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(Kitco News) – 2023 has seen a surge in legal and regulatory developments for digital assets, leaving many investors with unanswered questions and uncertainty about the future of the industry and how to invest in cryptocurrencies in a safe, secure, and legal manner.
To help provide insight into some of these developments from a legal perspective, Kitco Crypto had a conversation with Felix Shipkevich, a fintech regulatory attorney and Special Professor of Law at Hofstra Law School.
The first topic of conversation was the decision by Nasdaq to halt its plans for cryptocurrency custody due to regulatory uncertainty.
“My understanding is that Nasdaq is waiting for the New York State Department of Financial Services (NYS DFS) to issue Nasdaq the license so that custody of digital assets could be in compliance in the state of New York,” Shipkevich said.
He added that from a high-level perspective, Nasdaq just wants to get its ducks in a row so it can get the necessary licensing before it continues to pursue offering crypto custody services. “They just want to finalize, get that license, and then they probably restart that,” he said.
XRP
Turning to the recent court ruling that XRP is not a security and the exuberant response from the crypto community that followed, Shipkevich said the situation reminds him of the popular claw games at arcades and amusement parks where people sometimes spend large amounts of money for a chance to grab a cheap stuffed animal.
“It can be difficult to get one of those prizes,” he said. “The cryptocurrency space has been waiting to finally catch that duck or bear, and finally caught one. ‘I spent all this money. I have that little rubber ducky that costs 50 cents and I spent $50.’ It’s sort of that kind of phenomenon.”
“The XRP ruling, from a high-level perspective, was obviously like that rubber ducky or the bear that you picked out of that claw game, but it doesn’t necessarily answer all of the questions,” he said. “The case is still going to most likely proceed to trial on other counts, and there’s a possibility that the SEC might appeal the ruling.”
Shipkevich referenced the recent decision by the judge overseeing the SEC’s lawsuit against Terraform Labs in which the judge denied a request for dismissal and said that he disagreed with the XRP ruling that the token is not a security.
“Judge Rakoff completely disagreed, and actually specifically said in the decision in the Terraform case that he doesn’t agree with that ruling,” he said. “There are also a lot of unanswered questions in terms of, is it truly not a security for both institutional and retail investors?”
“So even though you won that 50-cent rubber ducky or that bear after spending $50, it doesn’t mean that you actually won the game, right?” he said. “That little win for the crypto space, in my professional opinion, is kind of silly because the space has been infiltrated with a lack of regulations or unclear regulations.”
Shipkevich referenced Bitcoin and the Whitepaper written by Satoshi Nakamoto to reinforce his position. “If you look at the crux and the foundation of Bitcoin, it was never meant to be security. It was just meant to be a payment instrument,” he said. “The fact that people hold the like assets doesn’t necessarily mean that securities. People buy cars and antiques, but that doesn’t mean that they are securities because they appreciate in value. This should not be a one size fits all approach.”
“So the reality is that I don’t know if the excitement behind the recent Ripple decision is really going to last for too long,” he said. “I’m not very optimistic. The real question is, is that going to be enough? I don’t think it’s enough. I think you’re going to have other federal judges, they’re going to probably have a very different approach. I congratulate Ripple on this decision, but I also don’t know whether that potentially will be overturned on appeal, if there’s going to be an appeal.”
He added that there is a possibility that this case (or a case with similar facts) could actually end up being litigated before the Supreme Court. “It might be a very important win for Ripple, but that doesn’t mean it’s an important win long-term,” he said. “Ripple may have won one battle, but they have not yet won the war.”
The real issue, according to Shipkevich, is that the SEC has been positioned as the primary leader in establishing regulations for the crypto industry, but failed for years to provide clear guidance to firms.
He cited the lawsuit against Coinbase as an example. “They were approved for an IPO and achieved a valuation of a hundred billion within days,” he said. “The SEC approved their publicly traded products and their services have gone through a comprehensive review. And now, all of the sudden, they’ve issued a request to stop trading everything but Bitcoin. It’s nuts.”
