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

In the first part of this series, I have discussed recent charges by the United States Securities and Exchange Commission against Coinbase And Binancetheir failure to properly regulate the crypto industry, the history of digital assets on the Congressional record, and the significant decline in mentions of digital assets by the US government.

For this part, we will dig deeper into 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 the need for a dedicated digital asset regulator that recognizes the unique nature of digital assets, fosters innovation and protects investors in the dynamic world of crypto.

There is growing evidence that a dedicated commission, perhaps a “digital assets commission (DAC)”, is needed to oversee this rapidly evolving industry and to formulate nuanced regulatory guidelines that foster innovation while protecting investors.

The Howey test and its limitations

The Howey test, established in 1946, has long been the standard for determining whether an asset qualifies as a security under US law. It is a legal framework established by the Supreme Court of the United States to determine whether a transaction is considered an “investment contract” and, therefore, falls within the scope of securities regulations.

The test includes four criteria: investment of money, joint enterprise, expectation of profit, and trust in the efforts of others. Failure to meet any of the criteria exempts an asset from being classified as a transferable security.

I argue that the Howey test is not suitable for digital assets in 2023, given the rapidly changing nature of the crypto landscape and the diversity of functionality of these assets. The test’s origins at a time when traditional investments like stocks and bonds dominated the financial market make it ill-equipped to deal with the complexities and nuances of digital assets.

In response to the SEC lawsuit, Coinbase released the following video to showcase its unsuccessful attempts to follow regulatory guidelines in the United States. In it, the company highlights the outdated nature of the Howey test and claims that one million jobs are at risk due to the lack of clear regulatory guidance.

One of the main limitations of the Howey test is its focus on profit expectations, which do not always align with the motivations of those who engage with digital assets. Users can buy and use cryptocurrencies or tokens for a variety of non-profit reasons, such as access to decentralized applications, participation in governance decisions, or support for specific projects and communities.

Additionally, 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 many individuals and entities, undermining the centralized control typically associated with securities.

Moreover, 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) challenge traditional definitions of securities, and applying the Howey test to these assets can result in regulatory overreach and stifle innovation .

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 personalized 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, bringing it “fully within the scope of securities laws.” If digital assets are defined as securities, platforms like Coinbase would be subject to stricter regulations, which could hinder innovation and limit consumer access to a wide range of digital assets. This reclassification could have significant implications for the entire crypto industry, as it would require substantial changes to the way digital assets are issued, traded, and managed.

Companies issuing digital assets would be required to register with the SEC and comply with reporting and disclosure requirements, which could impose significant costs and administrative burdens on new and existing projects.

Additionally, increased regulatory scrutiny can scare off potential investors, leading to less funding for innovative projects and stifling ecosystem growth.

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

This can lead to reduced liquidity, higher trading costs and restricted access for retail investors, especially those in jurisdictions with strict securities laws.

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

Historically, the SEC has limited access to staking and DeFi to “accredited investors,” leaving the public in the dark. For reference, one criterion that allows an individual to be considered an “accredited investor” is to hold at least $1 million in assets. So not a knowledge or experience requirement, just wealth. If your parents leave you a million dollars, you qualify for DeFi, basically.

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

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

The potential impact of the Coinbase SEC lawsuit.

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

If the SEC succeeds in establishing that Coinbase’s conduct and the digital assets it has listed are subject to securities regulation, it will set a precedent that could impact other crypto platforms and potentially stifle the sector growth. Coinbase, however, said it intended to fight the SEC in court.

The outcome of this lawsuit will likely shape the regulatory landscape for digital assets in the United States and beyond. If the SEC’s allegations are confirmed, other cryptocurrency exchanges and platforms could be forced to reassess their operations and listings, which could lead to a wave of delistings, increased compliance costs and reduced the variety of assets available for trading. This could discourage new market entrants, which would ultimately reduce competition and innovation within the industry.

Additionally, the lawsuit may serve as a catalyst for regulators in other jurisdictions to follow suit and impose similar restrictions on digital assets, potentially affecting the global crypto ecosystem. This could lead to a fragmented market, with different regulatory regimes and asset classifications in various 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, lawsuits against Coinbase and Binance have just become the most important legal cases in the industry.

Regulatory framework for digital assets

A regulatory framework for digital assets should be flexible enough to accommodate the diversity of the crypto landscape while providing clear guidance to platforms and users. It should be driven by a new commission, such as a DAC, with digital asset experts at the helm. While Gary Gensler can teach students about blockchain, he has never used digital assets or dApps.

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

What if this person ran all crypto regulation in the United States?

A true digital asset framework must involve creating a separate category for digital assets that recognizes their unique attributes, such as decentralization, programmability, and composability.

Such a framework should also encourage innovation and collaboration between industry stakeholders and regulators, fostering an enabling environment for the crypto space to grow and mature.

As regulators, such as the SEC, continue to address the issue, it is crucial that the industry engages in an open discussion about the best way forward and pushes for a more appropriate regulatory framework that recognizes the unique nature of digital assets.

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

Square dowel, round hole.

Use the lawsuits against Coinbase and Binance as a catalyst to set up a proper commission.

If digital asset securities are defined and managed by a digital asset commission, then the SEC’s case falls at the first hurdle, and retail users have a chance to participate in the future of DeFi in the United States.