Gary Gensler’s Catch-22 Vision of ‘Regulated’ Crypto Brokers

The House Financial Services Committee heard testimony from experts and insiders yesterday on the burning question of the best way to regulate digital asset markets. The discussion was specifically focused on a pair of draft bills on crypto market structure and stablecoin regulation, but also unfolded under the shadow of the U.S. Securities and Exchange Commissions’ (SEC) active lawsuit against the U.S. crypto exchange Coinbase.

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The final witness on the lineup was Aaron Kaplan, co-founder and CEO of Prometheum, “a FINRA [Financial Industry Regulatory Authority] and SEC regulated ATS [alternative trading system] and broker-dealer in digital asset securities” incorporated in 2021 and expected to launch in the third quarter of this year.

Kaplan (in contrast to most other witnesses) essentially echoed SEC Chair Gary Gensler’s position that existing securities laws are fully sufficient to regulate crypto markets. Some lawmakers held Kaplan’s platform out as evidence that Gensler’s repeated offer that exchanges “come in and register” was entirely sincere.

But to skeptics, Kaplan and his testimony instead wound up depicting the SEC’s stance as a classic instance of malicious bureaucracy:

You don’t have to be crazy to register with the SEC, but it helps

Novelist Joseph Heller coined the now-common term in his novel of the same name. In Heller’s screwball antiwar tragedy, “Catch 22” was a circular bureaucratic rule, designed by the U.S. government to prevent draftees from leaving the World War II-era military. According to the (fictional) rule, you could only get out of the Army if you could prove you were crazy – but if you wanted to get out of the Army, you were clearly all too sane.

Gary Gensler’s SEC seems to have relied on similar logic when imagining its preferred crypto market structure: You’re free to launch a regulated crypto exchange, as long as it doesn’t actually enable the purchase or sale of crypto.

This point was driven home by the (audibly frustrated) Representative Mike Flood (R-NE), who asked Kaplan a pair of simple questions: Does Prometheum allow users to buy and sell ether (ETH)? What about bitcoin (BTC)?

Kaplan’s answer to each question was a curt, faintly embarrassed no.

Prometheum, in fact, has not yet identified any assets that it plans to offer. While its website depicts an app offering tokens connected to the Flow, Filecoin, The Graph, Compound and Celo protocols, these appear to be merely hypothetical examples.

The path to actually “registering” a blockchain token as a security is not at all clear, suggesting a possible scenario where Prometheum becomes a formally registered digital asset marketplace … that doesn’t actually sell any digital assets. Additionally, Prometheum currently only plans to serve accredited investors, not the general public.

Flood argued that Prometheum’s shortcomings, particularly its exceedingly limited offerings, show the hollowness of the SEC’s claims that existing law provides a path to registration for crypto exchanges. Prometheum’s registration, Flood said, “does not address the core issue: There is not a consistent definition of a digital asset security within current law.”

You can check in anytime you like, but you can never trade

This is the Catch-22 the SEC has attempted to characterize as reasonable regulation: If you want to get properly registered as a crypto exchange, you won’t be able to offer the most popular and important digital assets.

That’s particularly illustrated by the cases of bitcoin and ether, the native token of Ethereum. While bitcoin has been fairly clearly designated a commodity for regulatory purposes, it’s one of many crypto assets that do not have any clear “issuer” or other figure who would even be able to properly register the asset with the SEC. That includes genuinely open-source and community-driven protocols like Dogecoin and Monero.

The hearing, and Prometheum, highlighted another fundamental shortcoming of the SEC’s current approach. Because it will only sell to accredited investors, Prometheum does not represent a viable way to get crypto assets into the hands of actual end users.

Lawyer Coy Garrison, former counsel to SEC Commissioner Hester Peirce, pointed out that this means the SEC is advocating an utterly incoherent market structure for crypto assets.

“People purchase [digital assets] for a number of reasons,” Garrison said, “but one is to use them on the network … The application of securities laws [to these assets] would be so burdensome as to render the operation of the network moot.”

That is, Prometheum is licensed to sell big blocks of tokens to institutions and whales. But if there’s no legal path to get those assets into the hands of everyday users, the tokens would have no value, because there would be no users.

“If you have to go through a broker dealer to [buy crypto assets], it adds a tremendous amount of friction to the system,” Blockchain Association CEO Kristin Smith told me this week. The SEC’s approach “ignores that these tokens have a function.”

As many crypto skeptics have pointed out, the SEC has no obligation to craft a set of classifications that better fit the way crypto works. And certainly, there are plenty of crypto assets which would be rightly designated as securities under the standard established by the Howey Test.