Corey Frayer: Crypto loses its identity when mimicking traditional finance, SEC’s independence is crucial for regulation, and compliance can create competitive advantages

Key takeaways

• Crypto loses its distinct identity when it begins to mimic traditional financial systems.
• If crypto projects function like banks or securities exchanges, they must comply with existing laws.
• The current state of crypto resembles traditional finance but often resists regulation.
• The SEC’s enforcement division operates independently from the chair’s direct involvement in investigations.
• Gary Gensler’s knowledge of crypto is a significant asset for the SEC’s approach to the industry.
• The crypto industry perceives the SEC’s office hours as a trap due to fears of future enforcement actions.
• The distinction between an asset being sold as a security and the asset itself being a security is crucial.
• Engaging platforms to comply with securities laws can create a competitive advantage in the crypto trading space.
• Vertical integration in crypto exchanges poses significant risks to financial regulation.
• Crypto’s fundamental value lies in enabling peer-to-peer transactions without intermediaries.
• Introducing intermediaries into crypto undermines its decentralized ethos.
• The crypto industry needs to start centralized to eventually achieve decentralization.
• The SEC’s approach under Gary Gensler has stifled the potential growth of the crypto industry.
• The crypto market poses a threat to the integrity of established securities laws if not treated equally.
• Crypto startups should be treated like other startups in terms of capital raising.

Guest intro

Corey Frayer is Director of Investor Protection at the Consumer Federation of America, where he leads efforts to advocate for policies protecting investors and promoting market integrity. Most recently, he served as Senior Adviser to SEC Chair Gary Gensler, focusing on financial stability and crypto asset markets, where he shaped the agency’s approach to securities law and digital assets. Prior to his SEC tenure, Frayer held key positions on Capitol Hill, including as a senior staffer on the Senate Banking Committee advising Chairman Sherrod Brown on financial regulation and consumer protection.

Crypto’s integration into traditional finance

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• If crypto projects aim to operate like banks or securities exchanges, they must adhere to existing laws.

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• The current state of crypto resembles traditional finance but resists regulation.

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• There is a misconception that the SEC under Gensler is pro-traditional finance.

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SEC’s regulatory approach and independence

• The SEC’s enforcement division operates independently from the chair’s direct involvement in ongoing investigations.

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• Gary Gensler’s knowledge of crypto is a significant asset for the SEC’s approach to the industry.

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• The narrative in the crypto industry suggests that Gary Gensler is leveraging his position to gain political capital at the expense of the crypto sector.

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• The crypto industry has largely been isolated from opposing viewpoints, leading to unchecked narratives about regulatory intentions.

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Securities law and crypto assets

• The distinction between an asset being sold as a security and the asset itself being a security is crucial in understanding investment contracts.

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• The SEC established precedent that crypto assets could be offered and sold as securities under certain conditions.

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• Focusing regulatory efforts on centralized platforms is more productive than targeting individual tokens.

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Compliance and competitive advantage

• Engaging platforms to comply with securities laws can create a competitive advantage in the crypto trading space.

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• Having multiple financial services under one platform creates conflicts of interest that violate foundational securities law.

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• Vertical integration in crypto exchanges poses significant risks to financial regulation.

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• The structure of FTX was a classic failing business model.

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Peer-to-peer transactions and decentralization

• Crypto’s fundamental value lies in enabling peer-to-peer transactions without intermediaries.

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• Introducing intermediaries into crypto undermines its decentralized ethos and necessitates compliance with traditional financial regulations.

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• The crypto industry needs to start centralized to eventually achieve decentralization.

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• The collapse of FTX significantly impacted traditional financial firms’ willingness to engage with crypto.

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Regulatory challenges and the SEC’s role

• The SEC’s approach under Gary Gensler has stifled the potential growth of the crypto industry.

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• If the crypto world had remained focused on electronic peer-to-peer transactions, regulatory scrutiny from the SEC might have been avoided.

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• The crypto market poses a threat to the integrity of established securities laws if not treated equally.

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• The economic reality of business practices in crypto must be treated the same as any other financial instrument.

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Crypto startups and investor protection

• Crypto startups should be treated like other startups in terms of capital raising.

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• The SEC’s role is to ensure issuers follow laws rather than make investment decisions for investors.

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• The orderly functioning of the securities marketplace is crucial for investor protection.

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• Peer-to-peer transactions are fundamentally what crypto was designed to facilitate.

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DeFi and centralized actors

• Decentralized finance (DeFi) aims to perform financial functions without intermediaries.

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• The definition of DeFi is nuanced and depends on the presence of centralized actors.

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• Centralized actors in DeFi platforms create obligations to comply with securities laws.

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• The SEC’s actions against Uniswap represent an attack on open source and DeFi.

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Uniswap and regulatory challenges

• Uniswap has achieved significant trading volume, making it a success story in the DeFi space.

