Do We Need Market Structure, Really?
Can SEC rulemaking secure crypto’s affirmative legality without Congress? We want your perspective.
I started Brogan Law to provide top quality legal services to individuals and entities with questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
Back in November, I wrote a CoinDesk op-ed titled Time for Crypto to Put the Pedal to the Floor, which argued that the industry had won a brief window of opportunity to develop and lock in affirmative legality.
I talk about “affirmative legality” a lot here, but I’ve never actually explained what it is. Since at least 2017, much of cryptocurrency has maintained only quasi-legality. Depending on who is in charge and the news cycle, certain activities might be permitted or disfavored, but without definitive ground legal principles, it was never possible to say for sure what would or would not draw scrutiny.
Affirmative legality is the status afforded by clear rules that operators can follow to establish and communicate the compliance of their programs. Not an argument, not principles, rules with bright red lines that we could land a plane between.
I also argued that, in order to lock in this status, we needed legislation.
“We should work with our new allies in Washington to implement a legislative solution to permanently inculcate cryptocurrency as a regulatory third way. There can be no half-measures. Only Congress can build a foundation beyond the reach of future regimes.”
Never again. That is the reasoning I think a lot of us carried out of the last administration. It was time for an outlaw industry to come in and register, and legislation was the best way to make that happen. I worried that rulemaking alone would be too easily reversed by a future, hostile, administration.
Now I’m not so sure.
Early Legislation
Off the bat: stables are happening. There have been a few different drafts and versions of pending stablecoin legislation kicking around, most recently Bill Hagerty’s GENIUS Act. I have serious reservations about the details about this legislation. I wrote a few months back about the potential of the then-current drafts to permit unregistered yield-bearing stablecoins, but more recent versions have replaced this with explicit prohibition.
And while I think this is deeply misguided, there is just no point in arguing. No-one with the ability to influence the bill has any incentive to allow yield. The banks don’t want it because they don’t want stables to compete with lucrative checking accounts, and the stablecoin issuers don’t want it because their whole revenue model is earning yield and not passing it on to their users. Even institutional users are at best indifferent, because they have yield earning options available to them at scale—like Figure Certificate Company’s recently approved YLDS. In the end, only retail users are hurt, and retail users do not have a voice in Washington.
That suggests to me that yield is never going to get into the final bill, and that’s just the democratic process. There is no point in crying about it. There are arguments about non-yielding stables increasing the velocity of money that I find halfway compelling, so it is a mixed bag anyway.
The other side of the coin is that the availability of affirmative legality for stables will likely draw all institutional players into the field. This is probably very bad for Circle and Tether, but good for the industry. As increasing amounts of money are represented on-chain, applications and adoption should increase dramatically, which will enrich the entire ecosystem.
But stables are just the opening act of the planned legislative salvo, and the second piece, which has become known as market structure, is a little thornier.
Market Structure
Market structure goes back a few years, with early attempts to legislate cryptocurrency stalling in 2023 and 2024. They generally include things like the segregation of regulatory authority between the CFTC and SEC, and permission for certain regulated entities to transact in cryptocurrency. In the last legislative session, former Rep. Patrick McHenry’s bill FIT21 passed through the house but the Democrat controlled Senate never took it up.
Now, there is new legislation percolating. This bill, as of yet unnamed in public, is likely to feature many of these same features, with an emphasis on decentralization and “control” for projects to be exempted from the securities laws. This is becoming controversial!
On Friday, Veronica Irwin at Unchained reported:
“Some crypto traders and investors are meeting with regulators in the hopes that they can convince the U.S. Securities and Exchange Commission (SEC) to clarify its views on crypto regulation before Congress is able to pass a market structure bill, according to three sources familiar with arguments between crypto industry players.”
Irwin is probably underselling the resistance of many in the industry to the bill. While some major players have been longtime advocates for legislative action, many smaller participants believe that the main reason for the legislation is to construct a regulatory moat around existing market leaders. They think that the semi-regulated market environment gives them a better chance of competing with established players — albeit with more risk — than would an established, and costly, compliance regime. For these firms, flexibility is a feature, not a bug. It allows them to move faster, take more risk, and compete on product — not on compliance budgets or lobbying access.
Many of these smaller players perceived Coinbase’s reported push to bundle market structure with stablecoin legislation as an attempt to suppress their voices specifically. They guessed that Coinbase had taken this tack to hurry market structure through before dissenting voices had time to percolate up into Congress.
