by Kevin S. Schwartz, Rosemary Spaziani, David M. Adlerstein, Samantha M. Altschuler, and Sabina M. Beleuz Neagu

Left to right: Kevin S. Schwartz, Rosemary Spaziani, David M. Adlerstein, Samantha M. Altschuler and Sabina M. Beleuz Neagu (Photos courtesy of Wachtell, Lipton, Rosen & Katz)

The U.S. cryptoasset industry just rang in the new year with the watershed SEC approval of the first spot ETFs for a digital asset.  With the approval of the first bitcoin Spot ETFs, making possible a path for millions of Americans to have direct bitcoin exposure in retirement and other traditional investment accounts, it is an appropriate time to reflect on significant recent developments that may shape the crypto industry in the year to come.

The frigid “crypto winter” over the last two years has been dominated by legal proceedings ranging from whether cryptoassets would be accepted into the U.S. mainstream financial system to confronting the implosion of cryptoasset exchange FTX and associated hedge fund Alameda Research, along with a number of other prominent failures from 2022, such as numerous shadow bank-like cryptoasset borrowing and lending operations. Throughout 2023, the SEC continued its regulation-by-enforcement approach to the sector, commencing actions against leading cryptoasset exchanges, numerous other cryptoasset companies, as well as developers, and continuing its long-running litigation against Ripple. Yet signs of a thaw began to emerge later in the year, including a pronounced recovery of asset prices, with bitcoin appreciating by approximately 160% and Ethereum by approximately 90% over the full year. 

We begin by noting important signs of increased institutional acceptance of cryptoassets and blockchain technology:

• Bitcoin spot ETFs. In 2023, the SEC declined to appeal a federal court holding that the SEC’s denial of asset manager Grayscale’s application for a bitcoin spot ETF was arbitrary and capricious.  This critical ruling prompted firms including BlackRock and Fidelity, among others, to submit amended applications for bitcoin spot ETF products, 11 of which the SEC first approved today for listing and trading, cementing bitcoin’s status as a mainstream alternative investment, and portending the possibility of future ETFs for other digital assets.  These product offerings by household name financial firms parallel continued growth in institutional blockchain products, such as JPMorgan’s “JPM Coin” private stablecoin, reinforcing the depth of financial institutional interest in this technology.  
• Accounting changes. In March, the Financial Accounting Standards Board proposed a mark-to-market accounting standard for cryptoassets, and in September, reportedly approved drafting of a final rule anticipated to be effective in 2025. This would mark a significant change from the prevailing GAAP standard whereby cryptoassets are normally accounted at the lower of cost and market value. Although there remain risk considerations associated with holding cryptoassets in a corporate treasury, this change could provide momentum for cryptoassets to find their way into some corporate balance sheets.  And in October, the U.S. Government Accountability Office found that the SEC’s 2022 Staff Accounting Bulletin No. 121 (SAB 121) amounted to a rule subject to Congressional review.  SAB 121 requires a cryptoasset custodian to record a liability for the fair value of the custodied assets, and has thus constituted a major practical impediment to banks acting as cryptoasset custodians.  Although SAB 121 currently remains in effect, it is under renewed scrutiny, including in the form of proposed bipartisan legislation to functionally rescind it.
• International receptiveness. Employing a relatively permissive approach towards cryptoassets, foreign jurisdictions such as Singapore and Dubai have witnessed significant growth in their cryptoasset sectors, attracting substantial foreign capital. Foreign bodies including the EU have outpaced the U.S. in adopting tailored rules, with the EU’s Markets in Crypto-Assets Regulation to become fully effective in December of this year. Argentina elected an avowedly pro-bitcoin president (on the heels of El Salvador making bitcoin legal tender in 2021). And numerous countries have made progress towards adoption of a central bank digital currency or integrating stablecoins into economic activity (such as the Bank of England’s proposal for a framework for payment systems using stablecoins).

