Satoshi Nakamoto, the mysterious creator of bitcoin, dreamed of a world where financial transactions and investing could occur without the need to trust a third party. According to Securities and Exchange Commission Chairman Gary Gensler, Nakamoto fundamentally misunderstood how markets work.
“Finance is ultimately about trust,” Gensler told MarketWatch in an exclusive interview. “And the official sector has a role to help instill that trust through a set of rules on disclosure, anti-fraud and anti-manipulation.”
It’s these principles that guided the SEC in a landmark enforcement action announced Monday, when it settled with cryptocurrency services company BlockFi for not following investor-protection laws when it offered users high interest rate payments in exchange for deposits of cryptocurrencies like bitcoin
BlockFi neither admitted nor denied wrongdoing, but agreed to pay a $100 million fine, a record for a crypto company
“90% to 95% of the activity in the lending and trading of crypto happens on a platform,” like BlockFi, Gensler said.
“That activity, centralized on those platforms, they need the investor protection, the market integrity and anti-manipulation” rules that govern markets for other financial assets, he added. “I think the problem is, right now, the public isn’t well protected and there’s a lot of folks who are going to get hurt.”
As part of its settlement, BlockFi will seek to register its lending product, BlockFi Yield, with the SEC, which will require filling a public registration statement that explains the risks associated with it.
This could create a compliance blueprint for other companies seeking to offer similar products, but questions remain as to whether the SEC will go after exchanges like Coinbase Global Inc.
FTX or Kraken for selling crypto tokens on their platforms the SEC deems unregistered securities. In a recent U.S. Senate hearing, Gensler lamented that Coinbase has not registered with the SEC as a securities exchange, “even though they have dozens of tokens that may be securities.”
Gensler told MarketWatch that exchanges should remain on notice, as the agency will pursue enforcement actions against platforms that remain outside the SEC’s regulatory framework. “We’ll continue to pursue [enforcement actions], based on the facts and the law, wherever that takes us,” he said.
Renovating the stock market
Cryptocurrency is just one market in which Gensler hopes to nurture Americans’ trust. He also remains focused on reforming the plumbing of the U.S. stock market and bringing to it more transparency and competition, which he says will lower costs for retail investors.
A primary concern for the SEC chairman is the rapid growth of so-called “dark” markets for stocks, like alternative trading systems or wholesale market makers. These companies, which include Citadel Securities and Virtu Financial
sometimes pay brokers, like Robinhood
or Charles Schwab
for the privilege of executing their customers’ orders, so they can earn the difference between the price at which they’ll buy and sell a stock.
The SEC and the general public don’t know as much about these orders as they do on “lit” exchanges like the New York Stock Exchange or Nasdaq
and these orders do not inform the National Best Bid and Offer quotes against which order quality is benchmarked.
“When just under half the market goes to wholesalers or dark pools, then the investing public says, that limited transparency, it’s harder to have that confidence, so that’s one of our projects,” he said, adding that the NBBO “is an incomplete or even false measuring rod right now.”
The SEC could move to reform the NBBO so that it is calculated using off-exchange trades and smaller on-exchange trades that are currently excluded, and could also reform rules that require exchanges to quote prices for stocks in increments of one penny. Because market makers do not have to follow this rule, they have an advantage over lit exchanges, enabling them to capture a larger market share.
Promoting competition for retail trades
Gensler also suggested the SEC could propose rules that require greater transparency around payment for order flow. “I’ve asked staff how we can ensure greater competition….so that if somebody places a market order on one of these brokerage apps, there’s this real-time, order-by-order competition,” so customers can see how much their broker is being paid by a market maker, and whether they’re really getting the best deal when they buy or sell a stock.
Greater transparency around PFOF could be a compromise between proponents of the practice, which argue it has helped create commission-free trading and contributed to the overall decline in bid-ask spreads and critics of the practice who argue it creates a conflict of interest that inevitably harms retail investors.
Gensler believes his agency has the statutory tools to make these changes, as competition is at the heart of the SEC’s mandate, in part due to amendments made by Congress to the legislation that created the SEC in the 1970s and 1990s.
“Our statute had the word competition added 20 times and in 1996 Congress did it again and added another 15 or 20 times,” he said, adding that the SEC is not just about financial oversight, but that “we are also a competition efficiency agency.”