What Can Be Accomplished Through Rulemaking, and What Cannot
Here is the thing that has really given me pause in recent weeks as I’ve thought about the relative merits of market structure legislation versus rulemaking alone. While legislation could be nice, I do not think it is necessary to meaningfully implement policy change for cryptocurrency tokens at large. SEC rulemaking alone could probably sufficiently open the relevant markets to meaningfully achieve the “affirmative legality” that is the threshold requirement of cryptocurrency in the United States.
To think about this, it’s helpful to first identify the actual barriers to cryptocurrency adoption as they currently exist in the United States. Here are four:
It is impossible to say, a priori, which cryptocurrency tokens are “securities.” The Gensler SEC stated publicly that Bitcoin and ETH were non-securities, so those are safely outside of the securities regime. The SEC also identified a huge number of other tokens as securities in the course of litigation, including major tokens like SOL and XRP. But then the SEC lost in court, sometimes! And sometimes they won. And the net of all of this was uncertainty. Right now, the sentiment around Washington is that the current SEC is probably not going to pursue enforcement actions premised upon arguments that certain cryptocurrencies are securities, but others still can. In fact, Oregon recently brought a new action against Coinbase. Ultimately, this uncertainty makes it difficult to launch new tokens in the United States, since nobody knows what rules to follow in doing so.
Because nobody knows which tokens are “securities”, it is very difficult for regulated entities to transact in cryptocurrency tokens. For instance, trade in securities generally must be effected through broker-dealers. Do intermediaries require broker-dealer license to trade in cryptocurrency? Do they need to be registered as Alternative Trading Systems? Are broker-dealers or ATS’s allowed to transact in cryptocurrency? What does best execution mean with respect to cryptocurrency assets? There are no answers to the questions, only arguments, and proceeding on that basis is too risky for many. Regulated entities like banks have trouble diligencing and partnering with cryptocurrency counterparties, because they cannot definitively assess whether those parties are in compliance with laws.
As an extension of the above, it is difficult for entities custodying cryptocurrency assets to identify whether they are required to register as investment advisers under the Investment Advisers Act or as Investment Companies under the ‘40 Act, because they cannot say for sure whether most cryptocurrency tokens qualify as “investment securities.”
Cryptocurrency governance models don’t fit naturally into off-chain environs. It is unclear whether on-chain code can or cannot be directly regulated by current laws. It is unclear what protection might be available through certain real world cryptocurrency “wrappers.” Cryptocurrency entities may not be able to pay taxes or execute transactions, and it is unclear when they may nonetheless be required to do so, and who will be responsible for their failure.
And here is the thing, the SEC could solve most of these by saying cryptocurrency tokens are not securities. Now, I think you do need rulemaking to do that, it can’t just be established through enforcement patterns and guidance, but as Commissioner Peirce has repeatedly observed, the SEC has authority under Section 28 of the Securities Act of 1933 to exempt roughly anything from its oversight for basically any reason they want. If they do that, then we know that they do not require broker-dealers, ATS’s, or national exchanges to transact in them, and we know that pools of them do not become investment companies.
Banks and third parties know that issuers and intermediaries are not violating securities laws in the course of their business activities, and can treat these parties as anyone else who transacts in commodities.
This is simplifying because the securities laws are the primary tool that the United States government uses to regulate financial products (though not the only one), and the securities laws only apply to securities. Severing this connection, alone, effectively opens the market.
I don’t think anyone questions that this is possible. But there are various drawbacks of the exempt and chill model of cryptocurrency regulation. Here are a few:
The SEC Prefers Legislation
For one, the SEC probably doesn’t want to do it. Even the staunchest cryptocurrency advocates at the Commission are committed to upholding the SEC’s mission of “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.” If simply exempted cryptocurrency broadly from the securities laws, then there would be a strong incentive for all capital markets to move into cryptocurrency to reduce compliance costs and oversight, and that would inevitably make it harder for the Commission to protect investors. Maybe, on net, this is desirable, but you can hardly blame those poised to lose power for being, uh, contemplative.
That said, the degree of industry influence is very high at the moment. It seems likely that the powers that be could achieve rulemaking if they chose to direct their focus there rather than on market structure. Indeed, reporting suggests that potential legislation is currently blocking rulemaking and Chair Atkins (very reasonably) prefers to wait and see what Congress does.
