New Year, New Approach: How the SEC and CFTC Can Modernize Crypto Market Structure Now
TL;DR
đŚ Our proposal: regulate crypto market structure by updating requirements for the intermediaries the SEC and CFTC already oversee.
Near-term: issue exemptive orders to create an opt-in âgrace periodâ for existing regulated intermediaries to trade, settle and custody crypto.
Longer-term: use notice-and-comment rule-making to provide permanent regulation of intermediary crypto activities.
đ§ Why it matters: creates more robust, competitive U.S. markets, with clear compliance obligations and customer protections.
Crypto policy moved fast last year, and thatâs good news. Congress passed the GENIUS Act with bipartisan support and made strides on market structure legislation. Meanwhile, the SEC and CFTC quickly began identifying and removing barriers for digital asset innovation and engaging stakeholders for deep discussions on how to provide clarity and relief. But one problem is still slowing the U.S. down: market structure uncertainty. In other words, market participants donât know whatâs allowed, which inhibits further growth of robust, competitive markets and customer protections.Â
Our solution is simple: use existing SEC/CFTC tools to create clear rules of the road now, starting with a transitional âgrace periodâ through exemptive relief and followed by durable rule-making.
Against that backdrop, Owl Explains (now known as the Avalanche Policy Coalition)* submitted comment letters to the SEC and the CFTC explaining how the agencies could create a market structure framework for trading crypto, specifically protocol tokens, independent of legislation. We discussed our ideas with the SEC Crypto Task Force in mid-December, shortly before the publication of the Statement and FAQs that moved in the direction we advocated. We like the terminology âprotocol tokensâ because it refers to a token that is integral to the functioning of a protocol, the amalgamation of software that provides an operating system or application. This definition is technology neutral, but also covers tokens integral to blockchain networks and all their associated functional protocols and layers including DeFi, L2s, restaking and liquid staking applications, subnets and custom L1s, etc.
Our main concept for both agencies is straightforward: regulate market structure through requirements on the intermediaries that they already oversee. The financial services industry has lots of experience with electronic trading, settlement and custody so leveraging existing regulatory infrastructure makes sense. Protocol tokens are just another asset that trades and settles electronically, such that it can be supported by well-established market integrity and customer protection controls. Our idea also recognizes the years of struggle about whether protocol tokens are securities or commodities, and takes the practical approach by having both agencies exert jurisdiction through their regulated intermediaries, which is within their statutory mandates.
To kick things off, we suggest the agencies use their exemptive powers to create a transitional âgrace periodâ during which regulated intermediaries could opt in to conducting activities in protocol tokens via a notification and certification process confirming their implementation of relevant policies and procedures. The policies and procedures could cover, as relevant, custody and segregation controls, conflicts of interest, market surveillance and manipulation detection, disclosures, recordkeeping, and operational resilience. The grace period would last while rule-making occurs to adapt rules for regulated entities engaging in protocol token activities.
This post briefly explores the agenciesâ powers under the Administrative Procedure Act (APA) and elsewhere to grant exemptive relief and conduct rule-making to show how our proposals might be accomplished through existing agency powers. This post is for informational purposes only; it is not legal advice. The relevant laws are complex, and readers should consult counsel before acting on any specific proposal.
The Administrative Procedure Act
The APA governs how federal agencies develop and implement rules and adjudicate administrative litigation related to such activities. The core principle of the APA is to ensure that agencies operate in a manner that is transparent, enables public participation through a standardized process, and provides for a fair adjudication process. Agency actions are reviewed by federal courts for compliance with the APA and other relevant statutes, as well as the Constitution. Courts will overturn agency actions that are âarbitrary and capriciousâ or violate congressional intent. The Supreme Court in Loper Bright shed further light on how courts review agency actions. That makes the quality of the agenciesâ statutory analysis and rule-making record especially important for any durable crypto market structure framework.
