This is the first of a three-part series based on Gary Gensler's extensive prior public statements on crypto. Here are parts 2 and 3.
As the heir-apparent to the Chair of the Securities and Exchange Commission, Gary Gensler’s most critical role in the future of crypto will be his thoughts on how cryptocurrencies intersect with securities regulation.
Where crypto meets the SEC
The SEC has been a focal point for the crypto world’s attention for a long time. While its initial enforcement actions in crypto were largely limited to overt fraud, the 2017 DAO Report was its entry into even the best-intentioned of projects. It was that report that determined that crypto pre-sales could fall into the category of securities offerings.
In the intervening years, however, the SEC has frustrated the crypto community with its lack of clear definitions as to which tokens would not fall into the category. This is a big deal because issuers of securities are subject to rigorous reporting requirements that, critically, complicate the path towards decentralization.
Real-time thoughts on SEC entrance into unregistered offerings
While Gensler left public office as Chairman of the Commodity Futures Trading Commission back in 2014, in the years since he’s left an extensive body of work allowing us to glean at least some insight into his thoughts on initial coin offerings. Not least among these are the actual lectures from his time at MIT, videos of which come from the fall of 2018, at the tail end of the ICO boom. Which Gensler noted:
“The majority of ICOs have failed already. And because they keep failing so fast — by the end of this year or certainly by the middle of next year, over 90% or 95% of them will have failed if you take the whole total. So it's pretty clear it's going to come down”
Indeed, Gensler lectured on ICOs just days after the SEC made clear that it would start pursuing ICOs for failure to register: “For the first time, they really talked about illegal securities offerings. So they used the word illegal. And they're starting to get to the place where they're shutting some of these down that were not necessarily scammy or fraudy, but just saying you didn't register.”
The commodities
Bitcoin, based on its decentralized network and the lack of an issuer — aided by the mystery behind the identity of Satoshi Nakamoto — gets treatment as a commodity throughout the U.S. It’s a status that many other networks aspire to.
At the time, Gensler had positive things to say about projects like Ethereum and Filecoin, but did acknowledge that Ether benefited from being so early, saying that he would consider it a security:
“Ether: We'll talk later in the semester as to whether that was really a securities offering. I've publicly said I think so, but that was in 2014. And in 2018, the Securities and Exchange Commission has said, ‘regardless of what it might have been in '14, it's now sufficiently decentralized that we'll consider it not a security.’”
Similarly, Gensler was quick to point out that given the market dominance of Bitcoin and Ether, even amid the rush to fund ICOs, the bulk of crypto investment was not in securities at all:
“So we already know in the U.S. and in many other jurisdictions that 3/4 of the market are not ICOs or not what would be called securities, even in the U.S., Canada, and Taiwan, the three jurisdictions that follow something similar to the Howey Test that we've talked about. 3/4 of the market is non-securities. It's just a commodity, a cash crypto.”
Whether Gensler agrees with predecessor Jay Clayton that every ICO he’s seen has been a security is in doubt, however.
The saga of the SAFT
The Simple Agreement for Future Tokens, or SAFT, was an important legal framework that many of the biggest ICOs of all time followed. The largest ICO to date, EOS in some ways led the charge by splitting the investment contracts it sold from the actual token distribution, but Block.one did not use a true SAFT.
The biggest SAFT ICO was Telegram, which raised $1.7 billion on its prospective GRAM tokens in the first half of 2018. In June of 2020, the SEC won a final legal judgment to cut off distribution of those tokens before the network even launched. At the time of the initial case, Telegram and the SEC were stuck arguing about how functional the actual network had become independent of Telegram — a critical determination when you are talking about decentralization.
While impressed with Telegram as a firm was skeptical about what function the actual GRAM tokens were supposed to be performing to merit their $1.7 billion valuation. Overall, he questioned the value of the bulk of ICOs being based, as they were, on prospective ideas rather than written code: “How do you really get to the value of a token when there's so little written in these white papers about this specificity?”
It seemed that Gensler was, overall, pretty unimpressed by the SAFT framework, saying of the writers of the initial whitepaper that “I think they were wrong, by the way.” However, he did have positive things to say about Filecoin, which ran an ICO using the SAFT framework to raise a quarter billion dollars.
“Filecoin seemed to be a good-faith concept about using a token to motivate the exchange of file storage,” said Gensler, before getting more skeptical: “They raised the money in October of 2017. It's 13 months later. They still do not have a live network. And the latest announcement says it will come either in the first or second quarter of 2019. Some people might call that a scam. I wouldn't.”
Filecoin’s network launch delays became a running joke, but the network did indeed launch near the end of 2020 and seems to be functioning as well as anyone could hope, with a circulating market cap of over a billion dollars and, theoretically, another $49 billion in value to come. Indeed, Filecoin seems to be the success story of the latter days of the ICO market, which Gensler was prescient enough to identify two years ago.
A reckoning for Ripple
Ripple’s relationship to XRP has historically been extremely controversial, with the firm running what many consider an extended ICO since 2013. Gensler was very open that he considered XRP to be a security as an investment in Ripple, an opinion that it would be another two years before the SEC would bring to court to fight for:
“Yes, I do think it's a non-compliant security. But this will not be resolved just by the Securities and Exchange Commission. It will be resolved by some courts, whether it's appellate courts or the Supreme Court.”
Given that Gensler will inherit the suit against Ripple, his attitude toward the company is critical. For comparison, another former CFTC Chairman, J. Christopher Giancarlo came out in support of XRP’s status as a currency last summer. Obviously, Ripple would prefer the commission to see it this way. Gensler, on the other hand, lambasted Ripple’s lack of use case — a critical part of demonstrating that a token does not depend upon the third party behind it in the same way that a stock does upon its issuer:
“For four years, you had no use of XRP, as I understand it zero use. Today, it's the second highest-valued cryptocurrency. It's past Ethereum with the fall-off of the value of Ethereum and Bitcoin. And at $18 billion, I couldn't tell you what it's worth. I can tell you that's what coinmarketcap.com says they're worth. But their revenue model is selling XRP in that case.”
Overall, Gensler’s mentality doesn’t seem to represent a sharp divergence from what the SEC has already said. He is, however, quite prepared to identify specific areas of concern for future ICOs, which seems a strong basis for future policy.