The Node Ahead 68: The most significant two weeks in crypto regulatory history

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By Brett Munster

From a regulatory and political perspective, the last two weeks have been the most significant in crypto’s history. Oklahoma became the first state to pass a law protecting individuals’ right to self-custody digital assets. Martin Gruenberg, Chairman of the FDIC and a long-time crypto opponent who was instrumental in orchestrating Chokepoint 2.0 against the digital asset industry, was forced to resign after it became clear he presided over a culture of toxicity and sexual harassment. SAB 121 was repealed by both the House and the Senate with strong support from both sides of the aisle making it possible for banks to custody digital assets. The first ever crypto market structure bill, FIT 21, was passed in the House by an overwhelming bipartisan majority. The House also passed the CBDC Anti-Surveillance State Act which if it passes the Senate, would prevent the Federal Reserve from issuing a central bank digital currency (CBDC). And most surprising of all, the SEC did a complete one-eighty at the last minute and approved the Ethereum ETF to just about everyone’s surprise.

Before we get into the recap of all the key regulatory events that have happened recently, it’s worth taking a minute to highlight the massive political sea change the past two weeks represent. It’s not just the number of wins the crypto industry has had on the regulatory front, it’s that there has been a deliberate change in tone from the White House, Donald Trump, the House and the Senate with regards to their stance towards the crypto industry.

It’s widely believed that in exchange for her support in the 2020 election, President Biden has deferred a lot of the White House’s financial policy, especially with regards to crypto, to Elizabeth Warren. Since Gensler’s confirmation in 2021, Warren has coordinated with Gensler in cracking down on the crypto industry. But in the past couple of weeks, many within the Democratic party have begun breaking rank with Senator Warren and opting to vote for crypto-friendly regulation. Warren also lost an important ally when Martin Gruenberg said he would resign, whose job Warren fought to save even though more than 500 women at the FDIC reported instances of sexual harassment, discrimination, or verbal abuse.

Furthermore, there is concern within the Democratic party that Trump’s recent embrace of bitcoin and crypto could lead to Biden losing a key demographic in the upcoming election should the White House continue to be hostile towards the crypto industry. Upwards of 90 million U.S. citizens own crypto with that number skewing towards younger voters and minorities (key demographics for the Democratic party). It’s also worth noting that a recent poll showed that 20% of voters in swing states consider crypto a key issue in the upcoming election.

Crypto is becoming a meaningful political force and the tides have dramatically shifted in the past two weeks. It’s very likely those at the highest ranks of the Democratic party, perhaps the president himself, realized that Senator Warren’s stance on crypto is a losing one which has led to an entire change in messaging from the Democratic party. Though a number of Republicans have long supported the industry, for the first time Donald Trump is now giving speeches about bitcoin, building crypto in the U.S. and protecting self-custody. We are witnessing in real time both parties actively positioning themselves to compete for votes from digital asset holders. Come November, it’s possible both presidential candidates and both political parties will be doing their best to portray themselves as crypto friendly. We may very well look back at these past two weeks as a watershed moment with regards to Washington D.C.’s engagement with the crypto industry.

Now, let’s get into the details starting with the most surprising development of them all.

Ethereum ETF is unexpectedly approved

Earlier this year after the bitcoin ETF was approved and launched, we explained why there was a strong possibility an Ethereum ETF would also be approved by May 23. The quick recap is that all the same conditions that backed the SEC into a corner and forced them to approve the bitcoin ETF were also in place for Ethereum. Similar to bitcoin, Ether also has a robust, regulated futures market which is highly correlated with its spot price. The SEC has already approved futures based Ethereum ETFs. There are spot Ethereum ETFs operating in other markets. And Grayscale’s win in their lawsuit meant that the SEC could not deny an Ethereum ETF based on fears of market manipulation like it did for bitcoin for all those years.

And why May 23rd? Just like there was a deadline of January 10 for the SEC on the bitcoin ETF decision, there was a May 23rd deadline on Ethereum ETF applications that forced the SEC to either approve or deny.

