COLOSSAL WRECK
SEC : Failure AND Future
"My name is Ozymandias, King of Kings;
Look on my Works, ye Mighty, and despair!
Nothing beside remains. Round the decay
Of that Colossal Wreck, boundless and bare
The lone and level sands stretch far away."
-Percy Bysshe Shelley, "Ozymandias", 10-14
Forward
I received a message today from someone quite senior in the Democratic party asking why I have been relentlessly hostile to the SEC and folks like Gary Gensler and Amanda Fischer, asking if I would consider toning it down.
I said no.
This is one of my problems: when I believe something, I tend to say it, and I'm bad at lying about it. My wife Raja can confirm how annoying I am about this for those who have doubts.
What I did agree to do is write up something to explain why I held that belief so strongly, so this is my attempt to do that and live up to my word.
for FAIR Regulation
Before anyone reads this as a screed against regulation, let me inform you that you would have it totally backwards. I break with much of the crypto space in believing that regulators are absolutely necessary, and serve some core purposes in markets. When you don't have them, there are major problems.
Namely, I believe in consumer protection, in making sure we don't have abusive, monopolistic, or inappropriate behavior in markets, I believe in transparency and disclosure standards, and I believe in setting a level playing field and creating fair rules so that the best products, ideas, and performers can rise to the top in a way where we all have faith the system is working properly.
I also strongly believe that people cannot and should not be put in the position where they have to do all of the evaluation, research, and market intel for themselves. For some, it is a capability question, and there is a certain degree of tyranny of the intelligent when people significantly above average in brainpower and reasoning tell others to "figure it out yourself". For others, it is the fact that private knowledge, insider cabals, and things like pump and dump schemes proliferate in darkness and "don't buy one, duh" actually means don't buy anything if you truly understand markets without rules. Last, even for the otherwise capable, are we really supposed to tell the brain surgeon working 80 hours a week that his time would better be spent researching tokens with questionable value propositions as opposed to, oh, I don't know, saving the lives of people with brain cancer?
Specialization of labor exists for a reason.
My point is we need regulations, and we need regulators who understand their core role is orderly functioning of markets, fairness, and consumer protection.
SEC FAILS REGULATION
So now let's talk about a regulator who totally and 100% did not do that thing I just said: the SEC.
For the four year tenure of Joe Biden, the SEC was essentially the main antagonist facing crypto outside of the perpetual antagonist that crypto faces (crypto itself, for those keeping score at home). Specifically, the SEC managed to teach a masterclass in how not to regulate, and had I sat down on Jan 1 of 2020 and written down a list of what to absolutely not, under any circumstance, do to effectively regulate a novel technology, the SEC marched down that list and then blew through it, inventing new list entries I never would have had the audacity to conceive of and also doing them. In a way, it is impressive. I have never seen someone speedrun a collapse of regulatory trust and authority in this fashion, and the incredible energy and complete imperviousness to reality, feedback, or the consequences of their actions was remarkable.
Unfortunately, it also totally undermines everything.
So what happened? I will try to keep this at least somewhat brief and touch on the large themes of the SEC under Biden, so if I missed some things in here, please understand even in an article I only have so much space, and I only have so much time on this earth.
Failing to SEE: a Ledger
This is perhaps the most obvious, most odious, and most simply problematic thing the SEC did. They looked at a blockchain and said "ah, okay, obviously everything recorded on a blockchain is a security". For those of us who understand what a blockchain is, this raises a lot of questions. For those who don't understand what a blockchain is, I'm going to tell you what it is, and then you're going to have the same questions:
A blockchain is an electronic ledger.
Yes, there's more to it than just that, but honestly? Not that much more. It's an electronic ledger with some special properties about how you write entries and how we agree things exist on the ledger, but it is just a ledger in the end. So if you are re-reading that previous statement and going wait, does that mean the SEC essentially said "Everything recorded in Microsoft Access is a security" if you know to replace one type of ledger with another ledger then what I say to you is this: yes, literally that.
The correct understanding is obviously that the core economic substance of the thing is what determines if something is a security. There cannot and should not be a way for me to take Apple (AAPL) shares and put them on a different ledger and desecuritize them, nor a way for me to take a literal physical Apple and record it on a ledger and turn it into a security. The ledger is not the important part here. AAPL is a security and a literal apple is a food. The ledger is not the important part!
This colossal mistake naturally leads to a lot of totally broken outcomes if this is the place you start with. You can see this in Gensler's own Congressional testimony, where when confronted by Ritchie Torres on this exact issue regarding Pokemon cards, he actually answers under oath that yes, it's possible recording a Pokemon card on a blockchain makes it a security and needs more information.
