Crypto regulation gets even messier after SEC setbacks

Securities and Exchange Commission chair Gary Gensler is very clearly anti-crypto — but other parts of the U.S. government aren't necessarily on the same page.

Why it matters: Recent court rulings against the SEC underscore how crypto regulation is going to remain messy and unpredictable for the foreseeable future.

Driving the news: Although the SEC boasts awesome powers, its decisions are still subject to judicial review.

• The agency suffered a major loss in July, when a federal judge in New York controversially ruled that the XRP token issued by crypto company Ripple is not a security, thereby effectively removing it from SEC oversight.
• This week the SEC racked up another loss. This time, a federal court in Washington, D.C., ruled the agency was being "arbitrary and capricious" when it barred crypto company Grayscale from creating a bitcoin-backed ETF.

Between the lines: The central line of argument in the Grayscale case was that the SEC had already approved slightly different bitcoin ETFs issued by rivals Teucrium and Valkyrie. If those were allowable, said the court, then there was no good reason to bar Grayscale's product.

Be smart: Teucrium and Valkyrie had engaged in some cunning regulatory arbitrage to get their bitcoin ETFs approved. Instead of backing the shares with actual bitcoins, they backed them with bitcoin futures, as traded on the regulated Chicago Mercantile Exchange (CME).

• The CME was allowed to offer bitcoin futures by its regulator, the Commodity Futures Trading Commission (CFTC), which was at the time (and probably still is) less anti-crypto than the SEC.
• Once the CFTC was comfortable with the CME product and said it was safe, the SEC had to defer to its sister regulator when it came to the safety of futures-linked bitcoin products.

Where it stands: The SEC still has extensive powers — as well as friends in the judiciary. For instance, a different New York federal judge, Jed Rakoff, recently ruled, effectively, that his colleague deciding the Ripple case was wrong.

• The SEC doesn't even need to appeal the Grayscale decision, notes Hashdex CIO Samir Kerbage — it can simply reaffirm its previous denial with a new set of reasons why it is rejecting the application.

The big picture: The SEC is tasked with enforcing the law, not with making it. If one thing has become clear from these rulings, it's that the law is very messy and that Congress needs to clarify a lot about what it's asking the SEC to do.

• Realistically, however, that's not going to happen any time soon. While pro-crypto members of Congress never had the might to pass bills making it clearly legal, they retain enough power to stymie any attempt to outlaw it.

The bottom line: There used to be a dream that "regulatory clarity" would help investors — and law enforcement — draw a clear distinction between legitimate crypto products, on the one hand, and illegal scams, on the other.

• It's now clear that's not going to happen, and that the SEC will continue to frown on just about all crypto activity.
• Some crypto players like Grayscale and Coinbase might — out of boldness or necessity — attempt legal remedies that force the SEC to live with their activities. But most mainstream banks and investment shops are likely to read the mood music and abjure the legally messy asset class entirely.