Few investors made it through 2021 and 2022 without learning of, discussing, or perhaps purchasing, cryptocurrency or other blockchain assets, and the federal agency responsible for regulating the securities industry has announced significant new initiatives as resources intended to keep pace with the rapid development of this market.
Whether it’s the more traditional tokens such as Bitcoin or Ether, or the newer asset classes such as NFTs or digital “land” in the metaverse, these digital assets are everywhere and are here to stay. Massive amounts of money flow into the crypto space every day, with the current market cap surpassing $1.7 trillion. As with all industries, as more money flows in, more bad actors will seek to profit off of those vulnerable to exploitation. And with new cryptocurrencies being introduced onto digital asset exchanges daily, and start-up companies launching crypto, smart contract, NFT, and/or metaverse products at record pace and faster than anyone can keep up, the potential for fraud, exploitation, and theft abounds. Thus far, the government has put up a good fight but struggled to keep pace with alleged bad actors.
Historically, the SEC has targeted offenders through its Crypto Assets and Cyber Unit, which formed in 2017 and has ramped up its operations each year. In 2021, the Crypto Assets and Cyber Unit imposed over $2 billion in sanctions against bad actors in the crypto space and brought 20 enforcement actions. Nearly 70% of its enforcement actions related to initial coin offerings, the crypto equivalent of an IPO. Nearly all actions were based on allegations of fraud or the sale of unregistered securities pursuant to the four-part Howey test established by the 1946 U.S. Supreme Court decision (note, however, that the SEC has published guidance expanding the four-part test to include more than 38 “considerations” enforcement agents should analyze given the unique aspects of digital assets). In the SEC’s terms, “something is a security if it represents an investment in a common enterprise with the expectation of profit solely through the efforts of others. In practice, as interpreted by the courts and the Commission, profit need not be solely from the effort of others.”
These vague and sometimes-conflicting standards, coupled with a lack of widespread or uniform regulation of the crypto space, have led to industry professionals, consumers, and counsel often feeling uncertain regarding the propriety and legal framework governing specific crypto assets or even entire asset classes. Indeed, the SEC’s Chair, Gary Gensler, has urged digital asset trading platforms to register with the SEC because their actions might be illegal; so far most have declined the invitation. Recognizing the confusion and opportunity for exploitation in the marketplace, Gensler dubbed the crypto space the “Wild West” and declared it was one of the main areas into which the Commission planned to funnel resources.
To that end, on May 3, 2022 the SEC announced that it is doubling the size of its Crypto Assets and Cyber Unit. The new Unit will include 50 employees, with at least 20 new investigators and/or litigators. These new Unit members will focus on securities law violations connected to:
- Crypto asset offerings;
- Crypto asset exchanges;
- Crypto asset lending and staking products;
- Decentralized finance platforms;
- NFTs; and
The Director of SEC’s Enforcement Division, reading the tea leaves as Commissioner Gensler apparently has, stated that “Crypto markets have exploded in recent years, with retail investors bearing the brunt of abuses in this space. Meanwhile, cyber-related threats continue to pose existential risks to our financial markets and participants… The bolstered Crypto Assets and Cyber Unit will be at the forefront of protecting investors and ensuring fair and orderly markets in the face of these critical challenges.”
It remains to be seen whether this funneling of resources and manpower into investigation and enforcement efforts will have a meaningful impact on detecting, stopping, and deterring criminal conduct related to digital assets, especially as the market continues to expand at record pace. The SEC also has not offered insight as to whether these new members will allow the Crypto Assets and Cyber Unit to expand its enforcement efforts, or if initial coin offerings will remain the government’s primary target. The only certainty is that market participants should continue to exercise caution, keep up with the SEC’s enforcement actions and – just as importantly – no-action letters, and seek counsel when navigating these muddy waters.