Prior to the bitcoin ETF approval earlier this year, the SEC spent four months reviewing, communicating, and iterating on applications with issuers. In contrast, the SEC had been radio silent on the Ethereum ETF all year. By all accounts, with three days left until the deadline, not a single issuer had received any comments or communication from the SEC about their application. That lack of engagement from the SEC compared to the process of the bitcoin ETF basically signaled to the market that the agency was planning on denying the Ethereum ETF.

Then on May 21st, three days before the deadline, everything suddenly changed. That Monday afternoon, the SEC sent out a request to each of the issuers asking them to update their filings.

This was a total shock to the market and everyone involved with the ETF process. According to all accounts and interviews in the days since, every applicant was expecting to be denied heading into last week. Exchanges weren’t ready. Lawyers weren’t prepared. Even the SEC’s own internal staff was caught off guard. Every single person involved seems to have been blindsided by the SEC’s sudden change of stance.

Needless to say, there was a mad scramble by each of the issuers to update their filings and resubmit them to the SEC in time. On May 23rd, the SEC approved 8 Ethereum ETF applications.

Why the sudden 180-degree reversal by the SEC? It is likely that President Biden’s administration may be attempting to appear less hostile to crypto. There was the backlash the administration faced from their threat to veto the SAB 121 repeal along with the fact that several prominent Democrats in the House and Senate voted for the bill anyways. There was Donald Trump’s embrace of the crypto industry which threatened to steal voters from key demographics and key swing states. There were prominent Democratic donors such as Mark Cuban, Mike Novogratz and many others who have become very vocal about Gensler’s actions having a negative impact on the Democrat’s chances in November. All of which put pressure on the White House to do something to appear more friendly to the crypto industry.

There was also the total lack of internal coordination at the SEC which suggests that the decision to approve the ETF came from outside the agency. Not only was there no communication to the issuers for months, but the two divisions within the SEC responsible for working on ETF applications (the division of corporate finance and the division of trading) were reportedly just informed days before the deadline. It turns out the internal staff at the SEC was not aware that the agency was planning on approving the Ethereum ETF until Monday afternoon and had not taken the necessary steps because there is no reason to work on an application when everyone is under the assumption it was going to be denied. “They’re not even internally coordinated yet, which is why this is most likely a political decision,” a source close to the matter said. In other words, it was likely that Gensler was planning on denying the ETF until he probably got a call from the White House on Monday morning.

Regardless of the reason, the SEC ended up approving the Ethereum ETF. Much like the bitcoin ETF, this ruling dramatically increases access to Ethereum as an investment across a wide swath of the traditional financial system. Much of the traditional financial world will begin to study Ethereum in addition to bitcoin. What they will discover is a network that supports over 270 million unique user addresses and processes an average of 1.2 million transactions per day. On-chain value settlements on Ethereum exceeded $2.8 trillion over the last year, more than PayPal’s volumes of $1.5 trillion.

But this approval has far wider reaching implications for the crypto industry as a whole. Though nowhere in the 23-page approval did the SEC directly specify that ETH is a commodity, all applications were for commodity-based trusts. The ruling is an indirect admission by the SEC that ETH is a commodity and not a security contrary to the position Gensler and the SEC has had for years.

In its lawsuits against Coinbase and Kraken, the SEC claimed the digital assets they listed were securities because even though those networks do not have a centralized “common enterprise,” those tokens operate within an “ecosystem.” Not only is this a new interpretation of the law, the SEC is going to have a hard time explaining in court why Ethereum, which operates the largest ecosystem in crypto, is a commodity but other tokens are securities. The fact that the SEC approved ETH to be traded completely undermines all of the SEC’s enforcement actions they brought forth against Coinbase, Kraken, Uniswap, Consensys, Robinhood and more.

