Digital assets and blockchains can lead to financial innovations with a range of applications across countries, markets, and industries. Yet they also require comprehensive regulation, which is especially difficult within the fragmented financial-regulation framework of the United States. In a recent article, we provide an empirical study of regulatory fragmentation in digital asset markets.
The realities of fragmentation are evident in the increasing competition between the major federal regulators claiming jurisdiction over digital asset markets: the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). These regulators have traditionally operated separately and shared duties as the watchdogs of American commodity, derivatives, and securities markets. However, in the realm of digital assets, both agencies claim jurisdiction over the same assets and firms.
Our article examines this regulatory fragmentation and responds to several policy developments. First, in 2022, the White House urged various U.S. regulators to develop new “whole-of-government” approaches to digital assets, mitigate the risks of those assets, and reinforce the “[g]lobal [f]inancial [l]eadership and [c]ompetitiveness” of the United States. Next, Congress introduced several bills in 2022 and 2023 to address jurisdictional uncertainty and fragmentation in digital asset markets. These developments stirred policy debates, provoked an uproar from scholars, and were ultimately not implemented.
In our article, we contribute to the scholarship on digital financial innovation and seek to assist policymakers operating in a fragmented legal regime. We also aim to fill a gap in the literature on digital assets. To date, this scholarship has not paid sufficient attention to the interaction among U.S.-specific factors such as regulatory fragmentation, specific modes of regulation (i.e., regulation through statutes and formal rulemaking versus regulation through enforcement), and the centrality of U.S. agencies in global markets.
The SEC and CFTC approach digital asset regulation mainly through enforcement of existing securities, commodities, and derivatives laws, i.e., there are no new formal rules on digital assets. To assess the impact of enforcement, we examine investor reaction to 116 enforcement events announced between April 2017 and November 2021. We use cryptocurrency price data extracted from CoinGecko, one of the largest crypto price data aggregators. Specifically, we extracted daily prices, volume, and market capitalization of 2,397 liquid cryptoassets with a minimum market capitalization of $1 million. (From now on, we will use the terms “cryptoassets,” which covers digital assets secured through cryptography, and digital assets interchangeably.)
Our cross-sectional analyses and event study indicate that the global digital asset market is, to surprising degree, sensitive to enforcement actions initiated by the two agencies. Generally, the global market reacts negatively to announcements of U.S. enforcement. It is notable that enforcement actions of national regulators in one market can so significantly move global cryptoasset values.
The price reaction is negative in enforcement actions targeting several types of market actors, such as issuers and developers of cryptoassets, and especially brokers and exchanges. Importantly, the markets react differently based on which agency enforces the law: the SEC (in securities law enforcement actions) or the CFTC (in commodity and derivatives law enforcement). SEC actions appear to trigger a more negative market reaction than doCFTC actions. These effects, however, are somewhat weaker for Bitcoin and Ether, which have traditionally been viewed as well-established, decentralized, and global cryptocurrencies. Courts and the CFTC typically classify both cryptoassets as commodities, which may render them less sensitive to U.S.-based enforcement risks.
Markets are also sensitive to quality differences among highly heterogenous cryptoasset classes. For instance, investors perceive more liquid, better performing, and riskier cryptoassets as more vulnerable to U.S. enforcement after controlling for the agency initiating it. These observations confirm that regulation and enforcement may improve market quality.
Finally, although crypto-investors view enforcement as costly, the more positive reaction to antifraud actions, which improve market integrity, offsets this view. This result helps to counter the argument that money laundering and crime drive crypto markets and that the community’s libertarian ethos is inconsistent with law and compliant behavior. But our data indicate that, although investors perceive enforcement negatively, they do not view antifraud actions in the same light. This suggests that many crypto-market participants understand that fraud undermines market integrity. Although crypto investors treat regulation (mainly enforcement of pre-crypto U.S. securities statutes) as costly, the benefits of improved market quality and integrity mitigate these costs. Our results also lend support to the notion that U.S. regulators play an important role in global financial markets.
We provide several possible explanations for why overall investor reaction to the SEC and CFTC may be negative. One line of scholarship warns that regulation may stifle economic growth and innovation. Not all regulation, however, is counterproductive. Properly designed rules may improve market integrity, correct market failures, foster innovation, protect consumers and investors, and reduce transaction costs, information asymmetry, and agency costs. Instead of rejecting regulation and enforcement, our results should be interpreted as a signal from digital asset markets that some regulatory efforts are inefficient. A need for updated law and regulation may explain our results.
Similarly, scholarship showing that pre-crypto securities statutes are not an ideal framework for regulating digital-asset innovation may explain the indicated differences in price reactions to SEC and CFTC enforcement actions. That literature spans the cryptoasset ecosystem: from definitions of cryptoassets as securities to the rules on primary markets (i.e., distribution of tokens and coins by issuers to investors and consumers) to secondary market and infrastructure regulation. If securities laws were more outdated, rigid, or unsuitable for cryptoassets than commodity and derivatives regulation, then SEC enforcement would be associated with higher risk and more negative market reaction. The intensity of SEC enforcement would only exacerbate these trends – the SEC brings more enforcement actions and typically imposes larger penalties than does the CFTC or its foreign counterparts.
It also does not seem likely that the SEC, which is larger than the CFTC, has more skillfully addressed information asymmetry or a possible crypto bubble than the CFTC has. If that were the case, the effect of SEC enforcement would be stronger and last longer than a few days around the event date. Yet, it would be wrong to assert that the SEC is uniformly less effective in regulating crypto than the CFTC is. It is possible, however, that digital asset markets challenge the agency in novel ways as investors react negatively to securities law enforcement. In cryptoasset markets where asset classifications overlap, reconsidering and redesigning fragmented regulation could address possible inefficiencies of securities law and yield benefits from the joint efficiency of the SEC and the CFTC.
The economic potential of blockchains and other relevant technologies makes regulation of digital assets one of the most important topics on the agenda of policymakers, the SEC, and the CFTC. Our empirical evidence supports the case for a comparative reassessment and reform of the currently fragmented regulation of cryptoassets. The central role of U.S. regulators in the global finance makes this need for reform more pressing.
This post comes to us from professors Yuliya Guseva at Rutgers Law School and Irena Hutton at Florida State University’s College of Business. It is based on their recent article, “Regulatory Fragmentation: Investor Reaction to SEC and CFTC Enforcement in Crypto Markets,” available here.