SEC Backtracks on Officially Defining Digital Assets

The United States Securities and Exchange Commission (SEC) appeared to be making progress in regulating the crypto industry, but recently took a step back by removing the proposed definition of "digital asset" from its latest hedge fund rule. Previously included in the 2022 proposal for overhauling mandatory hedge fund disclosures, the SEC withdrew the definition in the final rule approved by its commissioners.

The SEC noted that the commission and staff are still considering the term "digital asset" and will not adopt it as part of the rule at this time. Despite this decision, the agency is actively evaluating crypto-related matters, which play a significant role in enforcement actions and ongoing rule proposals.

Recently, the SEC reopened a previously proposed rule that redefined the term "exchange," explicitly incorporating decentralized finance (DeFi) into it. This move received criticism from the industry and two of the five SEC commissioners. The SEC also proposed a rule in February that could prevent investment advisers from holding assets at crypto firms.

The initial definition for "digital asset" in the hedge fund rule was neither extensive nor controversial, describing it as using distributed ledger or blockchain technology and including virtual currencies, coins, and tokens. However, the SEC has yet to officially adopt a definition for digital assets, even though Chair Gary Gensler and other SEC officials frequently discuss the topic.

Anne-Marie Kelley, a partner at Mercury Strategies and former longtime SEC official, criticized the SEC for not providing regulatory clarity by defining digital assets. She suggested that the commission may have removed the definition because acknowledging the uniqueness of digital assets could undermine their litigation stance that these assets are securities subject to SEC laws.

Consumer advocacy group Americans for Financial Reform had previously praised the SEC for creating a separate category for hedge funds disclosing digital assets. However, the Securities Industry and Financial Markets Association (Sifma), an industry lobbying group, argued that the definition's wording was too broad and requested more specificity.