One will be forgiven for not closely following the myriad crypto developments in recent years. Mixed signals from regulators have complicated matters: some cryptocurrencies may be securities, some are commodities, some exchanges are being prosecuted and settling with regulators, some are fighting vociferously, and others, like FTX, blew up in a Ponzi-like manner (only to have the receivership recover over 100% of creditor claims in bankruptcy). Some large retirement and investment companies are allowing Bitcoin ETFs in IRAs (Fidelity, Schwab), while others are outright refusing to list them (Vanguard). It’s almost too much to follow, even for crypto die-hards. For the skeptics, it is more of the same. If they didn’t believe in it during the last Bull Run and 2021’s all-time highs, looking back on the last three years, they have been proven right in many ways.
However, the last six months, beginning with the Bitcoin ETF approvals and culminating in the events of the last two weeks, lead us to believe that the winds have shifted for institutional and regulatory adoption of crypto. This does not mean that every cryptocurrency is legitimate (they are not), or that bad actors will go away (they never will), or that regulators will not continue to scrutinize registered advisers, broker-dealers, and investment companies engaging in the space (that is their job). But if you are like many of our clients, cautious and risk-averse (in all the right ways), but also looking to provide beneficial products and services to both retail and institutional investors alike, here is what you need to know:
History: Custody of assets has been a major area of scrutiny for regulators since Madoff. A growing number of firms providing platforms for cryptocurrency transactions prompted the SEC to address how these firms should account for the safeguarding of crypto assets. The SEC's Staff Accounting Bulletin No. 121 (SAB-121), effective April 11, 2022, mandated that firms must present a liability line item for the cost of safeguarding crypto assets on their balance sheets and recognize the assets at fair market value. This mandate contradicts a basic rule of bank custody: that bank custodial assets are always held off of the balance sheet, and as a result, banks have largely stayed on the sidelines, allowing other players to custody the assets (primarily Coinbase). What is also notable about the mandate is that it was proffered as a Staff Accounting Bulletin, which in many ways has the effect of a law or SEC rule, but without having followed the protocols of the rulemaking process under existing agency laws. “Guidance” is not supposed to dictate a major change or controversial policy.
Congressional Review Act: The Congressional Review Act (CRA) allows Congress to overturn certain federal agency actions. Enacted as part of the Small Business Regulatory Enforcement Fairness Act in 1996, it provides Congress with special procedures to consider legislation, known as a joint resolution of disapproval, to overturn these rules. If the joint resolution is approved by both houses of Congress and signed by the President, or if Congress overrides a presidential veto, the rule in question cannot take effect or continue to be in effect. The law has only been used effectively 20 times since 1996, with 80% of those instances occurring during the first two years of the Trump presidency.
Congress: On May 8th, a bipartisan resolution led by Representative Mike Flood (NE-01) to disapprove the SEC's Staff Accounting Bulletin No. 121 (SAB 121) under the Congressional Review Act (CRA) passed Congress with 21 Democrats joining the Republicans in a show of bipartisan support. On May 16th, the Senate passed its own resolution to roll back the SEC's Staff Accounting Bulletin No. 121, with 11 Democrats joining the Republicans.
White House: As of today, how the President will act remains uncertain. President Biden initially vowed to veto the resolution after it passed the House, but he is increasingly feeling pressure from within his own party. The White House was notably quiet after May 16th, a day which saw major leading Democrats (including Majority Leader Chuck Schumer) side with the Republicans.
Financial Innovation and Technology for the 21st Century (FIT21) Act: On May 22nd, Congress passed the FIT21 Act with broad bipartisan support, as 71 Democratic members joined Republicans to pass the bill. This important piece of legislation will redefine compliance requirements for securities issuers and create specific definitions for digital assets, determining when they are considered securities or digital commodities, thus taking crypto out of the grey area quagmire where it has been living all these years. The White House again issued a statement in opposition to the bipartisan bill, stating that it lacks sufficient protections for consumers and investors who engage in certain digital asset transactions. However, notably absent in the May 22, 2024 Statement of Administration Policy was the explicit declaration of a veto, signaling a subtle messaging change from the executive branch.
Ethereum Updates: On May 23rd, the SEC approved a rule change allowing for the listing and trading of Eight Spot Ether Exchange-Traded Funds; and so, Ethereum joins Bitcoin in allowing registered funds to hold the asset class.
Regulators appear to be moving towards acceptance of the reality that cryptocurrencies are here to stay. Not only has there been tremendous demand for the asset class with record-setting ETF inflows, but it seems like there has been a new political consensus recently, setting the stage for money managers to consider the asset class more broadly.
