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

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

A resilient cryptoasset industry is emerging from weathering years of headwinds — from edicts prohibiting the banking of the industry, to an SEC leadership bent on aggressive regulation-by-enforcement in lieu of transparent rulemaking. Looking ahead, tailwinds abound: Bitcoin and Ether exchange-traded products, approved just this year, already have over $150 billion in assets under management. Leading financial institutions have announced plans to tokenize substantial new funds on public blockchains. And tens of millions of Americans own cryptoassets, as use cases continue to proliferate — from payments for goods and services, both on- and off-blockchain; to decentralized financial (DeFi) platforms; to the authentication of content provenance (an essential need amidst AI’s rapid development). With a new Administration and Congress in the offing, there are at last prospects for regulatory clarity in an arena long clouded by uncertainty.

As attention turns to crafting a clear, comprehensive crypto legal landscape, it will be important to heed lessons from recent failures while also replacing ill-fitting regulatory rails with transparent, sensible rules of the road. Investor protection and anti-money laundering imperatives remain critical in the traditional finance and crypto arenas alike, but long overdue is a sober reckoning with what distinguishes digital assets as the basis for shaping the healthy evolution of this industry.  As a first step, it is high time to extricate this technology from the conceptual millstone of the SEC’s attempted rote imposition of the securities laws through ad hoc civil litigation.

With these goals in mind, we believe that a meaningful dialogue in pursuit of legal clarity for the cryptoasset arena should consider the following (among other initiatives):

• Financial regulators must be open to cryptoasset-related activities. The arbitrarily imposed ban on banks engaging in cryptoasset-related activities must cease. These activities can be conducted safely and soundly, consistent with supervisory requirements, and as we have urged, the development of proper guardrails must begin with a posture of constructive engagement.
• Stablecoin regulation should preserve this technology’s benefits and remain outside the SEC’s purview. We continue to believe that effective stablecoin regulation should require robust, transparent reserves subject to proper oversight without creating friction that deprives stablecoins of their comparative advantages. For example, know-your-customer controls applicable to stablecoin recipients should be appropriately risk-based, such that stablecoins remains compatible with the use of DeFi applications and the preservation of financial privacy. And stablecoins should remain outside the SEC’s remit.
• Develop a comprehensive legal framework for cryptoassets and centralized exchanges. As we have repeatedly argued, the SEC’s practice of issuing summary declarations about the status of widely held digital assets through one-off enforcement actions is not conducive to U.S. leadership in this industry or meaningful investor protection. Legislators and regulators of all political stripes must work together to dispel the significant market uncertainty about who has supervisory authority over crypto spot markets and promote market integrity through a tailored regime for compliant capital formation and trading activity. In this spirit, policymakers must confront all that makes the cryptoasset arena distinct from traditional finance.  This includes dispensing with efforts to map the existing plumbing for the trading and settlement of securities onto the market for cryptoassets tradable 24/7 through open, public blockchains that settle instantaneously. What’s more, as courts and the SEC have now acknowledged, there is no basis to treat all digital assets in and of themselves as constituting securities — that goes for fungible digital assets (such as Bitcoin and Ether, and countless others), and non-fungible tokens (NFTs) as well. Nor is there any credible basis to label as a “broker” noncustodial wallet software used by millions of people to access and use cryptoassets in Web3.
• Permit decentralized software to compete with traditional intermediated services, subject to tailored safeguards. Decentralized exchanges, such as Uniswap, function effectively through autonomous, open-source software without the participation of a third-party broker, dealer, or clearinghouse as financial To foster innovation, thoughtful rules of the road must eschew the impulse to interpose such intermediaries on the basis of how traditional markets are regulated, and instead craft new, tailored statutory and regulatory approaches that protect investors while preserving technological efficiencies. As a corollary, consistent with this week’s federal appellate decision striking down OFAC sanctions on crypto mixing software Tornado Cash, the impulse to focus enforcement efforts on autonomous software, rather than on illicit activities by market participants, should be resisted.
• SAB 121 should be repealed. The requirement that custodied cryptoassets be accounted for as liabilities has functionally precluded many otherwise willing traditional financial institutions from offering custody services, pushing custody services out of the prudential regulatory perimeter. We have previously discussed the GAO’s finding that SAB 121 amounted to a rule subject to congressional review, but even after a bipartisan vote in Congress in favor of repeal a presidential veto has kept this rule in effect.
• Facilitate flexible design over software governance and liability protection for DAO participation. Last week, a federal court denied a motion to dismiss a purported class action relating to the token sale by a decentralized autonomous organization (“DAO”), exacerbating the specter (for DAOs of all profiles) that merely holding a token providing governance rights over software could render a person a general partner with unlimited liability for the activities of a purported general States should continue to explore and refine frameworks, such as the Wyoming DUNA, to promote flexible design and liability protection for participating in governance over open source software.

After years of relative inertia, prescriptive rulemaking in this arena need not, and should not, entail a partisan “cramdown.” Already, bipartisan support for crypto legislation in the outgoing Congress revealed substantial common ground for achieving consensus on important issues. As industry participants look ahead to a more constructive paradigm, we urge a transparent, inclusive dialogue that is informed by lessons learned from recent regulatory shortcomings as well as a mature understanding of the benefits and risks of the technologies at issue.

Kevin S. Schwartz is a Partner, David M. Adlerstein is Counsel, and Samantha M. Altschuler, and Sabina M. Beleuz Neagu are Associates at Wachtell, Lipton, Rosen & Katz. This post first appeared as a client alert.

The views, opinions and positions expressed within all posts are those of the author(s) alone and do not represent those of the Program on Corporate Compliance and Enforcement (PCCE) or of the New York University School of Law. PCCE makes no representations as to the accuracy, completeness and validity or any statements made on this site and will not be liable any errors, omissions or representations. The copyright of this content belongs to the author(s) and any liability with regards to infringement of intellectual property rights remains with the author(s).