SEC Takes a Closer Look at Cryptocurrency Regulation

rather avoid. The Securities and Exchange Commission. For the first time, the SEC's Office of Compliance, Inspections and Examinations put cryptocurrencies and initial coin offerings on a list of priorities that inspectors will scrutinize this year at the financial firms and advisors the agency overseas. What will the impact be here? To tell us that and more is Robert Hockett, a professor at Cornell Law School. So, Bob, what does being

a top examination priority for SEC inspectors mean? Well, it basically means that the SEC will join the CFTC now in monitoring the markets for cryptocurrencies, watching them very carefully with an eye to a couple of things. The first is it really kind of contained in that prefixed crypto and the word cryptocurrency, so as that prefix would suggest cryptocurrencies are terrific vehicles for money laundering, for the financing

of terrorism, and other sorts of illicit activities. Uh. And so there's some concern at least that some of the cryptocurrencies are being used for illicit, illicit purposes, and so they're going to be viewed with that in mind. The other reason, or the other significance here is that cryptocurrencies have become a bit like um other fat investments, like junk bonds, say in the nineteen eighties, or sub prime back mortgage so probably mortgage backed securities in the early

two thousands. They become the object of a sort of fad uh investment craze, and a lot of people have been borrowing in order to buy them, and indeed some people have even taken out mortgage loans, believe it or not, in order to speculate on these things. That of course leads to systemic danger of the kind that the subprime mortgage boom did, and SEC and other regulators have their eye out for that now as well. Bob, The SEC says that digital currencies fall under its oversight. Is that

definitive and what does that mean? As far as SEC registration requirements? And the like. Yeah, so I think maybe it's best to think of cryptocurrencies as following within, falling within a sort of overlap between the jurisdiction of the SEC on the one hand and the CFTC on the other. And that's because cryptocurrencies are in some ways like a kind of commodity like gold or some of the precious metal of the sort that the CFTC concerns it with.

But they're also a bit like securities basically, uh, financial claims of the kind that the SEC is concerned with either way, right. Either whether it be whether cryptocurrencies be thought of as commodities or securities, it all basically comes down to the same thing. It basically means that they're subject to careful monitoring by financial regulators, be they the

CFTC or the SEC or both in common. Uh. And when the regulators are watching over them, are the markets for these things are watching for a couple of things, basically the things I mentioned at the top, um the possibility of fraud and double dealing that kind of thing on the one hand, uh and um, you know, sort of systemic danger through hyper investment which can lead to

a bubble behavior on the other hand. The announcement about this new list and it being on the new list comes one day after SEC Chairman Jay Clayton identified regulatory gaps surrounding cryptocurrencies in a Senate Banking Committee oversight hearing. Are those gaps serious? Well, they would be serious if the regulators weren't looking at them right, weren't watching them. Um. But as it happens, they're not serious now that the

regulators are kind of keeping an eye on them. Because the regulators have all of the jurisdiction they need to act right. That's largely thanks to Dodd Frank. Arguably they would have had that jurisdiction even before Dodd Frank, but there's no doubt about it now that they have the jurisdiction, and furthermore that they have concurrent jurisdiction right, the regulators tend to work together now thank to the f sock arrangement that we find in Dodd Frank, in a way

that they didn't do as well before. So um. In effect, what Clayton has said is that, well, there would be a gap if we weren't exercising oversight, and the fact that he's expressing an intention to exercise oversight effectively closes what gap there would have been at that here in Clayton and CFTC Chairman Christopher gene Carlo call for greater oversight of cryptocurrencies, but they didn't propose measures to sharply curve the industry, and that led to a sort of

sigh of relief from traders and gains for bitcoin. Should they have been tougher, um, I don't know that it's necessary to be tougher thus far. I mean, at the moment, what they're doing is signaling that they've got an eye on things and that they're actually going to be intervening as necessary. At present. I think what we're seeing is the potential for significant danger, but we're not seeing the actual manifestation in a big way of that danger as

of yet. In particular right the thing that was most resome for me at least, and I suspect for a lot of other sort of macropudentially oriented finance regulatory ups um was the news that came out in back in November in December to the effect that people actually, we're taking out mortgage loans in order to speculate on these things.

And that's that's the kind of thing that leads to systemic risk, systemic problems that basically endanger the entirety of the financial system and indeed even the broader middle class economy.

Until you get into that, the dangers are much more sort of restricted to just those people who engage in idiotic trading behavior, and we're not really as concerned, um, you know, to sort of protect people against their own idiocy as we are to protect innocent parties who can be damaged when idiotic behavior spills over, which of course it does when you've got a lot of borrowing going

on in order to speculatively purchased things. So, speaking of that, America's biggest banks have moved to ban their customers from using credit cards to buy bitcoin or other cryptocurrencies. What are their concerns? In about a minute, it's it's the

same kind of concern basically doing. What you really worry about is any time anybody can use credit to speculate on the prices of any kind of exotic new investment vehicle, especially some some some such vehicle that's the object of a fad, that's when you worry, because, of course, then if the asset in question suddenly plummets in price, as bitcoin has done. You've got a lot of people who owe more than they own because the debts don't go

down with the assets themselves. When you get people in debt in that way, people underwater, you get debt deflation. That's essentially what we went through after the two eight crash, and neither banks nor regulators want to see that happen again. Thank you for your insights as always, Bob. That's Professor Robert Hockett of Cornell Law School. Thanks for listening to the Bloomberg Law Podcast. You can subscribe and listen to the show on Apple Podcasts, SoundCloud, and on Bloomberg dot

com slash podcast. I'm June bralso this is Bloomberg