields in terms of digital asset oversight. 

The FED vs Grayscale Bitcoin Spot ETF Lawsuit

In October 2021 the SEC approved a Bitcoin Future ETF product. This approval was the very first time that an ETF  with Bitcoin as the underlying value was approved in the United States. While the SEC approved Future based ETFs the proposals for a Bitcoin spot based ETF were rejected. 

The logic of the FED’s arguments for approving a Future based ETF and denying a spot based one did not make sense to many industry observers. For this reason Grayscale decided to sue the SEC for rejecting their Bitcoin spot ETF proposal in June 2022 arguing that the SEC would deny consistent treatment for similar investment vehicles. The main argument of Grayscale is that the Bitcoin spot and future markets are very much correlated and the spot and future assets are directly tied to each other.  

The case was brought in front of a panel of three judges at the District of Columbia Court in Washington with a hearing taking place in March 2023. At the hearing the judges ended up questioning the SEC’s decision to reject spot ETFs while future based ETFs were granted. As a response to the hearing the price of GBTC, Grayscale’s Bitcoin Trust, soared in the week thereafter as investors priced in higher odds that Grayscale will be able to convert its Bitcoin trust into a Bitcoin spot ETF. 

Sources on Twitter speculated that SEC insiders are expecting the FED to lose the case against Grayscale. If the SEC were to lose the Grayscale ruling it could mean that further Bitcoin spot ETFs would be able to get approval. This would be a catalyst for a renewed influx of institutional money and hedge funds into the space and would potentially lift the total cryptocurrency market capitalization back to higher levels. Investors looking to invest in the digital asset space should follow the case closely and keep themselves informed about investment vehicles such as Hedge Funds in order to obtain a position before an inevitably bullish Bitcoin spot ETF approval.  

Corporate Adoption and Fair-Value Accounting for Digital Assets

Several companies such as Microstrategy and Tesla hold cryptocurrency assets in their balance sheet. However, in the past they were not able to value these assets at market prices due to the applicable accounting rules. In 2022 the Financial Accounting Standards Board (FASB) suggested that cryptocurrency assets such as Bitcoin should be valued at their fair value which essentially represents the market value. The proposal has obtained voices of approval from Accounting Rulemakers. As a consequence the balance sheet of companies holding cryptocurrency assets would start reflecting the market prices of these assets. In the past the market prices could only be accounted for if a company sold digital assets. In March 2023 the FASB eventually issued a proposal that would enable the valuation of digital assets at fair value. At the current stage the proposal remains open for comments until June 2023. 

The SEC’s Crusade against the Digital Asset Industry

Since 2020 the SEC is in a lawsuit against Ripple for issuing an unregistered security. Ripple has spent significant funds in defending their position against the FED. In the second quarter of 2023 the lawsuit was still pending. If the SEC were to lose the lawsuit it could make it more difficult for the agency to establish oversight over the digital assets space and apply the almost a century old Howey test for the emerging asset class. In any case the lawsuit is expected to continue for several more years and is tying up resources at the SEC. 

After the collapse of FTX in November 2022 the Securities and Exchange Commission suddenly changed its regulatory stance towards digital assets. Gary Gensler had previously met several times with Sam Bankman-Fried, the founder of FTX, who misappropriated billions in customer funds. The fraud scandal associated with the exchange caused the SEC to approach industry players more aggressively. As a consequence, multiple Wells notices and  public statements against the digital asset industry were issued in the first quarter of 2023  and manifested the SEC’s crusade against cryptocurrencies. 

In the past years Ethereum has gradually migrated from a Proof of Work to a Proof of Stake consensus mechanism in a transition called the merge allowing exchanges to offer staking services to their users. In February 2023 the SEC stopped Kraken’s Ethereum staking program and classified it as unlawful. Kraken agreed to stop the staking program immediately for US customers. In the same month the SEC issued a Wells notice against Paxos the stable coin issuer of Binance’s BUSD. Additionally, in February 2023 the SEC opposed the takeover of the bankrupt crypto lender Voyager through Binance.  

In 2021 the SEC had approved the Coinbase IPO and enabled investors to purchase Coinbase shares in good faith that the business would be legitimate in the eyes of the regulator. However, less than 2 years after the IPO the SEC issued a Wells notice to Coinbase and threatened the company with legal actions with regard to its spot, earn, prime and wallet products. 

The public statements made by the SEC and the approach pursued by the agency to go after legitimate cryptocurrency businesses have raised concerns about the legitimacy of the actions of the federal agency. As notable cryptocurrency advocates have pointed out, major policy decisions should be made by congress and not by unelected officials. There is no evidence that the recent actions of the SEC are suitable to serve the core mission of the SEC which is to protect investors.

Resistance inside the SEC 

Despite the various attacks that the SEC has launched against the Web 3.0 industry in 2023 not all SEC Commissioners are negatively inclined towards the space. Commissioner Heister M. Pierce serves as one of the five Commissioners of the SEC and has repeatedly advocated for a fair treatment of the industry that is crucial for the innovation in the financial service sector in the US. Commissioner Heister has urged the SEC in public statements to engage in a constructive dialogue with industry participants and warned against over expanding its regulatory reach.

Regulatory Outlook

In 2023 the US Treasury Department investigated the risks associated with DeFi but so far did not suggest any policy recommendations that would change the legal framework for Decentralized Finance and cryptocurrencies in the United States. However, regulating cryptocurrencies and DeFi protocols is challenging since writing code that lives in smart contracts essentially represents free speech which is protected under the First Amendment. 

As long as the United States denies the digital asset space guidance on how to design legitimate products and services it risks that the innovation leaders in the space emigrate to other jurisdictions. This essentially can become a national security issue since the economic power of a country depends on the growth that comes along with innovative technologies. The next elections in the US are scheduled for November 2024 and the administration coming out of the election might follow a different path with regard to digital assets regulation

Non profit organizations such as Coin Center are raising awareness about the nature of blockchain technology and how to treat the tech stack within the existing legal schemes while at the same time enabling innovation to thrive. 

While the US agencies are following a harder stance towards digital asset regulation the situation is improving on the other side of the Pacific. Positive signals are coming out of China and in particular of Hong Kong that the administration is open to experiment with the technology. Apparently the trading of large cap cryptocurrencies for retail investors should be legalized in Hong Kong via licensed exchanges. The roll out to Hong Kong only serves as an experiment with blockchain technology for the Chinese administration. In addition the Chinese government enables a legal path for Web 3.0 companies to set up a shop in Hong Kong and develop groundbreaking technologies.  
The industry has matured significantly over the past years and new innovations such as Decentralized Finance have expanded the use cases within the realm of blockchain technology. At the same time the need for regulatory clarity especially in the United States has increased. It can be expected that more guidance will be given to the industry in the upcoming years. If legislators are lacking to provide this guidance it might be up to the courts to decide what is appropriate and what is not as it will be the case in the Grayscale lawsuit against the SEC with regard to a Bitcoin spot ETF.

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