Regulation by Enforcement: Problems with the SEC’s Approach to Cryptoasset Regulation

Carol R. Goforth

On August 3, 2021, Securities and Exchange Commission (“SEC”) Chairman Gary Gensler specifically told a global conference on crypto that Congress needed to “give the agency more authority to better police cryptocurrency trading, lending and platforms, a ‘Wild West’ he said is riddled with fraud and investor risk.” He has repeated these themes multiple times, including in testimony at hearings before the House Financial Services and House Appropriations Committees. In addition, on September 14, 2021, when he testified before the Senate Banking Committee, he reported that “clarity is needed from Congress on how the federal regulatory agencies can work together on crypto issues.” Gensler has repeatedly been quoted as having complained that crypto lending is so underregulated that it is still like the “Wild West.”

In order to explain how the SEC has, in effect, been regulating by enforcement and to illustrate the problems with this approach while advocating for a legislative response, this Article is divided into five Parts and a conclusion. Part I of this Article offers a brief and high-level overview of the development of cryptoassets and their functions, as well as associated products that the SEC is claiming are securities. Part II offers an equally high-level explanation of how such interests have generally been regulated in the United States, with an emphasis on the test most often used by the SEC to determine how the securities laws apply. Part III examines four distinct instances that illustrate how the SEC’s approach to crypto has evolved and some of the open questions causing confusion in the crypto ecosystem. Part IV considers what it means for the SEC to be “regulating by enforcement” and why that approach is suboptimal. Part V offers some suggestions of how Congress might address the question of how cryptoassets should be regulated. This Article concludes by determining that regulation by enforcement is an inefficient and ineffective way to proceed, and that congressional intervention is likely to be necessary to resolve the problems that now exist in the crypto ecosystem.