Even though the Ethereum ETF was approved last week, it will likely be several weeks before it begins trading. There are two steps to the ETF application, the 19b-4 which allows the asset to trade on exchanges and the S1 which is the financial and risk disclosures for each issuer. With the bitcoin ETF, the SEC worked for months in lockstep on both parts of the process so that when the approval came, the issuers could start trading the next day. Because the Ethereum ETF process was started at the last minute, the SEC only had time to review and approve the 19b-4 filings because that was the part of the process that was subject to the May 23 deadline. However, the issuers still need to have their S1 statements approved before they can begin trading.

The fact that the SEC wasn’t prepared to review and approve any S1 statements gives further credence to the theory that the SEC was planning to deny the ETF and was forced to change course only days before the deadline. It’s unclear how long this process will take but most analysts are speculating that it could take weeks before the S1 is finalized and the Ethereum ETF officially launches.

It’s impossible to know how successful the Ethereum ETF will be but focusing on how many billions of dollars flow into these products misses the bigger picture. The approval and launch of the bitcoin ETFs were historic in that for the first time, it made accessing the crypto industry easy for much of the traditional financial world. Because of that, we saw the bitcoin ETF shatter just about every record in ETF history.

Even if the Ethereum ETF only brings in a fraction of the dollars the bitcoin ETF did, the Ethereum ETF is much more politically significant. Approving this ETF was not Gensler’s intention, nor was he forced to by the courts as was the case with the bitcoin ETF. Gensler was clearly overruled here by high-ranking members of the Democratic party who have clearly pivoted their stance on the crypto industry within the last two weeks. The approval of the Ethereum ETF signifies at worst an acceptance of crypto from Washington D.C. and at best, the possibility of advocating for the industry moving forward. That is a markedly different tone from just two weeks ago.

House and Senate strike down SAB 121

Last November we did a detailed breakdown of Staff Accounting Bulletin 121 (SAB 121) in which we explained why the rule is problematic and why the Government Accountability Office determined the SEC broke the law when it issued this rule. Niche accounting rules typically don’t draw the attention of Congress or the President so that just goes to show how egregious this rule is. As a quick refresher, SAB 121 was created by the SEC in March 2022 and attempts to lay out how financial institutions are expected to account for any cryptoassets they custody on behalf of clients.

The first problem is that the SEC is required by law to submit any new rule to Congress for review and is expected to work with FASB in creating any new accounting rules. The SEC never engaged with FASB and never sent SAB 121 to Congress; they just issued it without going through proper rulemaking procedures. Which is why the Government Accountability Office determined that the SEC illegally issued this rule in the first place.

The second problem with SAB 121 is that it requires banks that custody cryptoassets to report those assets as a liability on their own balance sheet. By law, banks must maintain a strict ratio of capital reserves against their liabilities. Thus, SAB 121 instantly made custodying cryptoassets an unprofitable endeavor for banks because it would cost the bank more to hold the assets than they could charge customers for doing so. Banks can custody stocks, bonds and a variety of other assets for customers because the accounting rules do not require the banks to hold assets that belong to customers on their own balance sheet.

Which leads to the third problem created by SAB 121, namely that it treats cryptoassets differently than every other asset class, including securities. This is the same SEC that claims all cryptoassets except bitcoin are securities. According to the SEC’s own logic, when consumers purchase cryptoassets they are securities but when it comes to storing those very same tokens, the SEC believes cryptoassets somehow magically morph into a different, unique asset class.

Unfortunately, SAB 121 has already had major implications on the market. Ever wonder why 10 of the 11 bitcoin ETFs all use Coinbase as the custodian (the lone exception being Fidelity who uses their own in-house infrastructure)? Isn’t it odd that there aren’t any traditional custodian providers involved with any of the bitcoin ETFs? It’s because SAB 121 prevents most qualified custodians from entering this market. The irony here is that the SEC created the conditions such that nearly every bitcoin ETF and now Ethereum ETF is forced to use Coinbase as its custody provider at the same time the SEC is actively suing Coinbase for violations of security laws. It just goes to show you how illogical the SEC’s approach to crypto has been.