I want to be clear: this was the actual, literal belief of the SEC that they were operating with for four years. That if I tokenized a rock, or a pokemon card, or a painting, it somehow magically transformed into a security. In fact, shout out to my friend and excellent musician Jonathan Mann for immortalizing this exact issue in song.
Failing to ACT: Custody
Helpfully, the SEC also aided and abetted FTX by refusing to give any sort of sane opinion on custody or make rules around custody. In traditional finance, this is a pretty uncontroversial situation:
There is a custodian
That custodian is not the exchange
Assets held at a custodian don't belong to the custodian, they belong to the customer, and are held on their behalf
That's not super complicated. If you have your car at a dealership for service and the dealership goes out of business, the bankruptcy estate of the dealership does not get to seize your car and sell it and turn you into a creditor.
You know who did not understand that? The SEC. They published an absolutely insane document called SAB-121 that said if you custody crypto, no, you own those assets, not the customer.
This means that first, custodians need to hold capital against customer assets as though the custodian owns the price risk of the asset if they are a bank (e.g. that's not your BTC, that's JP Morgan's BTC and they hold capital for it because even though they have no exposure to price risk, they also somehow own the price risk), and more hilariously, which I am 100% certain the SEC did not understand, if the custodian goes bankrupt those customer assets actually belong to the bankruptcy estate and will not be returned to the customer. This is, after all, what it means to consolidate things onto the balance sheet.
It gets even better. This rule, which blocked banks from getting into custody, also blocked a move to a proper model of separation of exchange from custody. There was one place in the world that did not go this way, or follow the lead of the SEC, or even allow the SEC to intimidate them into not speaking, and that was Japan. Here, the JFSA deserves serious respect for essentially ignoring the SEC and also telling every crypto exchange in Japan to get their act together and stop handling customer assets directly. They were all required to hold assets at onshore custodians in Japan.
Do you know where the one place in the world that customers of FTX did not lose money was? That's right: also Japan.
The SEC fumbling custody this badly and not just failing to promulgate rules that encouraged safety but actually promulgating a rule that encouraged anti-safety blocked a pathway out of FTX and locked US users into that model, especially if they wanted any access to perpetuals or the many tokens launching outside US jurisdiction.
Yes, the SEC literally caused tens of billions of losses for US investors by being a combination of actively problematic and completely uninformed on custody. They also, hilariously, gave Coinbase Institutional a near-monopoly on BTC ETF custody since the banks were banned at the same time they were suing Coinbase. Perfection.
FumblING Registration
I wish I was joking about this one. Who remembers the many complaints by Gary Gensler and his team of aggressively uninformed people to "just come in and register"?
Well, as someone who has, you know, actually traded securities and helped to issue securities in the past and has registered things, let us talk about what the registration process actually is.
Essentially, you have to file forms (an S-1, and then ongoing reports in the form of a 10-K, 10-Q, and 8-K, among other stuff, which are your annual, quarterly, and material event statements, to summarize them) that have a ton of information, and then how those things can trade going forward is highly restricted.
So first, let's start with the information. Here is a brief (no, this is brief in context) summary of what goes on an S-1:
Business and Offering Details
Description of Your Business: Overview of your company, its history, operations, products/services, and industry.
Properties and Assets: Information about physical assets, facilities, or intellectual property.
The Securities Offered: Type (e.g., common stock), number of shares, price, and terms of the offering.
Use of Proceeds: How you plan to use the funds raised (e.g., operations, debt repayment, expansion).
Risk Factors: Specific risks investors face (e.g., competition, regulatory issues, lack of operating history for a small company).
Management and Ownership
Management Information: Names, bios, and compensation of key executives and directors.
Ownership Structure: Details on major shareholders (e.g., those owning 5% or more) and their stakes.
Financial AUDITS
Audited Financial Statements: At least two years of audited financials (or less if you're an emerging growth company), including:
Income statement.
Balance sheet.
Cash flow statement.
Notes to financials. These must be certified by an independent CPA.
Management's Discussion and Analysis (MD&A): Explanation of your financial condition, results of operations, and trends.
Legal and Regulatory
Legal Proceedings: Any ongoing or material lawsuits or regulatory actions involving the company.
Recent Sales of Unregistered Securities: Details of any prior exempt offerings.
Additional Requirements
Certifications: Your CEO and CFO must certify the accuracy of financial data in periodic reports post-offering.
Trading Symbol: If applicable, disclose where and how the securities will trade (e.g., stock exchange ticker).
So can anyone help me out here and answer those questions for the ETH token? Who is the CEO and CFO of Ethereum? What is the business plan of Ethereum? What are the audited financial statements of Ethereum?
Note here that we are not talking about the Ethereum Foundation, we're literally talking about the token and the network. Does the blockchain have any ongoing lawsuits against it? Again, literally, the chain. How about a cash flow statement? What's the legal address of the ETH token or blockchain? How does the blockchain intend to use the funds raised?
