Securities laws that protect investors continue to apply even as new technologies emerge.
What do carmakers have to do with crypto lending platforms? Whether it’s a car or an investment vehicle, consumers and investors should be protected.
In September 1966, President Lyndon Johnson signed the National Traffic and Motor Vehicle Safety Act. Nearly six years later, seat belts and other essential safety features are still standard. This is true despite many innovations in automotive technology. Whether the car runs on gasoline or electricity, drivers and passengers should be protected.
Likewise, the federal securities laws signed by President Franklin Roosevelt during the Great Depression were designed to protect investors. There is no reason to treat crypto markets differently from other capital markets just because they apply different technologies.
Recent market events have shown why it is crucial for crypto companies to comply with securities laws. Some crypto lending platforms froze investors’ accounts or went bankrupt. When the platform goes bankrupt, these investors have to line up in court.
Consider this hypothesis: Bob runs an app that can increase returns by 4%, 7%, or 19%. Alice and millions of everyday investors put their assets in the app. Investors benefit from knowing Bob’s reasons for claiming that he will provide a certain return. If an investment sounds too good to be true, it probably is. Alice can decide whether to invest or not based on these disclosures.
These disclosures help her understand what Bob has done with her assets. Is he trading? Did he lend his assets to other investors? Is he running a hedge fund? How does he fund the promised returns and what risks does he take?
It’s worth noting that it doesn’t matter what kind of asset Alice has invested in Bob’s app — cash, gold, bitcoin, chinchillas, or whatever. What Bob does with these assets determines what protections the law provides.
Additionally, depending on how Bob uses Alice’s assets, he may also run an investment company, such as a mutual fund. In this case, Bob will have to provide additional collateral, which makes it more difficult to defraud investors.
Bob cannot escape these tried and true investor protections by putting new labels on products or promised benefits. He might call it interest, earnings, income, or annualized earnings incentives. He might say his app is a lending platform, a cryptocurrency exchange, or a decentralized finance platform. In decades of cases, the Supreme Court has made it clear that the economic reality of a product — not the label — determines whether it is a security under securities laws.
The SEC confirmed this in a recent agreement with crypto lending platform BlockFi. The company has borrowed more than $10 billion in crypto assets from 570,000 investors, offering them variable interest rates in return. This makes its loan product to investors, the BlockFi Interest Account, essentially a security. BlockFi pools these assets, packages them for loan to institutional borrowers, and invests in other securities. This makes BlockFi an investment firm.
It is not a problem here that BlockFi has borrowed cryptocurrencies. In fact, you can replace “cryptocurrency” with any other asset. The problem is what it does with borrowed assets that it doesn’t do as a company: provide investors with the required disclosures. Complying with our laws protects the investing public. Unfortunately, some platforms offering crypto loans did not comply.
We reject the idea that crypto lending is unregulated. In fact, these rules have been around for decades. Some crypto platforms are not following the rules. Non-compliance is not an inevitable consequence of the encryption business model or the underlying encryption technology. Yet these platforms seem to be saying that they have a choice — or worse, “grab us if you can.”
As I said in my presentation last year, “Make no mistake: If a lending platform offers securities, it is regulated by the SEC.” In many cases, the Commission and state regulators have addressed relevant case law in relation to cryptoassets and crypto lending the question of how to apply it.
Like automakers adding seat belts, there is a cost to complying with securities laws. Regardless, platforms offering crypto lending need to comply, not only because it’s the law, but because it helps protect investors and increases trust in our markets.
Fortunately, there is a way forward. I encourage platforms that offer crypto lending to come in and talk to SEC staff. Bringing these platforms to compliance with securities laws will benefit both investors and the crypto market.
At the same time, the SEC will act as a police officer to regulate the crypto market. As with car seat belts, we need to make investor protection a standard in the crypto market.