Gary Gensler envisions regulating crypto brokers, creating a Catch-22 situation.

Yesterday, the House Financial Services Committee held a hearing where experts and insiders shared their opinions on how to best regulate digital asset markets. The discussion mainly focused on two draft bills related to crypto market structure and stablecoin regulation. However, the hearing took place while the U.S. Securities and Exchange Commission (SEC) is actively suing the U.S. crypto exchange Coinbase.

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The final witness to testify was Aaron Kaplan, the co-founder and CEO of Prometheum. Prometheum is a FINRA and SEC regulated ATS and broker-dealer in digital asset securities, which was incorporated in 2021 and is expected to launch in Q3 of this year.

Unlike most other witnesses, Kaplan echoed SEC Chair Gary Gensler’s position that existing securities laws are sufficient to regulate crypto markets. Some lawmakers pointed out Kaplan’s platform as evidence that Gensler’s repeated offer that exchanges “come in and register” was entirely sincere.

However, skeptics saw Kaplan’s testimony as depicting the SEC’s stance as a classic instance of malicious bureaucracy:

An inescapable Catch-22.

You don’t have to be crazy to register with the SEC, but it helps

The term “Catch 22” was coined by novelist Joseph Heller in his novel of the same name. In Heller’s screwball antiwar tragedy, “Catch 22” was a circular bureaucratic rule designed by the U.S. government to prevent draftees from leaving the World War II-era military. According to the fictional rule, you could only get out of the Army if you could prove you were crazy. But if you wanted to get out of the Army, you were clearly all too sane.

Gary Gensler’s SEC seems to have relied on similar logic when imagining its preferred crypto market structure: You’re free to launch a regulated crypto exchange, as long as it doesn’t actually enable the purchase or sale of crypto.

Prometheum, in fact, has not yet identified any assets that it plans to offer. While its website depicts an app offering tokens connected to the Flow, Filecoin, The Graph, Compound, and Celo protocols, these appear to be merely hypothetical examples.

Representative Mike Flood (R-NE) asked Kaplan if Prometheum allows users to buy and sell ether (ETH) and bitcoin (BTC), to which Kaplan answered “no”. Prometheum currently only plans to serve accredited investors, not the general public.

You can check in anytime you like, but you can never trade

The SEC has attempted to characterize its regulation as reasonable, but this is the Catch-22: If you want to get properly registered as a crypto exchange, you won’t be able to offer the most popular and important digital assets. That’s particularly illustrated by the cases of bitcoin and ether, the native token of Ethereum. While bitcoin has been designated a commodity for regulatory purposes, it’s just one of many crypto assets that do not have any clear “issuer” or other figure who can properly register the asset with the SEC, including genuinely open-source and community-driven protocols like Dogecoin and Monero.

The hearing, and Prometheum, highlighted another fundamental shortcoming of the SEC’s current approach. Because it will only sell to accredited investors, Prometheum does not represent a viable way to get crypto assets into the hands of actual end-users.

Lawyer Coy Garrison, who previously served as counsel to SEC Commissioner Hester Peirce, has highlighted that the SEC is proposing a market structure for crypto assets that is completely contradictory.

Garrison stated, “People purchase [digital assets] for a number of reasons, but one is to use them on the network… The application of securities laws [to these assets] would be so burdensome as to render the operation of the network moot.”

Prometheum is licensed to sell large amounts of tokens to institutions and whales, but if there is no legal way for everyday users to obtain these assets, the tokens would be worthless as there would be no users.

“If you have to go through a broker dealer to [buy crypto assets], it adds a tremendous amount of friction to the system,” said Blockchain Association CEO Kristin Smith. The SEC’s approach “ignores that these tokens have a function.”

See also: David Z. Morris – The SEC Is Fighting the Last War | Opinion

As many crypto skeptics have noted, the SEC is not obligated to create a set of classifications that better fit how crypto works. Moreover, there are many crypto assets that would be properly designated as securities under the standards set by the Howey Test.