This development quickly took over the news cycle, pushing the XRP decision into the background, he said. “And the XRP ruling doesn’t stop the dozens of other lawsuits the SEC initiated, which could also overturn the decision or create bad laws. That’s why the Ripple decision has little effect on the macro picture.”
One area of the Ripple case that Shipkevich pushed back on was the use of the Howey test to judge whether an asset is a security or a commodity. The Howey case “involves orange groves in the State of Florida from the 1940s,” he said. “While we do take legal precedent, the products and the times have changed. We are applying a case from 70-plus years ago, and frankly, that case should not be applied in many instances when it comes to crypto. The courts should consider creating a modern approach and a reasonable standard to determine whether a crypto offering is a security. We need to stop the obsession over Howey, and enter the 21st century.”
“In my professional opinion, the Howey test should stop being the main pinnacle in this space,” he said. “We’re living in a different century, a different millennium.”
Gary Gensler and the CFTC
“Gary Gensler was the chair of the CFTC and has taken credit for the formation of very challenging compliance rules in the Dodd-Frank Act related to swap execution facilities, swap data repositories, futures commission for merchants, and major swap participants on the CFTC side,” Shipkevich said. “The objective was to regulate the swaps market so that we avoid another financial meltdown.”
“The problem was that the rules created under his guidance have become so difficult that we have lost a significant amount of the small to mid-sized companies in the commodities and futures spaces,” he said. “Many of the onerous laws and regulations under his helm had absolutely nothing to do with the financial meltdown of 2008. Many of the products defined as swaps should have never been categorized as such. Just look at the entire FX swaps category. I do not recall FX products and services being even remotely tied to the 2008 financial meltdown. There was absolutely no reason to define almost all FX products (except FX spot) as swaps.”
“This resulted in making bigger companies even bigger, and there was a significant consolidation of swap dealers, and swap execution facilities,” he said. “I know this because I worked as general counsel for one of these companies in 2011. BlackRock, Goldman Sachs, and JP Morgan got bigger because they had multiple swap dealers, and Bloomberg was able to afford registering a swap execution facility, but some of the smaller participants couldn’t afford to do that.”
“Many small and mid-size CFTC-registered companies ended up closing their doors due to extremely burdensome and costly regulatory compliance,” he added. “These entities were never part of the 2008 financial meltdown problem. Between 2010 and 2013, I was sad to see legitimate and compliant US commodities business close their doors while the big swap dealers swallowed up the rest of the commodities market.”
Shipkevich said that while at the CFTC, Gensler created a very long laundry list of rules to abide by. “This likely helped him be approved for the position of SEC Chair, but it should have also been seen as a warning for crypto investors,” he said.
“If you take a person who created very difficult rules, do you think he’s going to come to a different area and do something different?” Shipkevich asked.
“I’ve been a vocal opponent of some of his policies in the commodity side and future side,” he added. “I think they should have carved out things for small and mid-sized businesses. But guess who’s getting screwed on the securities side now? The big businesses. The Coinbases of this world. So when the Ripple case decision was made, I was like, okay, I don’t know if I want to even read it because who cares? There are so many other cases out there that could lead to a different outcome.”
“I love the crypto space, I think it’s fantastic,” he said. “I just find that there are a lot of people who are just salivating over something that’s very small. We need to be mindful of the potential bigger outcome, which has a real possibility to be adverse to the crypto space.”
Regulatory clarity
Shipkevich said that when it comes to regulatory clarity for the U.S. crypto industry, the process “is going to take years,” adding, “It’s not a short-term road.”
“Companies like Coinbase and Ripple will litigate,” he said. “They have deep pockets, and there’s no turning back. What’s their alternative? It’s not a case that you could settle because if Coinbase settles, that means they go out of business.”
“So it’s a do-or-die type of scenario, and unfortunately, the legal process is not only complex, but it’s one that is lengthy,” he added. “It takes years until you get to some kind of form of adjudication after the motion passes.”
He called the situation unfortunate because the enforcement through litigation approach has resulted in job losses and has made the U.S. less competitive on the global stage. “Other countries, like Hong Kong, Japan, Switzerland and Malta, have taken a very different approach.”
