As federal enforcement actions against cryptocurrency firms have significantly decreased, state regulators are raising alarms about a potential decline in their ability to hold crypto criminals accountable. Authorities from various states, including Alabama and Montana, are sounding the alarm over pending crypto market-structure legislation in Congress that could hinder their prosecutorial powers against malefactors in the digital asset space. This concern arrives at a critical moment, as incidents of crypto fraud and criminal activity are surging globally, with bad actors looking to exploit the growing investor interest amidst a market rebound bringing prices close to their all-time highs.
Concerns Over Legislative Changes
The proposed Responsible Financial Innovation Act, currently under consideration in the US Senate, does not grant state agencies explicit authority to oversee cryptocurrency companies. This oversight could leave them powerless to prosecute fraud cases, as highlighted by Amanda Senn, the director of the Alabama Securities Commission. Additionally, the bill proposes a revision in the definition of an investment contract, which could potentially allow criminals to evade prosecution, according to warnings from Montana State Auditor James Brown. “The dam is going to break,” Senn stated, emphasizing the need for state engagement in fraud prosecution.
Reduction in Federal Enforcement
Since the Trump administration pledged to lessen oversight believed to be stifling industry growth, federal enforcement actions against the cryptocurrency sector have sharply declined. The US Securities and Exchange Commission (SEC) has reduced its staff dedicated to enforcement and has closed numerous investigations related to cryptocurrencies, resulting in a drop from 33 enforcement actions last year to just nine as of August 31. This trend indicates that 2023 may mark the lowest crypto-related enforcement level since 2017, when only four actions were initiated.
Escalating Criminal Activity
Alongside rising cryptocurrency values, criminal activities associated with the industry have also intensified. In the first half of this year, over $2.1 billion was reported stolen in at least 75 distinct hacks and exploits globally, making it the worst first half on record, according to TRM Labs, a provider of crypto risk management solutions. This figure exceeds the previous record set in 2022 by approximately 10%, accounting for nearly all recorded losses in 2024.
Increasing Complaints and Fraud Risks
Future of Regulation and Enforcement
While there hasn’t yet been a significant surge of major domestic crypto scams, experts like Robert Whitaker, director of law enforcement affairs at Merkle Science, predict that this may soon change. He warns that the dismantling of government cryptocurrency crime units, coupled with the rapid introduction of new stablecoins, could lead to an increase in fraud similar to the aftermath of the ICO boom in 2018-2019. The evolving landscape of stablecoins and enhanced blockchain interoperability presents new challenges for the industry.
State Regulators Seeking Clarity
The office of Senate Banking Committee Majority Leader Tim Scott, a Republican from South Carolina, did not provide a comment on the matter. A representative from the House Committee on Agriculture, which is working on a competing market-structure bill, mentioned that the Banking Committee holds jurisdiction over the topic. State regulators have proposed amendments to the bill, though their implementation remains uncertain, particularly as the government faces a shutdown, delaying discussions on the market-structure bill until late October.
Ongoing Legal Debates
Not everyone believes the legislation will completely undermine state regulators. They maintain their authority to pursue fraudsters under consumer protection laws. Mauro Wolfe, a leading partner at Duane Morris’s Digital Assets and Blockchain Group, acknowledged the states’ concerns, especially in light of potential federal inaction. However, he suggested that lawyers may challenge the states’ capabilities in court. The current draft of the legislation does not mandate digital asset companies to register with state authorities or respond to inquiries, unlike traditional broker-dealers. Furthermore, it lacks explicit provisions granting states the authority to prosecute crypto fraud.
Impact on Securities Law
Another significant change proposed in the bill involves revising the federal definition of an “investment contract” by introducing new criteria. This shift could hinder regulatory efforts to combat fraud. The previous flexible definition allowed regulators to address schemes marketed as ‘trading strategies’ or ‘projects’ lacking an identifiable business entity, according to a September letter from the NASAA. The association cautioned that the proposed changes could undermine decades of established securities law, creating loopholes that might allow fraudulent activities to slip through regulatory cracks. The traditional Howey Test, which has been used to assess whether an asset qualifies as a security, may no longer apply under the new legislation, raising additional concerns about regulatory clarity and effectiveness in preventing fraud.
