SEC Scrutiny and Crypto Insurance: Protecting Your Investments

Recently, Uniswap Labs received a Wells Notice from the Securities and Exchange Commission (SEC). The notice formally warns Uniswap, the largest decentralized crypto exchange (DEX), that federal regulators will bring charges against it.

This is the latest in a string of SEC actions against cryptocurrency and DeFi organizations as the financial sector undergoes a seismic shift. Cryptocurrency, once relegated to the fringes of finance, is gaining mainstream traction. Bitcoin and other major cryptocurrencies are near all-time highs, and momentum seems to be growing.

Regulatory agencies are figuring out how to best monitor crypto to protect consumers and investors, which is challenging — and sometimes frustrating — to those in the crypto business.

Navigating this new frontier as an investor or a crypto company requires a deep understanding of the current landscape. You’ll need to know about potential SEC investigations and cryptocurrency insurance coverage considerations.

SEC regulations, actions, and investigations

Transformative periods in the finance sector always come with regulatory uncertainty. The rise of crypto is as revolutionary as when Western Union introduced the ability to transfer money though the telegraph.

Many in the industry believe that clear rules and regulations would help legitimize crypto and support its progress, but the path to clear rules is unclear. Questions about cryptocurrency regulations will continue to swirl as crypto companies and the SEC go back and forth in court. However, progress is occurring.

Key advancement: Bitcoin Exchange Traded Fund (ETF) Approval

The SEC's long-awaited approval of the first Bitcoin ETF in January 2024 was a game changer for the industry, pushing crypto further into the mainstream. This decision signifies a shift in regulatory sentiment, making Bitcoin more accessible to retail investors through existing brokerage accounts and boosting opportunities for institutional players.

The domino effect might soon extend to other cryptocurrencies, with Ethereum potentially next in line for ETF approval in the coming months.

What is the SEC doing now?

To protect investors, the SEC is looking into crypto companies, exchanges, investments, and platforms.

At a conference hosted by Columbia Law School, SEC Chair Gary Gensler said, “crypto markets could use a little disinfectant,” emphasizing that he intends to hold them to the same standards and regulatory framework that governs traditional financial markets. Gensler repeatedly refers to the crypto markets as the “Wild West.”
This stance has led to legal actions against prominent crypto platforms like Coinbase Inc. and Kraken, which the SEC accuses of operating without proper registration as exchanges, brokers, dealers, and clearinghouses.

Some believe SEC registration for crypto platforms isn’t currently feasible. Others say that the SEC’s actions are an overreach of power and are pushing back through legal action of their own.

Complying with SEC investigations

Everyone in the crypto industry, including VCs and private equity firms, need to be prepared for a potential SEC investigation. These can range from an informal notice to a subpoena of all correspondence, to lengthy, detailed investigations requiring significant labor and lawyer involvement.

SEC investigations can be costly and can last many months. Make sure your costs are covered under the right insurance policy.

Cryptocurrency insurance needs, insurance policy developments

Currently, insurance carriers’ off-the-shelf policies do not adequately cover crypto-related business risks faced by venture capitalists, hedge funds, or portfolio companies in the crypto industry.

Manuscripting — creating a custom policy — is the only way to ensure proper coverage right now. The policies with adequate protection for crypto companies  typically include:

• General Partnership Liability Insurance (GPL)
• Directors & Officers Insurance (D&O)
• Errors & Omissions Insurance (E&O)
• Employment Practices Liability Insurance (EPL)
• Cyber Insurance
• Crime insurance covering fiat as well as digital assets (including cryptocurrencies, stablecoins, NFTs, and so forth)
• Worldwide coverage, covering the jurisdiction of the world’s largest financial institutions
• Language specific to the crypto industry, including crypto venture funds, crypto hedge funds, DeFi, staking, stablecoins, web3 developers, and more.

In Uniswap’s case, the Wells Notice could invoke insurance if the organization has it. Given the formality of the notice, even a policy that excludes informal investigations could respond to a Wells Notice. (Crypto businesses have seen numerous subpoenas that do not allege any wrongdoing but require time and resources for responding. Typically, these subpoenas would not trigger a policy unless a business has coverage for “informal investigations.”)

Carriers are likely to fully embrace and offer ready-made cryptocurrency insurance policies that cover crypto investments in the near future, as the market matures. They recognize the industry's potential, but require more claims data to accurately assess risk.

Which countries have regulated cryptocurrency?

More than 20 countries have implemented cryptocurrency regulations. And over 40 are discussing it at the legislative level. To understand where the U.S. might be headed as it works out how to regulate and legitimize crypto, we can look to two specific regions as international models for crypto-friendly regulation:

Singapore

Some major players in the crypto industry consider Singapore an aspirational crypto-friendly environment, one in which crypto businesses can thrive while citizens are properly protected.

Singaporean regulators have adopted a consultative approach, with banks and authorities working closely together. This approach balances risk mitigation with fostering technological innovation. They closely monitor risks associated with crypto-related transactions and have implemented comprehensive licensing and money laundering compliance requirements for cryptocurrency businesses.

European Union (EU)

The EU is actively developing a regulatory framework that prioritizes consumer protection while promoting innovation. It includes the Markets in Crypto-Assets Regulation (MiCA), which establishes rules for crypto-asset service providers and issuers, and the Anti-Money Laundering Directive (AMLD), which requires crypto firms to comply with Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) regulations. Additionally, the EU is working on a Digital Finance Package, which includes proposals to regulate stablecoins and enhance the regulatory framework for digital assets.

Though the framework is still a work in progress, it could soon serve as a global model for dealing with the complex world of crypto regulation.

Mitigating crypto risks and providing a clear framework

Though it has remarkable potential, crypto is also rife with risk, including fraud, scams, market volatility, security breaches, and abuse in certain applications. After recent industry scandals like the FTX collapse and Binance pleading guilty to breaking anti-money laundering laws, investors are hyper-aware of crypto risks.

Establishing clear rules and regulations will help mitigate these risks by providing a framework that promotes transparency, accountability, and investor protection. Clear regulations can help investors make informed decisions, reduce the likelihood of fraudulent activities, and increase market stability. In addition, defined rules would help make crypto firms more appealing to insurers and pave the way for carriers to develop crypto-specific policies.

Regulatory framework would also address critical questions for the crypto industry, including:

• Classification of crypto as a security or commodity
• Trading regulations
• Tradable cryptocurrencies
• Taxation of crypto as an asset and crypto funds
• Decoupling cryptocurrency value from the USD

While the industry desires clear definitions and rules, the SEC's authority to enact them remains a point of contention. Some continue to ask: Should cryptocurrency be regulated? Who regulates cryptocurrency? The onus may eventually fall on lawmakers to make the call.

A tipping point for crypto investment landscape 

We are living in a transformative moment for the finance sector and the cryptocurrency industry; but we still have a lot of regulatory “figuring out” ahead of us. In the short-term, this looks like lawsuits, inquiries, and investigations.

SEC investigations are expensive, but regulatory compliance is necessary. Stay informed and proactively monitor regulatory developments. And secure the right insurance coverage to stay protected no matter what happens.

Once the dust settles and crypto regulations are solidified, it will be a far safer environment. Investors and private equity firms will be able to move confidently, which will help to further legitimize crypto, making it a mainstream asset widely accepted by trusted traditional financial institutions.

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