The APA provides two primary tools for agency action: rule-making and adjudication. The rule-making process governs how agencies develop new regulations or amend existing regulations. For example, our proposals to the SEC and CFTC suggest developing new regulations and amending existing regulations aimed at creating robust, competitive markets for protocol tokens by regulating existing registered intermediaries. Under the APA, this process would involve proposing rules and soliciting written public comments for some period, usually between 30 and 90 days, depending on complexity. The agencies then review the comments and assess whether and how to incorporate them as they prepare a final rule. Like rule proposals, final rules are published in the Federal Registerâthe U.S. Governmentâs official record that is used to announce new rules, among other things. New rules go into effect some period of time after publication. Note, however, that the notice and comment process may be suspended if there is âgood cause,â and this is referred to as an interim final rule.Â
The other main part of the APA, adjudication, is when an administrative agency conducts an enforcement action to address a specific case based on the facts and circumstances, which is not relevant to our proposal but occurred a lot under prior SEC leadership.Â
Meanwhile, other common agency communications, such as interpretive rules, and general statements of policy are explicitly exempted from the APA.
Exemptive Orders
In addition to the SEC and CFTC being governed by the APA, Congress provided each agency with its own process for issuing exemptive relief. The agenciesâ exemptive order authority complements the APA and allows the agencies to offer regulatory relief and respond to market conditions quickly. As Congress, through legislation, and the agencies, through rule-making, work on crypto market structure, each agency can offer clarity to market participants through exemptive relief, such as the grace period we propose. This can function as a credible bridge: faster than rule-making, but more formal and durable than informal guidance.
The authority for these orders comes from specific sections in the foundational laws of each agency. The SECâs authority is found in both the Securities Act (in Section 28, focusing on creation, registration, and initial sale of securities and codified at 15 U.S.C. §77z-3) and the Securities Exchange Act (in Section 36, focusing on intermediaries and trading and codified at 15 U.S.C. §78mm). Each provides the agency with broad general exemptive authority, âto the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.â The Exchange Act specifically allows exemptive relief via Commission order, which is relevant to our proposal because it relates to regulation of intermediaries.
The CFTCâs authority is found in Section 4(c) of the Commodity Exchange Act (7 U.S.C. §6(c), allowing it to exempt any agreement, contract, or transaction if it is consistent with public interest and applicable law, it does not have a material adverse effect on the CFTC or contract market or derivatives transaction execution facility, and the transaction is between âappropriate personsâ (essentially, regulated financial services intermediaries and other market participants).Â
Before implementing an exemptive order, each agency typically provides an opportunity for public comment through publication of information about the proposed exemption in the Federal Register. Agency staff review any public feedback before finalizing the exemptive order. The CFTC typically votes on the issuance of the final order, while the SEC may choose to vote (usually if the issues are novel) or delegate authority to a division director to implement the order.Â
The result of the exemptive order process is a commission-level action that binds the agency and all regulated entities, which is stronger than non-binding communications, such as a no-action letters, FAQs and division statements. In this way, an exemptive order can offer market participants a transitional grace period through quick and binding agency action to meet the needs of a rapidly evolving market structure. For compliance teams, that durability matters: it supports consistent supervisory expectations and reduces the risk of shifting interpretations.
Although mentioned above, this note does not discuss interim final rule-making, which is designed for emergency situations. While it could be relevant to the implementation of our proposal, the agencies right now are content to operate through their interpretive powers, so the exigent circumstances that typically apply to interim final rule-making do not seem present.
Why We Advocate for Exemptive Relief and Rule-making
Both agencies have recently issued various forms of interpretive guidance on crypto activities to their regulated entities. While these interpretations provide clarity on the agenciesâ thinking about specific areas, they do not have the binding effect of an exemptive order or a rule-making. Moreover, our proposed transitional âgrace period,â created by exemptive order, would formalize a process for all regulated entities who wish to engage in protocol token activities. And the rule-making process would settle many more issues for regulated entities, giving market participants clarity on how to proceed with their activities in protocol tokens.
We believe the agencies have both the opportunity and the power to jump-start robust, competitive markets in the United States. And we know from the interpretive guidance releases that both agencies are thinking carefully about how regulated intermediaries can conduct the activities in crypto. Accordingly, we hope to see exemptive orders and rule-makings in the near future to formalize and solidify this important work and take further action to maintain the competitiveness of the U.S.
If you are a market participant, policymaker, or other stakeholder, now is the time to engage. Why? Because the conditions set during a grace period can shape the durable rules that follow.
*same Owl, new name