The bottom line is that SAB 121 is a backdoor attempt by the SEC to make it impossible for the most trusted banking institutions to enter the crypto market. Gensler instituted this rule so the SEC can then use the fact that none of the most trusted financial players hold crypto as a reason to claim that the industry is unsafe for consumers. It’s pretty disingenuous to create a problem and then blame the crypto industry for the very problem the SEC created. If the SEC was sincere in its mandate to protect consumers, it would have long ago issued guidance that encourages the companies with the longest track record of safekeeping assets to enter the space, rather than creating rules that purposefully keep them out. SAB 121 is blatantly anti-consumer protection.

Apparently, Congress feels the same way the crypto industry does. On May 8th, the U.S. House of Representatives approved a resolution to overturn SAB 121, demanding that the SEC roll back its anti-crypto banking policies. The resolution passed with bipartisan support. Though the bill was spearheaded by Republicans, a number of democrats voted in favor to repeal SAB 121. Democrat Wiley Nickel even published a public letter stating, “the SEC’s open hostility toward the digital assets industry isn’t serving President Biden’s best interests.”

Which made the White House’s initial response to this bill so perplexing. Hours before the vote, the White House released a statement stating it would veto the bill if passed. President Biden came out in support of Gensler’s SAB 121 rule despite the fact that the vast majority of congress, including many members of his own party, are staunchly against it. It’s odd that a sitting president would expend political capital on a niche accounting rule, but it’s likely that the White House was blindly taking its cues on this issue from Elizabeth Warren who has not been shy about her desire to shut down the crypto industry in the U.S.

Unfortunately for President Biden, this move seemed to backfire. The announcement led to an enormous backlash not just from the crypto community, but from many prominent democratic voters and donors. Furthermore, not only did the House pass the bill shortly after the White House’s comments, a week later the Senate also voted to strike down SAB 121 with a bipartisan supermajority. Despite President Biden’s threat to veto, numerous Democrats, including Majority Leader Chuck Schumer, chose to vote for the bill. It’s also telling that a number of Democrats in key battleground states such as Pennsylvania, Arizona, Nevada, and Michigan broke rank with the President and voted to support the crypto industry.

The fact that the majority of Republicans and Democrats in both the House and Senate voted to repeal SAB 121 by such wide margins is notable for two reasons. First, it is a resounding rebuke of the SEC’s overreach from both houses of Congress. Second, it shows that crypto is and should be a bipartisan issue. Although it is true that more Republicans than Democrats have initially embraced crypto, an increasing number of Democrats are breaking rank with Elizabeth Warren. The number of crypto supporters within Washington is steadily increasing. Though there are a few very public detractors, the truth is we now have a majority of elected officials in both Houses of Congress that support the growth and development of bitcoin and crypto in America.

This now puts President Biden in an awkward situation. He has until June 3rd to veto the bill as he said he would but that would be an incredibly unpopular move even within his own party. Given the recent backlash the White House received, the growing sentiment that Gary Gensler is increasingly becoming a political liability for the President in his re-election campaign and that the White House realizing the downside of outsourcing policy making on the crypto industry to Elizabeth Warren, it’s anyone’s guess as to what the President will ultimately decide to do. An unpopular accounting rule isn’t the type of thing most politicians die on a hill for. It’s possible that the recent events that have transpired since that veto threat was first issued and the sudden desire from the White House to not appear hostile to crypto holders may cause the President to back track on his previous statement and sign this into law.

Should the repeal of SAB 121 go into effect, do not underestimate the potential impact it could have for the adoption of crypto. Many traditional financial firms rely on banks and broker dealers to operate their business. Broker dealers and banks such as BNY Mellon have wanted to provide crypto services for years but have been unable to due to SAB 121. Should that bill be overturned, the path to adoption would get dramatically easier for much of the infrastructure that powers the traditional finance industry. Just as the bitcoin ETF made it easy for financial firms to buy bitcoin, revoking SAB 121 makes it easier for the financial industry to integrate crypto into their current practices.