“I’ve been to all those countries, I’ve met with companies and some of their regulators. They have taken a very different approach,” he said. “They gave info on what you can do as well as what is not allowed. If you aren’t sure what to do, they say to submit an application and they’ll discuss it with you.”
In contrast, the SEC encouraged companies to come in and lay their cards on the table, only to turn around and say that what the companies were doing was illegal and file lawsuits against them, he said.
“Coinbase opened their books and records, got approved to go public, and look what happened – they got sued,” he said. “Why would other companies be willing to voluntarily open their books to the SEC after that?”
He likened it to the popular guns for toys programs that allow people to exchange firearms for toys during the holidays. “Imagine you go in and you turn in your weapons, and the moment you turn it in in good faith, they handcuff you and they say, ‘gotcha!’ Why would anyone do that?” he said. “So the idea is that we don’t have that type of transparency in the U.S. that other regulators have.”
FTX
Shipkevich suggested that the collapse of FTX has played a part in the SEC’s increased enforcement actions as the regulator had previously worked closely with the exchange and its former CEO Sam Bankman-Fried, and the resulting bankruptcy and criminal charges have reflected badly on the agency.
“The federal government does a pretty decent job in trying to put some bad people away, but it also has done a pretty bad job in certain areas where people with a lot of money were able to get access, like FTX,” he said. “Where are all those politicians that pocketed tens of millions of dollars? Have they given all that money back? Where was the SEC that I’m sure knew of these meetings? SBF had everybody in their pocket. He was on the stage with Bill Clinton, he was in the States, he regularly met with both parties, he testified in front of Congress.”
Shipkevich said what really piqued his interest was when they renamed the American Airlines arena in Miami, Florida, to FTX arena. “An airline company, one of the largest airline companies in the world, lost its name to a company that was founded in 2019,” he said. “I said at the time that it doesn’t make any sense. To me, that was another WeWork story.”
“This is another fraud,” he continued. “Where was the SEC, the Feds, and the Department of Justice during that? How does somebody become so rich so quickly through a Bahama-based company?”
Jurisdictional authority
Shipkevich, citing his background as a derivatives attorney and as general counsel for a CFTC-registered company, said that when he first became aware of Bitcoin, he immediately thought that it should be under the CFTC’s jurisdiction.
“The CFTC, or perhaps the FDIC, or some type of other regulator that focuses on payment instruments, should have taken charge,” he said. “But the problem is that the banking regulators really didn’t pay attention to this because everybody was calling it a fraud, which makes sense. You even had the likes of Warren Buffett and Jamie Dimon calling it a fraud.”
“So they made negative comments at the time, but then behind the scenes they built trading desks, institutional trading desks, and if I am not mistaken today JPMorgan Chase is now a digital asset custody provider,” he said.
“The banks always wanted this business,” he added. “This is a perfect business for the banks. The Ripple lawyers did a great job getting a small but important win under their belt. I think it was a good decision, but it’s too early. I think everybody’s just got a little too excited.”
Spot BTC ETFs
Pivoting to the recent spot Bitcoin ETF applications, Shipkevich said he doesn’t see the BTC ETF market exploding in the U.S. anytime soon.
“I don’t think the SEC wants that market,” he said. “The first Bitcoin ETF application was submitted seven years ago, and they have been denied ever since.”
That being the case, Shipkevich said that “If anybody were to get it, it would be the BlackRocks of the institutional world. They’re old, well-capitalized machines that know how to get things approved.”
FedNow
Shipkevich also touched on the launch of the FedNow payment system in the U.S., stressing that it is not the basis for a digital dollar.
“That’s not the foundation of CBDC, it’s just a federal payment network,” he said. “It’s for banks, credit unions and money transmitters that want to participate, and has nothing to do with a CBDC. It’s similar to what credit card networks have been using digital currency for since 1960. We are basically just trying to catch up with China, and finally, we have a new payment system.”
He noted that when he travels to Europe, he’s the only one in the supermarket trying to pay with a physical credit card while everyone else is using their phones. “We’re 50 years behind on the payment system,” he said, and he sees FedNow as the first step in remedying that.
Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