Also, I would like to point out, if you lie about any of this, it's a crime. You will face financial liability or jail, meaning if you answer and it's materially incorrect, you have a problem. And if the question is literally unanswerable? Well... if you as the SEC, they will tell you helpfully that they don't answer questions, but if you asked a judge, they would tell you that it's not a security and you can't register. Only if you don't register, you will get sued anyways, because the SEC thinks it is a security, because you used a ledger that makes your apple (the physical one, not the stock) into a security.
To say these requirements are nonsensical for many tokens is pretty obvious. Especially when you get to things like Bitcoin, or physical commodity tokens. I will echo Ritchie Torres here: Gary, how exactly do I register a Pokemon card?
I haven't even raised how the token will do ongoing reporting, because at some point even I understand beating a dead horse for comedy value has diminishing returns. Unless you tokenize the dead horse. Then it had better file that 10-K.
SUPPORTING ScamMERS
You'd think that this would be something a securities regulator would understand was probably not the greatest idea in the world, but the SEC seems to have gotten it totally backwards.
There has been, to not sugarcoat it, a lot of bad conduct in the crypto space. Like, a lot of it. More than there should be. I am a long-time critic of the crypto community for not taking this seriously, and I hold opinions that many crypto ideologues find totally unacceptable, like believing in regulation and thinking total "neutrality" and refusal to censor is actually the exact environment you would want to create for maximum crime and bad acts.
With that said, regardless of your view there, it should be pretty clear that we can make a list of bad names, good names, and grey names, and divide them cleanly in many cases. In fact, I'm going to try right now. I've created this list by asking the following questions:
Did you steal a lot of money from your users?
Did you lie in commercial dealings and steal a lot of money from counterparties?
Did you facilitate a bunch of financial crime at least kind of on purpose or in grossly negligent fashion?
If I answered "probably yes" to those things, you go on the bad list. If I answered even "maybe" to one of them, you are on the grey list. If I answered "probably no" to those things, you're on the good list.
Here we go:
Good
Coinbase, Kraken, Consensys, Uniswap
Grey
Binance (I love you guys but you know there were controls issues in the past)
Bad
FTX, 3AC, Celsius, TerraForm Labs
Okay, so that's not a complete list, but it's good enough for government work. Or is it? Because, you know, even without the benefit of hindsight, random guessing means that the SEC would have been suing those folks randomly. However, it would take a truly non-random set of guesses for the SEC to have sued every single one of the good folks and literally none of the bad folks before something bad happened.
And you know what? That's exactly what they did. The SEC brought enforcement actions against all of Coinbase, Kraken, Consensys, and so on while completely and totally missing (slash deliberately not going after) FTX, 3AC, Celsius, and TFL until after the fact or even at all.
This is completely wild. Again, random guessing would have produced a better outcome than this. At the same time, the SEC was using the immense power of the government to shut down a decentralized library and intimidate creators making cartoons like Stoner Cats.
In what I can only describe as a work of legal art, the SEC did manage to sue Binance, but it was over exchange-related listing issues and the idea that a stablecoin (a thing designed explicitly not to have an expectation of profit) was a security by having an expectation of profit for... reasons... and were so far out to sea that in the DoJ settlement around all the AML and controls issues, they were left out of it, likely for being so ungrounded nobody could work with them.
Just absolutely incredible. The SEC did everything they could to inhibit the good actors while absolutely ignoring bad conduct. Put differently, if I were a crypto scammer bribing SEC leadership, they would not have done anything different than what they were actually doing.
Defying Court ORDERS
Yeah, that totally happened too. It happened in the BTC ETF fiasco, where the SEC somehow decided that futures on BTC are acceptable but the underlying BTC itself is not from a price standpoint. This, to speak as a finance professional, is completely illogical - the futures price is based on spot price, and it would be like saying an electric car is safe but electricity is not and should never be used for power.
So the SEC was taken to court, lost (thank you to Davis Polk and Grayscale in this case), and was ordered by a judge to essentially go back and not make the same error this time.
One would think this would be uncontroversial, and yet I will remind the audience at home that 2 of the 5 SEC commissioners (both Democrats) voted to defy the federal judge and still reject the ETFs, essentially saying they are above the law and will do what they want. Something something be careful about setting precedents you might regret later.
COMMittING Perjury
If you thought the SEC was merely enabling other criminals rather than potentially, incriminate themselves, well, bad news. Let me tell you a story, in the form of a court order, thanks to the work of one of the best litigators in the entire crypto space, Jason Gottleib.
The SEC was sanctioned, the case ejected, and the entire Salt Lake City office shuttered and attorneys forced to resign.