The political calculus has changed dramatically since the White House initially issued its threat to veto the repeal of SAB 121. It will be very telling where the President now stands with regards to the crypto industry now that this bill has hit his desk.

Crypto Market Structure Bill passes the House

Last July the House Financial Services Committee and House Agriculture Committee put forth a crypto market structure bill which was a watershed piece of legislation aimed at providing a comprehensive regulatory framework for the crypto industry. Though the bill passed both committees in a bipartisan vote, a slew of spending bills, conflict in the middle east, and a group of Republican representatives pushing for a new speaker delayed the bill from making it to the House floor for almost a year.

Last week, that bill finally went to a vote in the House of Representatives. The Financial Innovation and Technology for the 21st Century Act (or FIT 21 for short) would be the first regulatory framework for digital assets in the U.S. and aims to alleviate many longstanding uncertainties that have plagued the industry.

The first, and most important, part of the legislation is that the bill specifies when a cryptoasset should be treated as a commodity or a security thereby clarifying the jurisdictional boundaries between the SEC and CFTC. The bill would set the Commodity Futures Trading Commission as the primary regulator of digital assets, and it sets out clear divisions for what the CFTC will handle and what would fall under the reach of the SEC. For example, Ether, the native token for Ethereum, would be clearly classified as a digital commodity under this framework thus eliminating this turf war between the CFTC and the SEC which has caused massive confusion in the market.

Additionally, the legislation includes consumer protection measures designed to prevent fraud and market manipulation, mandates comprehensive disclosure requirements for digital asset issuers and establishes clear guidelines for market participants looking to build blockchain based networks​.

Just as important, the bill does not address how decentralized finance (DeFi) would or could be regulated. Instead, it proposes that the government conduct a study of DeFi similar to what Europe did with MiCA. The acknowledgement from congress that DeFi infrastructure is fundamentally different from traditional infrastructure built by centralized players (even when those centralized players are involved in the crypto industry) and needs to be treated differently is a clear step in the right direction for how the U.S. views the crypto industry.

The bill was spearheaded by Chairman of the Financial Services Committee Patrick McHenry who has been one of crypto’s best advocates in Washington for a number of years. Majority Whip Tom Emmer, Financial Committee Vice Chairman French Hill, House Ag Committee member Dusty Johnson and Glenn Thompson also provided substantial leadership and support in getting this bill to the floor.

But it wasn’t just Republicans, Democrats played a large role too. Prior to the vote, eight House Democrats signed a memo arguing in favor of the bill in an attempt to persuade many of their colleagues to vote yes. “This should not be a partisan issue,” according to Wiley Nickel (NC), Yadira Caraveo (CO.), Jim Himes (CT), Jasmine Crockett (TX), Ritchie Torres (NY), Darren Soto (FL), Josh Gottheimer (NJ) and Don Davis (NC).

That message seemed to work as FIT 21 passed the House vote in an overwhelming bi-partisan majority of 279 to 136. Not only did nearly every Republican vote in favor of the bill, but 71 democrats also voted in favor. That is a much higher number than anticipated and sends a strong message to a democratic appointed Gensler that he has failed in his duties as well as to the president that an “anti-crypto” is a losing platform this year. Even more telling, four Democrats in key leadership positions supported the bill including Speaker Nancy Pelosi, Minority Whip Katherine Clark, Chairman Pete Aguilar, and Vice Chairman Ted Lieu.

Now that it has passed the House, FIT 21 will make its way to the Senate. While there is a strong base of supporters in the House, the Senate will be more contentious due to anti-crypto politicians such as Elizabeth Warren and Sherod Brown. However, we just saw the Senate vote overwhelmingly in favor of crypto when it struck down SAB 121. According to reports senior staff working on FIT 21 said that they are already having discussions with Senate counterparts who are open to legislative vehicles the bill could eventually be attached to as this congressional session winds toward its close. Given the recent pivot from within the upper echelons of the Democratic party, FIT 21 might have a chance of passing the Senate, something that would have been unfathomable mere weeks ago.

