Crypto enthusiasts wrong to target Gensler.

The focus of the entire cryptocurrency world is on Securities and Exchange Commission Chair Gary Gensler.

Critics claim that he is unfairly categorizing cryptocurrencies. They argue that he is misleading well-intentioned entrepreneurs by encouraging them to “register,” knowing that his process is designed to make them fail. They argue that he knows new rules are necessary but prefers to enforce impractical regulations in order to stifle the industry entirely. And, of course, under his supervision, the SEC has taken legal action against Coinbase, claiming that several top cryptocurrencies, including Polygon’s MATIC, Solana’s SOL, and others, are securities primarily because their issuance involved capital formation, despite their necessity in operating underlying networks.

And it’s not just critics in the sidelines. The campaign is costing the United States a lot. Venture capital investment in the U.S. cryptocurrency industry has fallen this year compared to the European Union. America is losing its edge, and time is running out.

The MiCA effect The share of VC investment into European crypto projects is up almost 10x in one year – from a share of 5.9% in Q1 2022 to 47.6% in Q2 2023. Regulatory clarity attracts capital & entrepreneurs from around the world. Great development for crypto in Europe! pic.twitter.com/kUVp3rwlg3

• CACEIS Bank obtains France’s initial crypto custody license.
• Catawba Nation seeks experienced banking regulators for Bitcoin-friendly jurisdiction growth.
• Lobbyists in the UK advocate for interoperability between the Digital Pound and cryptocurrency.

— Patrick Hansen (@paddi_hansen) May 9, 2023

The cynical explanation for Gensler’s stance is political. Gensler taught a blockchain course at MIT and is on record explaining that not all tokens are securities, so he presumably understands the nuances of digital assets. However, he is pretending to be ignorant to implicitly support the agenda of Massachusetts Senator Elizabeth Warren, who is mobilizing an “anti-crypto army” and has been informally deputized by President Joe Biden’s administration to define cryptocurrency policy. If Biden is re-elected, perhaps this will help Gensler secure an appointment as Treasury Secretary.

In response, lawmakers are proposing bills to fire him. Representatives Warren Davidson and Tom Emmer introduced the “SEC Stabilization Act,” which proposes removing Gensler and restructuring the agency to make it less partisan.

Intermediaries for investment contracts are required to comply with securities laws & register with @SECGov . Instead, many crypto platforms are contending that their investment contracts are something else. The law cares about what something actually is, not what you call it.

— Gary Gensler (@GaryGensler) April 27, 2023

This would be misguided—not because Gensler is correct, but because his positions are not clearly wrong under current law.

The U.S. approach to securities law relies on the Howey test, which asks whether buyers have an “expectation of profit to be derived from the efforts of others.” Of course, buyer expectations can be influenced by but are not entirely in the issuer’s control. They might also be affected by trends in the market, groupthink, or even whimsy. The benefit of this approach is that it is difficult to manipulate. But the cost is a “Schroedinger’s cat” paradox, in which the very act of perception by third parties determines whether a token is a security or not. This deters capital formation by imposing immense risk on entrepreneurs and users that is inherently out of their control.

Related: The EU is watching your wallet, but it still beats the US for crypto

This paradox is highlighted by the EU’s groundbreaking Markets in Crypto-Assets (MiCA) legislation. The regulation acknowledges that utility tokens are not all financial instruments and prescribes clear and practical requirements for disclosure and behavior that legitimate projects can follow. The EU defines securities based solely on factors in the issuer’s control, namely the structure of an instrument itself and the way it is marketed. This is how MiCA allows for utility tokens, while the U.S. struggles to define them.

Related: 3 takeaways from the European Union’s MiCA regulation

This difference is essential. For instance, suppose you are an entrepreneur issuing a governance token for a protocol that entitles holders to vote for changes to open-source software. In the EU, under MiCA, you can publish a transparent white paper and do your best to dispute any mischaracterizations. In the U.S., you can do the same, but you have no guarantee it’s enough. If bad actors have conditioned buyers to expect profits from tokens writ large, you may be stuck. And since every new wave of technology gets hijacked by bad actors like Sam Bankman-Fried, there will always be bad actors who condition buyers when capital formation is most important for driving society forward.

The firing of Gensler in the United States may offer temporary relief, but it may not address the underlying issue of a lack of clarity and adaptability, which is a paradox. It is not guaranteed that the successor of Gensler will come to a different conclusion.

The only complete solution is new legislation that either clarifies the definition of a security in the United States or establishes a separate framework for digital asset issuers and exchanges. Until serious efforts are made in this direction, the U.S. crypto space will always be at risk, with the threat of a sword of Damocles hanging over it, and always just a single election or change in leadership away from being destroyed.