Again, this is a government agency misrepresenting facts in court, to the point that a Federal Judge basically lays waste to their entire case, office, and bank account. This doesn't happen. It's the equivalent of somehow getting the death penalty for something you did during a basketball game. This is also the point where even mainstream folks in finance turned against the SEC, because the whole "hey, uh, let's just misrepresent facts in court to do whatever we want" is never okay under any standard, ever, and does not require any knowledge of the technology.
Legacy
So what is the legacy of the SEC after this absolute masterclass in financial anti-regulation?
I would suggest that behavior of the past four years has had several impacts that will be long-lasting in America, and not in a good way. These are why I continue to speak out about this conduct, and why it's essential that others do the same and not let the people who did this off the hook.
Losing AN Election
Young people (especially men) and minorities disproportionately like crypto and dislike banks. Those are also people who experienced massive disruption due to all of these actions by the SEC (while being told banks are totally safe, as they fail yet again, and that securities markets are totally fine, while they get rugged by SPACs and the GME debacle happens).
They were a massive, energized voter block, and the folks at places like Stand With Crypto can tell you all about this.
But to put a particularly blunt note here: I have students, what with the being a professor and all, and when I ask them for their view of the Democrats and the SEC, I can best summarize it as "Ok boomer".
It is not a coincidence that the groups I just said like crypto above are also the ones who swung Republican in the election and delivered a win to Donald Trump. When you have people like David Sacks, Elon Musk, and Marc Andreesen all on the same side of things due to your absolutely misguided assault on technological progress, you might want to re-think your tactics. It's very possible that Gensler and the SEC lost the election for the Democrats due to the marginal losses among younger voters.
Offshoring OUR Innovation
So let's talk about one of the fastest growing technology spaces outside of AI.
Where is the biggest stablecoin issuer? Offshore.
Where are three of the four biggest exchanges? Offshore.
Where is the biggest custodian? Offshore.
Where are the banks actually using the technology? Offshore.
The SEC essentially forced a huge number of builders out of the country, and also created (along with the banking regulators and Operation Chokepoint 2.0) the single most profitable business on a per-employee basis in the entire history of mankind, Tether.
I will remind everyone that capital formation in the United States is literally part of the job of the SEC and here they did the opposite as hard as humanly possible and cost the US tens of billions of dollars and tens of thousands of well-paying jobs in tech. When you look at the unemployment time series for tech workers or you look at the inability of wages to keep up with the very high end of capital (where people can go offshore to invest), this is exactly why.
Destroying Its Credibility
"What is wrong with the SEC?" is a question I was asked for the first time in my life outside of discussions with securities lawyers over the last two years. It was actually last year, by someone over 60 years old, who had read about Debt Box.
The SEC, by being so incredibly tone deaf, incompetent, and out of line, has put themselves in a position where the average person no longer believes they are a good thing. I once did a poll in one of my classes asking if students thought the SEC had a net positive or negative impact on markets.
Negative won. Decisively.
I think this is likely unrecoverable for the agency as currently constructed. We are likely looking at a total teardown and rebuild, or we will just have increasingly intense financial nihilism as everyone believes the game is rigged and run by corrupt individuals (both, not either/or).
Destroying PEOPLE’S Lives
I have the privilege of being an advisor to Inca Digital. I say privilege because these folks actually give a damn about policing the ecosystem to stop scammers, bad actors, and criminals from harming your average, everyday people. There is still plenty of crime in the financial system writ large, and in crypto, one of the most toxic forces (other than the North Koreans) are the pig butchering scammers.
Mostly, they steal from their victims in BTC, ETH, and USDT, and by pushing everything offshore, we've made it vastly more difficult to police this behavior and interdict the scams.
This was driven home for me when I was checking in with someone at the firm on one of our cases where we are trying to get money back and was told one of the victims committed suicide.
That is a moment where you stop and really think. Lives are actually being destroyed, both by the criminals themselves (and we're going to find you), but also by the incredible incompetence of people who, through their profound ignorance and petty malice, created the system where this can persist because they refused to do the very day one basic parts of their job to make a system better.
Finally
I will not stop saying bad things about the past SEC regime. They messed it up, and fumbled the American economy, the Democratic party, and people's lives.
They are going to get fought on @X by me and should be held accountable for their actions. Certainly they should not be celebrated. They should not be allowed to return to the government, allowed anywhere near the levers of power, and anyone in the Democratic party supporting, aiding, abetting, or directing them should be ejected immediately and roundly debased for this absolutely shameful chapter in US financial regulatory history.
Overall, America has the greatest economy of the past century. One of the greatest in history. The way you lose that is by tolerating this kind of rank incompetence. We should reject it, and be honest with ourselves about what happened so it does not happen again.