SEC Exemption = No Preemption
The second issue with an SEC exemption regime is that it doesn’t preempt state enforcement. Now, in general, state crypto enforcement has been a bit of a red herring. New York has been highly active, but most other states are easily placated with an occasional scalp, and happy to let industry operate relatively freely. But it is true that one of the reasons the securities laws were passed was to clarify the path to legality among a tangled web of individual states' laws. Section 28 exemptive authority spits assets out of SEC-land, but leaves them in state law land. This would be best remediated through legislation. I did propose a different solution using Rule 506 of Reg D, but it is probably too aggressive to ever be seriously considered.
Rulemaking is Impermanent
The next issue is that rulemaking can be reversed. If a favorable SEC sweeps in liberalized securities exemptions for cryptocurrency tokens, those rules could just as easily be removed by an unfavorable one. Except they usually are not. Back a few months ago I spoke with Bill Hughes about the use of the Congressional Review Act to remove the IRS Broker Rule — an effort which since been successful. One takeaway I had was that, absent such CRA process, it is actually quite difficult to remove rules, and there is a great deal of path dependency to successful rulemaking. If the SEC puts a framework into place, and participants begin to follow it, the risk of the Gavin Newsom administration abandoning it is relatively low, in my view.
The SEC Cannot Ban Memecoins
Finally, probably the most important consideration is not legalization at all. The top of operators' wish list is making all of the damaging and deceptive cryptocurrency schemes illegal. Chief among these is memecoins, which the SEC has already said sit outside of its jurisdictional reach. Unfortunately, there is no current legislative proposal to fix that particular market, and so we’ll have to discuss it another time.
What Market Structure Forfeits
There is an old story that cryptocurrency is about decentralization. In this conception, government and central banks are too dangerous to trust, and we need an alternative economy that is not subject to the whims of an individual. At times I find myself moved by this mission, but it is a touch utopian. Let’s be real here, these networks are controlled by people, and AIs aside, future ones will be too.
Instead, I think the purpose of the cryptocurrency economy is deregulation. Liberalisation of antiquated laws. Cryptocurrency creates an alternative pathway to securely accomplish tasks that once required elite intermediation, and so were easily regulated. People were suddenly able to just raise money, or just structure financial products, without first asking permission, and the result is economic growth.1
An exemptive regime preserves this feature, but market structure may not. Proposed models, like this one from a16z, often revolve around decentralization or distributed control, effectively requiring projects to work towards these goals to avoid the securities laws. These are probably laudable goals, but if abdicating control is a prerequisite to exemption from the securities laws, the possible breadth of the cryptocurrency industry will be shrunk dramatically.
Here is a bitter pill, decentralized systems can be very secure, which is a huge advantage when operating trustlessly, but they are also cumbersome and inefficient. Most progress is made by small teams with visionary leaders. Almost all successful start-ups follow this model, and even traditional partnerships like investment banks and law firms are often at their best when a singular force is at the helm agenda setting.
If this becomes the legal predicate to developing within cryptocurrency ecosystems, talented people will be less incentivized to build in cryptocurrency. Few want to spend a decade working on a technology only to then give up control of its destiny, and that is exactly what meaningful decentralization is.
Legislation is appealing precisely because of its relevant permanence, but if it inculcates rules that are limiting, then that permanence becomes a liability. And, as justified as fear of a new administration is, changes made through rulemaking are probably pretty durable anyway.
So why lock in rules that could be harmful if we don’t need to? The only benefits I see are improved treatment of asset-backed tokens, which are unlikely to find a place outside of securities regimes through rulemaking alone, banning memecoins, and overcoming state preemption. These are real policy priorities, worth pursuing, but are they worth the risk? I’m not so sure.
Maybe this won’t matter, because there are already rumors swirling that market structure will be dead on arrival in Washington. While stables is relatively uncontroversial, incentives do not align here. With a tiny Republican majority in the house, it would not take much to tip the legislation out of viability. But as the legislation becomes public in the coming weeks, it is worth considering how much political capital we should spend on it.
You don’t build a future by locking in the past.
I’m still weighing the options—and I want your sharpest insights. I’m curious where you stand on the market‑structure bill or the future of crypto regulation. To that end, add a comment or email us at info@broganlaw.xyz. We would like to have some ongoing discourse about this now-polarizing policy.
Until next week.
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The trade-off for this growth is greater risk of loss. To believe in this story, you should also believe that current market protections are overly burdensome. The consumer protection gained is not worth the cost in reduced economic activity. There’s no point in pretending that users can be safer and richer too, there is no such thing as a free lunch.