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• The distinction between good and bad actors in crypto is often unclear until after events unfold.

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• Uniswap’s code allows users to verify its non-custodial nature, distinguishing it from centralized entities like FTX.

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• Uniswap’s claim of decentralization is misleading because it can still be identified and served subpoenas.

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Philosophical differences in regulation

• There is a philosophical difference regarding the facilitation and control of exchanges in the context of securities laws.

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• Uniswap Labs is not operating the Uniswap exchange, which is a significant distinction in terms of accountability under securities laws.

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• Mantle is not just another blockchain; it is an ecosystem designed for builders seeking real distribution and users.

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• Projects on Mantle can access Bybit, which provides exposure to over 70 million verified users.

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Outdated regulations and SEC’s capacity

• The SEC’s regulations from the 1930s may not be suitable for today’s decentralized finance landscape.

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• The SEC lacks the capacity to audit every platform’s code effectively without additional congressional support.

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• The SEC’s limited budget and resources hinder its ability to effectively oversee the vast securities marketplace.

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• The DAO concept is fundamentally flawed as a decentralized model.

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Broader implications of DeFi and DAOs

• Decentralized finance (DeFi) may not pose a significant threat to the broader financial services industry or securities laws.

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• The governance of decentralized autonomous organizations (DAOs) still holds individuals accountable, regardless of how decentralized they appear.

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• Comparing Uniswap to Google highlights the transformative impact of DeFi on trading, akin to how Google revolutionized internet search.

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• Corey believes that while there are bad actors in crypto, the presence of good projects is beneficial for both the US and the world.

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Fair regulatory treatment and the Howey Test

• Crypto should not receive preferential treatment in regulation compared to traditional financial industries.

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• The Howey test’s application to various assets may be overly broad, potentially classifying many non-traditional items as securities.

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• The SEC evaluates whether an asset is a security based on how it is offered and sold, not just the asset itself.

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• Relying solely on the Torres decision in Ripple is unfair, as there are many legal interpretations regarding what constitutes a security.

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Economic analysis and legal definitions

• The economic analysis behind a security is more important than a strict definition.

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• Creating strict definitions for securities could lead to increased fraud and undermine the securities market.

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• Defining legal terms in legislation is inherently complex and subjective.

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• The Howey Test remains a relevant framework for identifying securities.

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SEC’s motives and Uniswap’s alignment

• The SEC has ulterior motives that hinder the growth and potential of the crypto industry.

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• Uniswap has created fair and orderly markets that align with the SEC’s interests more effectively than the SEC itself.

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• Regulation does not inherently harm an industry; it can actually strengthen it.

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• We cannot identify bad actors in the crypto space until regulations are applied fairly.

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Market trust and the SEC’s approach

• Failing to regulate financial markets erodes trust, which is essential for market stability.

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• The SEC under Gary Gensler has taken a ‘bad cop’ approach to regulating the crypto industry.

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• Even without fraud, Sam Bankman-Fried’s company was destined to fail.

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• Crypto risks losing its distinctiveness when it engages in traditional financial activities.

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Private currencies and centralized entities

• Private currencies have historically not worked out well.

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• Centralized entities like Circle and Tether contradict the decentralized ethos of crypto.

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• The Genius Act is not a good idea as it treats economically identical assets differently.

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• Credit card companies will likely start processing stablecoin transactions without consumer protections.

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Bankruptcy law and political influence

• The accounting treatment of crypto assets in bankruptcy is complex and varies significantly from traditional assets.

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• Banks could have implemented capital rules to accommodate crypto without affecting their balance sheets.

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• The ambiguity in bankruptcy law for crypto will continue to lead to conflicting decisions.

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• The crypto industry did not significantly influence the 2024 election.

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Political actions and regulatory consequences

• The crypto industry’s political actions were not focused on promoting pro-crypto candidates.

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• The silence from the crypto industry regarding presidential corruption is harmful to its credibility.

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• Corruption will be a significant theme in the next election, impacting the perception of crypto.

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• The current regulatory approach under the new administration is a step in the wrong direction.

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SEC guidance and market uncertainty

• The current SEC guidance lacks the force of law and is easily reversible, which creates uncertainty for the crypto industry.

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• A new SEC administration could lead to chaos and legal challenges in the crypto market.

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• The SEC’s current actions are harming the integrity of the institution and will have broader consequences for the market.

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• There should be stronger advocacy for regulation and enforcement not just in crypto but across the entire financial system.

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Ethereum’s regulatory status and centralization risks

• Ethereum has characteristics that could classify it as a security at certain times.

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• The transition from proof of work to proof of stake has introduced centralization risks in Ethereum’s validation process.

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• The SEC chair cannot engage in open dialogue without risking market movement and legal repercussions.

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• Independent regulators should avoid engaging in public conversations that could compromise their responsibilities.

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