Despite these promising developments (and setting aside long-standing debates over matters such as the environmental impact of bitcoin mining), there remain numerous obstacles to broader U.S. acceptance of cryptoassets and sectoral growth, and some critical legal issues remain unsettled:

• Continued U.S. enforcement-focused regulation. While sustaining some setbacks in litigation, the SEC has continued to use enforcement actions to assert that most cryptoassets constitute securities, while simultaneously maintaining that U.S. securities laws are clear and decliningto engage in prescriptive rulemaking. As such, new capital formation in the form of token offerings has been driven substantially offshore and some legitimate U.S.-based projects stopped cold. The SEC is pursuing claims against each of Coinbase, Binance, and Kraken for purportedly operating as unregistered securities exchanges, brokers, and clearing agencies, and in 2023 extended its reach to the market nonfungible tokens, entering into an August settlement and a September settlement with issuers on the basis that their NFT sales constituted unregistered securities offerings. Other regulatory bodies have also brought enforcement actions, including the CFTC, which in September issued orders against, and entered into settlements with, the operators of three decentralized finance protocols for offering illegal digital asset derivatives trading.
• Legislative restriction and inertia. With notable exceptions such as Wyoming, U.S. lawmakers at the state and federal levels have generally eschewed “sandbox” approaches to cryptoasset regulation, instead focusing on curbing actual or perceived industry excesses.  For example, California in October adopted a sweeping Digital Financial Assets Law to create a state-level regulatory framework, including a licensure requirement for engaging in any digital financial asset business activity in the state, analogous to the New York “BitLicense” regime; and in May, the New York Attorney General proposed new crypto regulations that, if adopted, would functionally preclude most existing cryptoasset businesses from operating in the state.  At the federal level, while there have been bipartisan efforts around ensuring that stablecoins are backed by full reserves under regulatory oversight and delegation of authority over spot cryptoasset markets, a divided political climate and an election year serve as a challenging backdrop for efforts to clarify industry rules.
• Tension between regulatory imperatives and decentralization. A paramount challenge for the cryptoasset industry is to satisfy bona fide regulatory and public policy imperatives — such as preventing money laundering — while preserving as much as possible the potential efficiency, privacy, and reduced rent-seeking associated with decentralization and increasingly capable software applications. DeFi protocols, such as Uniswap and Aave, have demonstrated the practical viability of conducting traditional financial activities such as trading and secured lending, respectively, through decentralized protocols employing tested open source code, governed by decentralized autonomous organizations rather than traditional corporate forms.  However, industry participants, regulators and legislators continue to grapple with how to address policy concerns while harvesting the benefits of the technology—as opposed to simply forcing activity to be channeled through traditional regulatory rails. The latter impulse can be seen in the SEC’s proposal to require registration of DeFi trading platforms as Alternative Trading Systems (which we previously commented on here), as well as a Senate bill co-sponsored by Senator Warren that would extend KYC requirements to cryptoasset miners, validators, and wallet providers in the same manner as traditional banks. Insofar as decentralized software encroaches on the domain of systemically important financial functions, it is indeed appropriate that regulators and legislators proceed with great caution. But for the U.S. to remain at the vanguard of this industry as it further develops, it is also necessary that they proceed.

Following the collapse of FTX, we noted the irony that the cryptoasset market was laid low by the failure of centralized parties. With no less irony, the cryptoasset market now may be poised to reclaim heights precisely by virtue of its embrace by traditional financial institutions.  While many in the crypto community continue to adhere to a vision of subversive financial system reform, one need not embrace that vision in order to concur that cryptoassets and decentralized software applications have the potential to exist in parallel, oreven in symbiosis, with traditional institutions and assets (such as payment system enhancements and digitization of traditional assets).  Whether the U.S. will be largely frozen out from that potential’s unlocking hinges on the willingness of industry participants, regulators and legislators to engage on thoughtful solutions to pragmatically address core public policy mandates.

Kevin S. Schwartz is a Partner, Rosemary Spaziani is Of Counsel, David M. Adlerstein is Counsel, Samantha M. Altschuler is an Associate, and Sabina M. Beleuz Neagu is a Law Clerk at Wachtell, Lipton, Rosen & Katz. The post was first shared by the firm as a client memo. 

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