Investor Alert: First Look – Regulators are Taking a Look at Cryptocurrency

By Eric Peters, Spring 2018 IAC Student Intern

SEC and CFTC Chairmen Jay Clayton and J. Christopher Giancarlo, respectively, published a joint op-ed in the Wall Street Journal on January 25, 2018 providing an overview of the approach regulators are taking to address concerns in the newly-emerging cryptocurrency markets. Many internet-based cryptocurrency trading platforms are not subject to direct oversight by the SEC or the CFTC, as they have been registered as payment services, an area primarily regulated at the state level. Given the increasing number of market participants engaging this newly-emerging market, including both retail and institutional investors, the SEC is taking a look at creating and enforcing new rules and regulations that foster innovation while promoting market integrity and confidence. This effort to investigate and regulate cryptocurrencies is warranted and needed, especially considering the great risk and reward inherent in these types of investments. 

The technological development laying the foundation for financial products such as cryptocurrencies and digital payment services is Distributed Ledger Technology (DLT), also known as “blockchain technology” or “distributed database technology,” used in a wide variety of new financial products.  Broadly speaking, DLT involves a distributed database maintained over a network of computers connected on a peer-to-peer basis, so that network participants can share and retain identical, cryptographically secured records in a decentralized manner.  The operation of DLT may involve the use of either a public or private network, potentially containing digitally represented assets (e.g. cryptosecurities, cryptocurrencies), where participants on the network conduct and verify transactions and record related data on the network in an encrypted format.

The first DLT network, centered on the issuance and exchange of bitcoins, was established as a public network, without any central authority, relying on network participants to verify transactions and record data on the network based on a certain protocol.  In contrast, private networks are permissioned networks, and only those entities that have been granted access can join them.  In any event, many have identified DLT as the next great driver of economic efficiency, and some have even compared it to “productivity-driving innovations such as the steam engine and personal computer.”

The key issue before market regulators is determining the correct framework in which to view these new-age investments and ensuring that whatever framework is chosen is effective and efficient for the digital era. The SEC must decide if our current, historical approach to the regulations of currency transactions is appropriate for new cryptocurrency markets, and take any action needed to provide transparency and integrity to the current regulatory framework to protect investors.  The CFTC and SEC, along with other federal and state regulators and criminal authorities are working together to achieve these ends in order to deter and prosecute fraud and abuse, a difficult task considering that these markets are new, evolving, and international. As such, the SEC, along with state, federal (including Congress), and international institutions must be forward-looking when considering new regulations. Given that these are new markets and regulators’ efforts to set and enforce rules continue to be shaped and reframed, investors need to be mindful that the risks are high and extreme caution should be exercised when seeking investments in DLT initiatives such as cryptocurrencies and initial coin offerings.