Though the bill is not perfect, FIT 21 would provide a clear framework and likely foster investment in the crypto industry within the U.S. FIT 21 would also finally make the U.S. regulatory landscape a competitive jurisdiction on a global scale when it comes to attracting capital and talent. The U.S. is lagging behind the EU, UK, Singapore, Japan, South Korea, the UAE, Brazil, Australia and others, all of whom have passed significant, crypto-friendly regulations. With other countries advancing their regulatory frameworks, FIT 21 is pivotal to the U.S. remaining a leader in financial and technological innovation​. Let’s hope the Senate votes in favor as well.

Oklahoma passes self-custody law

The ability for an individual to store and control their wealth (aka self-custody) without having to rely on a third party (aka a bank) is one of bitcoin’s fundamental value propositions.

In order to store their hard-earned dollars, people historically have had to either trust a third party such as a bank (which 2008 showed is not without at least some risk) or hoard cash under a mattress. Prior to bitcoin, there was no way to hold value digitally without involving a counterparty. With the advent of bitcoin, individuals now have the ability to store and control their value in a completely self-sovereign manner without having to rely on a bank or outside party.

Which is why what Oklahoma recently did is so encouraging. On May 15th, Oklahoma became the first state to sign legislation into law that protects its citizens’ right to self-custody their bitcoins and other digital assets. The bill guarantees the right to self-custody and permits using bitcoin and other digital assets for transactions without additional taxes.

When the bill takes effect on November 1, 2024, it will set a precedent for other states that will hopefully enact similar laws in the future. By providing clear legal protection for bitcoin users, Oklahoma could wind up attracting crypto businesses, create economic opportunities for its local economy, and bolster state tax revenues. We have already seen this strategy pay off handsomely in states such as Texas, Florida and Wyoming.

But that’s not the only bitcoin friendly bill Oklahoma passed. The Sooner State also passed a “Right to Mine” bill joining Arkansas and Montana in protecting the right to mine bitcoin at home and for commercial use. The legislation prevents local governments from imposing restrictive measures specifically targeting mining activities or creating discriminatory rate schedules for mining companies. Lastly, the bill specifies that operating a node of any kind of cryptoasset network does not constitute a money transmitter business in the state.

By passing both these bills, Oklahoma has instantly made itself one of (if not the most) crypto friendly states in the U.S. alongside Texas, Wyoming, Florida, Colorado and Arizona. Thanks to the efforts of Dennis Porter and the Satoshi Action Fund, similar bills have been introduced in 15 other states. There may be friction at the federal level when it comes to crypto regulation, but most of the fifty states are beginning to adopt crypto-friendly positions as they jockey to position themselves as pro-crypto.

Don’t underestimate the impact state adoption can have on federal policy. According to Dennis Porter who runs the Satoshi Action Fund and has helped educate numerous states on the benefits of bitcoin, the bitcoin self-custody bill in Oklahoma is already providing momentum for policy action at the federal level. Now that self-custody is a right in Oklahoma, it is much more likely it eventually becomes a federal law at some point in the future.

In Other News

Millennium, Elliott Management, and Apollo Management among bitcoin ETF holders.

State of Wisconsin Pension Fund, the 9th largest pension fund in the U.S., discloses it bought $100m worth of bitcoin ETF.

Morgan Stanley discloses US spot bitcoin ETF holdings worth over $270 million in filing.

Franklin Templeton CEO says all ETFs and mutual funds will be on a blockchain.

Why, for some, crypto is the defining political issue of our times.

Vanguard appoints bitcoin-friendly former BlackRock ETF lead as CEO.

Why the new ESG narrative about bitcoin will power the next bull run.

Disclaimer:  This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital.

Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.


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