Why the SEC should never touch crypto again [Part 2]

In the first part of this series, I discussed the recent US Securities and Exchange Commission charges against Coinbase and Binance, their inability to properly regulate the crypto industry, the history of digital assets in the congressional record, and the significant drop in listings of digital assets by the US government.

For this section, we take a closer look at the implications of the SEC’s actions and explore alternative approaches to crypto regulation that could benefit the industry and its investors.

Digital Asset Commission

There are glaring flaws in the current regulatory landscape and there is a need for a dedicated regulatory body specific to digital assets – one that recognizes the unique nature of digital assets, promotes innovation and protects investors in the dynamic world of crypto.

It is becoming increasingly clear that a special commission, perhaps a Digital Assets Commission (DAC), is needed to oversee this fast-moving industry and provide nuanced regulatory guidance that promotes innovation and protects investors.

The Howey test and its limitations

Created in 1946, the Howey Test has long been the standard for determining whether an asset qualifies as a security under U.S. law. It is a legal framework established by the US Supreme Court to determine whether a transaction qualifies as an “investment contract” and thus falls under securities regulation.

The test includes four criteria: investment of money, joint venture, profit expectation and trust in the efforts of others. If a criterion fails, an asset is exempt from classification as a security.

I argue that the Howey test is not appropriate for digital assets in 2023 given the rapidly evolving nature of the crypto landscape and the diverse functionality of these assets. The test’s origins at a time when traditional investments such as stocks and bonds dominated the financial market make it ill-equipped to handle the complexities and nuances of digital assets.

In response to the SEC lawsuit, Coinbase has released the following video to demonstrate its unsuccessful attempts to follow legal guidelines in the US. In it, the company highlights the outdated nature of the Howey test and claims that 1 million jobs are at risk due to the lack of clear legal guidance.

A major limitation of the Howey test lies in its focus on earnings expectations, which do not always align with the motivations of those engaged in digital assets. Users can purchase and use cryptocurrencies or tokens for a variety of reasons beyond making a profit, such as access to decentralized applications, participate in board decisions, or support specific projects and communities.

In addition, the role of “the efforts of others” in the context of decentralized networks is often unclear, as these networks rely on the collective efforts of numerous individuals and entities, undermining the centralized control typically associated with securities.

In addition, the Howey test does not take into account the technological advancements and innovative features that digital assets now possess. Concepts such as smart contracts, decentralized finance (DeFi), and non-fungible tokens (NFTs) defy traditional definitions of securities, and applying the Howey test to these assets could lead to regulatory overruns and stifle innovation in the bud.

As the crypto ecosystem continues to grow and evolve, the limitations of the Howey test are becoming increasingly apparent, highlighting the need for a more tailored and nuanced approach to regulation that reflects the unique characteristics of digital assets.

Implications of classifying digital assets as securities

According to the SEC’s indictment against Coinbase, the platform provided access to existing crypto asset securities, placing it “squarely within the purview of securities laws.” If digital assets were defined as securities, platforms like Coinbase would be subject to more stringent regulation, potentially hindering innovation and limiting consumer access to a wide range of digital assets. This reclassification could have significant implications for the entire crypto industry as it requires substantial changes in how digital assets are issued, traded and managed.

Companies issuing digital assets would be required to register with the SEC and adhere to reporting and disclosure requirements, which can create significant costs and administrative burdens for both new and existing projects.

In addition, increased regulatory scrutiny may deter potential investors, reducing funding for innovative projects and stifling ecosystem growth.

For users, the classification of digital assets as securities may limit the availability of certain assets on exchanges and trading platforms, as these platforms would need to comply with securities regulations in order to legally offer these assets.

This may result in reduced liquidity, increased trading costs and limited access for retail investors, particularly those in jurisdictions with strict securities laws.

In addition, this reclassification could impact the development and adoption of decentralized finance (DeFi) applications and other innovative use cases of digital assets, as these applications often rely on the unique properties of digital assets to function effectively.

Historically, the SEC has limited access to staking and DeFi to “accredited investors,” leaving the public out in the cold. For reference, one criterion that qualifies an individual to be considered an “accredited investor” is holding at least $1 million in assets. So no knowledge or experience requirement, but wealth. If your parents leave you a million dollars, you’re basically eligible for DeFi.

Other ways to qualify as an individual include having an annual income of more than $200,000, licensed financial professionals, family offices, executives of companies selling the securities, and fund knowledgeable staff.

Therefore, defining digital assets as securities could have far-reaching implications for the crypto industry, impacting issuers, trading venues and users alike. While the intent may be to protect investors and maintain market integrity, this approach risks stifling innovation and stunting the growth of a rapidly evolving and potentially transformative industry due to outdated perspectives on digital financial instruments.

The Potential Impact of the Coinbase SEC Lawsuit.

The SEC’s lawsuit against Coinbase has significant implications for the crypto industry as a whole.

If the SEC succeeds in determining that Coinbase’s conduct and the digital assets it lists are subject to securities regulation, it will set a precedent that could impact other crypto platforms and potentially hurt growth in the industry. to obstruct. However, Coinbase has stated that it plans to fight the SEC in court.

The outcome of this lawsuit is likely to shape the regulatory landscape for digital assets in the US and beyond. If the SEC’s allegations are confirmed, other cryptocurrency exchanges and platforms could be forced to reevaluate their operations and listings, potentially leading to a wave of delistings, higher compliance costs, and a reduction in the variety of assets available. are to trade. This could discourage new entrants to the market, ultimately reducing competition and innovation within the sector.

In addition, the lawsuit could serve as a catalyst for regulators in other jurisdictions to follow suit and impose similar restrictions on digital assets, potentially impacting the global crypto ecosystem. This could lead to a fragmented market, with different regulatory regimes and asset classifications in different jurisdictions, making it difficult for companies and investors to navigate the industry.

On the other hand, if Coinbase successfully defends its position, it could encourage other crypto platforms to challenge existing regulations, potentially paving the way for a more favorable regulatory environment for digital assets.

Move over XRP, the Coinbase and Binance lawsuits have just become the most important lawsuits in the industry.

Regulatory framework for digital assets

A digital asset regulatory framework must be flexible enough to accommodate the diversity of the crypto landscape while providing clear guidelines for platforms and users. It should be driven by a new committee, such as a DAC, with digital asset experts at the helm. While Gary Gensler may be teaching students on the subject of blockchain, he has never used digital assets or dApp.

Would you trust someone who has never used MetaMask to help you set up a wallet?

What about if that person ran all crypto regulation in the US?

A true digital asset framework should include creating a separate category for digital assets that recognizes their unique characteristics, such as decentralization, programmability, and composability.

Such a framework should also encourage innovation and collaboration between industry stakeholders and regulators, fostering a supportive environment for the growth and maturation of the crypto space.

As regulators such as the SEC continue to address the issue, it is critical for the industry to engage in an open discussion on how best to move forward and push for a more appropriate regulatory framework that reflects the unique nature of digital assets.

I don’t claim to know exactly what a good framework should look like, but I know the SEC or CFTC don’t stand a chance.

Square pin, round hole.

Use the Coinbase and Binance lawsuits as a catalyst to get a good commission.

If digital asset securities are defined and managed by a Digital Asset Commission, the SEC’s case falls at the first hurdle and private users have a chance to participate in the future of DeFi in the US.