Contradictions in the Middle
A few weeks ago, a small corner of the internet erupted in response to an interview published in New York Magazine. The interviewee, Gary Gensler, claimed that all crypto assets fall under the category of "securities" (a United States legal classification), with the exception of Bitcoin.
This statement caused a stir for two reasons: first, Gensler is not just anyone - he is the head of the Securities and Exchange Commission (SEC). By making this assertion, he was attempting to give himself regulatory control over all crypto assets. Second, his comments contradicted his own previous statements and those of the SEC.
Regulatory turf wars are not something most Americans care about but the damage of this one is growing each day. It’s worth pushing through the jargon to understand more deeply.
Gary Gensler's Opinion
Let’s start by trying to understand Gensler’s view in his own words. Previous to the NY Mag interview Gensler publicly said most but not all crypto assets are securities – “Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities.” (September 2022). A very conservative interpretation of this statement might assume 95% of tokens are securities and 5% (500 tokens) are not.
So which ones are not securities and why?
This is where things get tricky, Gensler has refused to publicly state which tokens he has determined are not securities. The only token he has recently stated is not a security is Bitcoin (in 2018 he stated that the SEC determined Ethereum is not a security because it had become “sufficiently decentralized” but he has not reaffirmed his view recently).
This has naturally left people guessing and in the absence of any clarity we can only look to the one token he has revealed from his list – Bitcoin. Why does he believe Bitcoin is not a security?
This exact question was asked during Gensler’s testimony before the United States Senate in September of last year.
Senator: “What is it about Bitcoin that causes you to conclude it is not a security”
Gensler: “There is no group of individuals in the middle… the investing public is not betting on someone in the middle or six people in the middle”
This view aligns with how he is quoted in the NY Mag article “these tokens are securities because there’s a group in the middle…”, “Everything other than bitcoin, you can find a website, you can find a group of entrepreneurs…”
So this is Gensler’s most direct answer – Bitcoin is not a security because “no group of individuals is in the middle”. He further tries to draw a distinction by asserting that Bitcoin has no website, no group of entrepreneurs, and no foundation.
But is this actually true? And is it uniquely true about Bitcoin?
The Truth of No One in the Middle
The purpose of blockchain technology is to remove the need to have a person in the middle. Instead of having a person or company in the middle, a blockchain places autonomous software in the middle. Satoshi’s original paper outlining Bitcoin describes this, “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
In this sense, Gensler’s position is correct, Bitcoin is not a security because there is no group of individuals in the middle. But Gensler is incorrect in asserting that this is unique to Bitcoin. This is not unique to Bitcoin – it is a property of blockchains and smart contracts. Gensler has acknowledged this himself, in his 2018 MIT class he stated “Decentralized exchanges are basically – think of an algorithm that is decentralized, no central intermediary. But through an algorithm... I could trade…” (source). Gensler is not talking about Bitcoin but acknowledges no one is in the middle. He is communicating the fundamental property of blockchains and smart contracts, having no one in the middle. It logically follows that any crypto asset that shares this key attribute also is not a security.
This logical conclusion is a problem if you are trying to expand the SEC jurisdiction to cover all crypto assets. Gensler has attempted to deny the logical conclusion of his own position by asserting that Bitcoin is unique because of its history and founding story. But this is nonsense. That would be like saying what makes an airplane different from a car is the unique life story of the person who built it. But what makes an airplane different from a car is the technology innovation – not specifics of the story. There is nothing materially unique about Bitcoin’s founding story, ecosystem, or current operations. The materially unique part is the blockchain.
Humans on The Edges
Despite Gensler’s assertions, Bitcoin, like all blockchains and smart contracts, has many humans involved. Bitcoin has a small core team of 5 developers that have special privileges and regularly create upgrades and patch critical bugs. As the Wall Street Journal reported, “At least once, the maintainers secretly patched a bug that bitcoin proponents say could have destroyed the cryptocurrency’s value.” The most recent upgrade to the Bitcoin network was a few months ago. Bitcoin has a founder who still holds 5% of the total supply, conferences, foundations setup to pay developers, websites to make it easy to buy (bitcoin.org), and wealthy promoters who offer terrible financial advice like “mortgage their house to buy Bitcoin”.
Despite these facts Bitcoin is not regulated by the SEC as a security. Because the Bitcoin token does not represent ownership of any of the human elements. The core of Bitcoin is software not people. Yes, there are many humans and companies involved but the Bitcoin token solely represents cryptographically-enabled rights to use a permissionless digital network.
For this reason Bitcoin is not a security, the middle of Bitcoin is software and humans are on the edges. We cannot deny the logical conclusion that other crypto assets representing ownership of permissionless digital networks are likewise not securities.
Why Should You Care?
The last 20 years has brought a new innovation, the ability to own a permissionless digital network like Bitcoin. These digital networks are unlike companies, they don’t have revenue and expenses, they don’t have employees, they have “no one in the middle”, at the same time they can be immensely valuable, they are trading routes for digital goods and they automate services according to immutable rules.
Security regulations were developed to protect investors who buy and sell shares of companies, human enterprises. This is what Gary Gensler’s agency, the SEC, regulates. Trying to apply these regulations to tokens representing digital networks would be like trying to apply automobile regulations to airplanes.
Forcing digital assets into an incompatible regulation framework stops innovation and prevents access to this emerging asset class for Americans. This is the first reason you should care.
The second is the SEC’s failure to provide regulatory clarity allows fraud and scams to flourish. Just because a crypto asset exists does not mean it represents ownership of a digital network. There are many crypto assets that are outright fraudulent or exist for purely speculative purposes. There is a dire need for the public to understand that all crypto assets are not created equal. Gary Gensler himself knows they are not equal, he keeps a secret list in his head of cryptocurrencies that are not securities, but the failure of his agency to disclose which ones are on this list makes the public believe all crypto assets are the same. This enables scams and fraud.
It did not have to be this way, over 3 years ago the SEC’s own commissioner Hester Pierce proposed a framework for disclosures and regulation of tokens representing digital networks. Had such a framework been adopted we would have clear lines distinguishing legitimate digital assets and scams and undoubtedly billions of dollars lost to fraud over the last several years would have been avoided.
Nice Words for Gensler & Vision For The Future
Gensler became SEC chairmen in April of 2021, the near peak of a global asset bubble and a time when crypto asset scams were rampant. The charitable interpretation of his logically incoherent position is that he had to shock the ecosystem. To the degree this shock has helped protect consumers, I thank him and the SEC.
It’s now April 2023, euphoria has left the market and it’s time for intellectual honesty. Gensler often posits a false dichotomy, there are only two options – a complete wild west or forcing crypto assets into incompatible regulations. We must not fall for this.
It is quite literally impossible for crypto assets to comply with the existing securities regulations. Pretending otherwise is intellectually dishonest and equates to an unlegislated ban on United States entrepreneurship and ownership. What is needed is sensible regulation that takes into account what makes true crypto assets unique. The SEC need look no further than its own commissioners for where to start. If the SEC continues to be unwilling to do this, other government agencies or industry working groups need to step up. The industry is ready to work with regulators but regulators to be ready to work with us.