If the SEC Cannot Regulate Digital Asset Trading, Who Can?

By: Evan Dubow

April 15, 2022

The digital asset industry has experienced unprecedented growth within the last three years. This monumental growth has led countries such as the United States and China to take extremely different approaches to protecting its investors from risks including fraud, lack of traceability, and unpredictable volatility. Undetectable and untraceable, the United States and China have contemplated and attempted drastically different approaches as to how to regulate the multi-billion dollar digital asset industry.

Digital assets have been used to facilitate illegal transactions and fraudulent transfers or holdings since their inception. This illegal nature has continued to follow cryptocurrencies into more recent times in other ways such as ponzi, pump-and-dump, and other schemes designed to defraud investors.

Today, with the influx of many regulation-compliant investors looking to invest in digital assets and use them for legal cross-border transactions and transfers, illegal schemes have become more and more prominent, which has prompted the need for countries to act quickly to attempt to implement measures to protect their constituents.

One terminal for which the United States has implemented somewhat successful regulatory measures is through digital asset exchanges that record and report who withdraws and deposits funds, the amount of each transaction, and when the transaction occurs. Said measures have enabled some transactions and conversions into fiat currencies to become trackable and taxable. Regardless of these efforts to trace and tax digital asset transactions, billions of untraceable dollars are kept in peoples’ offline wallets and transferred without the use of these domestic exchanges.

As a result, the United States does not have a clear regulatory scheme for holding and transferring digital assets; while the SEC defines certain cryptocurrencies as a security, the Commodity Futures Trading Commission (CFTC), Internal Revenue Service (IRS), and Treasury Department’s Financial Crimes Enforcement Network (FinCEN) classify cryptocurrency differently to give themselves the “authority” to regulate the industry. By doing so, the jurisdictional authority of each agency is blurry at best.

The Crypto-Currency Act of 2020 sought to resolve the federal government’s current regulatory confusion over cryptocurrency. Specifically, it creates three categories of cryptoassets: cryptocurrencies, cryptosecurities, and cryptocommodities. The Act also divides the regulation of those assets between Fin-CEN, the SEC, and the CFTC, respectively. While this Act has provided necessary guidance in the industry, it is still generally unclear as to how a regulatory agency would gain a firm grasp over peoples’ digital transactions outside of exchanges and offline holdings.

Drastically different than the United States’ approach, China cracked down on the digital asset industry by imposing broad, draconian sanctions on the use and holding of digital assets altogether. As of September 24, 2021, the People’s Bank of China banned all cryptocurrency transactions within the country, with no exceptions.

China’s reflection on this measure revealed that it resulted from significant concerns with the ability of digital assets to completely evade domestic transaction terminals and financial oversight, including but not limited to taxation. Another primary concern was the lack of ability to trace and regulate foreign currency inflow and outflow.

Another key distinction between the United States and China is defining digital assets as “securities” or “currency”. While cases such as Securities and Exchange Commission v. Shavers United analyze whether Bitcoin and like investments are securities under the Howey test, and hold that they are, China analyzed cryptocurrencies as “currency” and further declared that bitcoin simply could not function as a currency in the absence of legal tender.

While such harsh measures likely could not survive in a western-style government structure, it is important to contrast the different approaches taken to digital asset regulation between the United States and China. With the successful banning of the use of currencies seeming initially successful in China, it begs the following question among regulators in the United States. Is anything short of an outright ban anything more than minimally effective in protecting domestic holders and investors in the digital asset industry?

Given the several case law holdings that bring cryptocurrency under the securities umbrella in the United States, and the current unclear regulatory landscape, United States investors may continue to invest and utilize digital assets while the government often cannot track, regulate, or tax their holdings. Simultaneously, Chinese investors may not invest, exchange, or utilize any type of digital assets without facing large liability exposure, including government-issued sanctions, fines, and other punishments imposed by the People’s Republic of China.

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