Crypto faces a reckoning with securities laws in the US that’s been years in the making.
Brand new rules specific to cryptocurrency may be the only salvation.
But rather than create rules that actually make sense for the new technology, regulation by enforcement (using a framework from the 1940s) is the weapon of choice for Gary Gensler and co.
Crypto or not, securities are still defined by the Howey test. It’s a four-pronged filter created in 1946 intended to instill accountability for companies in the process of offering investment opportunities to the public, conceived decades before the internet and eons before decentralized blockchain protocols.
Forcing crypto through that antique filter demands regular financial statements, among other things. Somewhat straightforward for traditional startups, but more difficult for ad-hoc groups of open source developers building networks that automatically issue their own tokens as part of a protocol’s coded rules.
Stacks and INX are two examples of token issuers successfully registering with the SEC. For comparison, CoinGecko lists over 10,000 coins and tokens. CoinMarketCap has an ambitious 25,000-plus. Even if the majority of those have no plans to register with the SEC, the ratio is still way off.
Gensler’s agency is considered by many to be a shadowy tendril of a creepy government conspiracy dubbed “Operation Choke Point 2.0,” a concentrated campaign to cut crypto off from the banking system, just as the original did with payday lenders, pawn shops, dating services and other ‘undesirables’ during the 2010s.
All this makes the crypto industry desperate for its own tailored regulatory framework in which to legally operate. But there have been very few clear pitches for what that might look like — if any.
So, here’s a five-step plan to regulate crypto in good faith. Gensler, take note. Founding a Real Crypto Regulation Commission with these in mind would be a perfect way to spend some of that $2.4 billion government budget.
1. Add ‘sufficiently decentralized’ to the dictionary
Regulators must hire computer scientists and software engineers unaffiliated with crypto projects to define “sufficiently decentralized.” They shouldn’t be connected to any particular blockchain to avoid technological biases, lest the bar be set too low and risk regulation by enforcement all over again.
Why does a dictionary definition matter?
Because bitcoin (BTC) is the only cryptocurrency directly deemed a commodity by successive SEC chairs (although ether [ETH] has also been given a subtle nod).
That’s because BTC is decentralized enough that there is no central issuer — no business address, nobody to submit financial statements and nobody’s efforts from which to derive profits.
So, when did bitcoin and ether cross over? Once a certain number of developers worked on the protocol? When they surpassed some secret threshold for nodes? Or was it some other mysterious goal?
Of course, ‘sufficiently decentralized’ was only ever the opinion of William Hinman at the SEC in the first place. It was never agency policy.
But if it was? Gary would need to enlist blockchain developers to create a system for ruling when projects abuse those metrics to fake decentralization. Appoint an independent arbitrator for appeals. Determine when too few people are able to shut down the network with too little oversight.
And then add that new definition to the regulatory dictionary and consider it case closed for now.
2. Create real tools that actually…protect investors
Gensler needs to recruit economists to figure out a system for determining when tokenomics turn predatory.
Centralization of token supply can turn seemingly legitimate projects into malicious traps for newbie investors. Is centralization of supply a concern at 50% kept with insiders, or only at 80%? How do market caps and order book depth play into those concerns?
Calculating exactly how much supply is kept by the project and its buddies is incredibly difficult, if not impossible — obfuscating token distribution is made easy by the pseudonymous nature of blockchains.
Still, regulators can and should try here — they can contract blockchain analysts to create bookkeeping software that tracks treasuries from raise to distribution and liquidation as part of efforts to stop embezzlement, insider trading and other malfeasance.
You know, stuff that harms investors.
3. Allow exchanges to list ‘securities’ without registering
Coinbase allegedly lists crypto securities for trading. But its general counsel is adamant that it doesn’t. The courts are set to decide who is right.
Let’s say for argument’s sake that the SEC’s general position was that crypto securities can decentralize over time. And if Gary took step one, we’d have a clear definition for when that might occur.
This would mean that centralized exchanges like Coinbase should be able to list tokens that may start out as securities without explicitly registering with regulators — as long as token issuers provide a clear and actionable plan for how they might achieve that decentralization.
Failure to achieve decentralization (marked by that dictionary definition we created above) within the specified timeframe would force the token issuer to register or face delisting.
That way, crypto startups wouldn’t be punished for launching tokens or networks that must start out centralized. This solution could protect investors while still promoting innovation. At the same time!
4. Divert traditional finance fines to defend crypto investors
Over the past 20 years or so, just six Wall Street banks have collectively coughed up more than $200 billion in fines and settlements.
What better way to fund the defense of crypto investors than with cash ripped straight from the corrupt institutions that inspired the birth of bitcoin in the first place?
Gensler and other global regulatory bodies like to say that the crypto ecosystem lacks investor protections — even though they themselves are tasked with protecting markets.
A great place for them to actually start would be to build a cybersecurity team to monitor front-ends for critical crypto infrastructure like decentralized exchanges, NFT marketplaces and Etherscan. A public good to stop phishing and other cyberattacks.
As a bonus, Gary could also divert some of the money laundering fines toward a fund that supports victims of crypto theft.
5. Bring stablecoins and crypto to stock exchanges
Armed with a clear definition for “sufficiently decentralized,” traditional equities markets should be encouraged to adopt stablecoins and cryptocurrencies with a specific licensing scheme.
Perhaps a buddy system: The likes of Coinbase, Kraken and Gemini, alongside their market-making partners, could team up with the New York Stock Exchange (NYSE) and Nasdaq in support of stablecoin-crypto-stock pairs.
Grant powers to buddy system applicants similar to the NYSE’s “membership.” Let them service markets for trading bitcoin with Apple stock directly, for example, treating digital assets as actual assets, first and foremost.
Allow foreign exchange markets to adopt stablecoins backed by various global currencies, bringing those onto crypto rails. This would no doubt boost supplies for non US-dollar stablecoins, opening all sorts of doors for better price discovery of fiat currencies.
Not to mention, equities traders directly interacting with crypto markets would almost certainly result in deeper liquidity across the digital asset sector — a pain point often brought up by naysayers when deriding crypto’s legitimacy.
Regulations like these would be bullish
These steps aren’t the be-all and end-all.
They’re high-level suggestions intended as a template; a guide for regulators receptive to technological innovation in finance, as unlikely as their existence may seem right now.
Because while it’s tempting for crypto entrepreneurs to wish for a world in which their products simply aren’t regulated, ever, that is not realistic.
Regulation — real, actionable regulation — could itself spur untold growth for the digital asset industry that is now unattainable while the laws are so murky.
But alas, just a dream — for now.
Unless you know someone who could drop this guide in Gary’s inbox?
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Source: https://blockworks.co/news/gary-gensler-regulation-sec-advice