Cryptocurrency as an asset class won’t survive unless it’s properly regulated, and while it isn’t, investors face harm — and some that don’t want regulation wish to avoid the law.

This was the message today from U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler, who spoke alongside former SEC chairman Jay Clayton at the Digital Asset Compliance & Market Integrity Summit.

“Where we are right now is, we don’t have sufficient investor protection in this space, this $2.6 trillion worldwide asset class,” Gensler said. “This is an investment asset class and needs investor protection, or people will be hurt, and trust will be undermined.”

Clayton said he believes the technology surrounding cryptocurrency holds “great promise” to achieve efficiencies, but Gensler redirected to the principal function of crypto so far as an investment vehicle — and not for its original intention as a currency and payment system.

Cryptocurrencies have “primarily been speculative stores of value,” Gensler said, “and as such, meet the time-tested definitions of an investment contract and are thus under the securities laws.”

There has been much debate about whether crypto assets meet the definitions of an investment contract and are, therefore, subject to securities laws, Chris DePow, senior advisor for financial institution regulation and compliance at blockchain analytics and monitoring firm Elliptic, told Bank Automation News.

DePow pointed to the Howey test, named for the 1946 U.S. Supreme Court case SEC v. Howey Co. in which an investment contract is deemed to exist if there is “an investment of money in a common enterprise, with profits to come solely from the efforts of others.”

“There’s been this lack of regulation and regulatory actions by the SEC in this space, largely,” DePow said, since cryptocurrencies have evaded being classified as the “other” third parties in the Howey test, but that’s open for interpretation. “The principles certainly are there — the standard analysis of, is there investment of money by individuals with the expectation of profits based on the efforts of a third party, right?” he told BAN.

‘Financial stability event’

Gensler rehashed his prior comments that cryptocurrency assets, as they stand, are like the “Wild West,” and said crypto is unlikely to survive as an investment class unless it’s properly regulated.

He also noted that like the actual 19th-century Wild West, some crypto entities may prefer the present situation lacking regulation so they can “avoid the authorities.”

“There’s a lot of projects that have gone live, entrepreneurs raising money in the crypto markets, and they’re turning to gatekeepers and lawyers to try to paper over, saying, ‘How do we… avoid the authorities?’” Gensler said.

What happens if crypto isn’t brought under regulation? Cryptocurrency investors could be harmed by some calamity, Gensler said, or “spill.”

“The ‘spill in aisle 3’ might be a financial stability event, because the lending in this space is growing,” he said, noting that crypto lending is now “at least” a $200 billion market. Gensler said such a hypothetical event could come in stablecoins — cryptocurrencies backed by assets and/or tied to fiat currencies, which he noted account for 80% of crypto trading today — and could result in “a lot of the investing public getting hurt,” he added, either by fraudsters or good faith actors.

Solutions

The potential benefits of cryptocurrencies and their accompanying technologies include blockchain and decentralized finance (DeFi), which is financial transacting without a traditional, central intermediary like a bank, Gensler said. Trading platforms could be open 24/7, he suggested, connecting customers via application program interfaces, or APIs.

Stock exchanges, for example, don’t yet have that kind of accessibility. “The innovations around DeFi could be real, but they won’t persist if they stay outside of the public policy framework,” Gensler noted.

Cryptocurrency exchange platforms should approach regulators and determine how they should be categorized, and what rules should apply to them, he said.

Regarding stablecoins, Gensler laid out several imperatives. First, they must be backed in a way that is “fully transparent to the various appropriate regulators,” he said, and if they function like a bank account, the Federal Reserve or Office of the Comptroller of the Currency should regulate them.

Finally, stablecoins must be within “the anti-money laundering and tax compliance perimeter,” Gensler said.