As technology evolves, the U.S. Securities and Exchange Commission (SEC) must evolve with it. Nowhere is this more true than in crypto, and now: the market for crypto assets has grown in size and sophistication, such that the SEC’s recent nefarious approach of enforcing and abdicating the regulations require urgent updating.
While the long-term future of the U.S. crypto industry will likely require Congress to sign a comprehensive regulatory framework, here are 6 steps the SEC could immediately take to create “fit” regulations – without sacrificing innovation or essential investor protections.
#1 Provide advice on “airdrops”
The SEC should provide interpretive guidance on how blockchain projects can distribute incentive-based crypto rewards to participants – without these qualifying as securities offerings.
Blockchain projects typically offer such rewards – often called “airdrops” – to encourage use of a particular network. These distributions are an essential tool for enabling blockchain projects to gradually decentralize, as they diffuse ownership and control of a project to its users.
If the SEC were to provide guidance on distributions, it would stem the tide of awards being made only to non-U.S. persons – a trend that effectively shifts ownership of blockchain technologies developed in the United States, but to the detriment of U.S. investors and investors. . developers.
What to do:
Establish eligibility criteria for crypto assets that may be excluded from treatment as investment contracts under the securities laws when distributed as airdrops or incentive rewards. (For example, crypto assets that are not otherwise securities and whose market value is, or is expected to be, substantially derived from the programmatic operation of any distributed ledger or on-chain executable software.)
#2 Change the rules of crowdfunding
The SEC should revise crowdfunding regulatory rules so that they are tailored to crypto startups. These startups often need broader distribution of crypto assets to develop critical mass and network effects for their platforms, applications or protocols.
What to do:
Expand the offering limits so that the maximum amount that can be raised is commensurate with the needs of crypto companies (e.g., up to $75 million or a percentage of the overall network, depending on the depth of disclosures ).
Exempt crypto offerings in a manner similar to Regulation D, allowing access to crowdfunding platforms beyond accredited investors.
Protect investors by capping the amounts an individual can invest (as Reg A+ currently does); strict disclosure requirements that encompass material information relevant to the crypto business (e.g. relating to the underlying blockchain, its governance and consensus mechanisms); and other guarantees.
These changes would allow early-stage crypto projects to access a broad pool of investors, thereby democratizing access to opportunities while maintaining transparency.
#3 Allow brokers to operate in crypto
The current regulatory environment prevents traditional brokers from meaningfully engaging in the crypto sector – primarily because it requires brokers to obtain separate approvals to transact crypto assets and imposes even more regulations burdensome to brokers who wish to hold crypto assets.
These restrictions create unnecessary barriers to market participation and liquidity. Their removal would improve market functionality, investor access and protection.
What to do:
Allow registration so brokers can trade – and hold – crypto assets, whether securities or not.
Establish monitoring mechanisms to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations.
Work with industry authorities like FINRA to issue joint guidelines addressing operational risks appropriate for crypto assets.
This approach would promote a safer and more efficient market, allowing brokers to bring their expertise in better execution, compliance and custody to the broader crypto market.
#4 Provide Custody and Resolution Advice
Ambiguity regarding regulatory treatment and accounting rules has deterred traditional financial institutions from entering the crypto custody market. This means that many investors do not benefit from fiduciary management for their investments and must instead invest on their own and arrange their own custody alternatives.
What to do:
Clarify guidance on how investment advisers can hold crypto assets under the Investment Advisers Act, ensuring adequate safeguards such as multi-signature wallets and secure off-chain storage. Also provide guidance on staking and voting on governance decisions for crypto assets under the custody of investment advisors.
Develop specific guidelines on the settlement of crypto transactions, including deadlines, validation processes and error resolution mechanisms.
Establish a flexible, technology-neutral framework that can accommodate innovations in conservation solutions, meeting regulatory standards without imposing prescriptive technology mandates.
Rectify the accounting treatment by repealing SEC Staff Accounting Bulletin 121 and its treatment of balance sheet liabilities for retained crypto assets. (SAB 121 transfers custodial crypto assets to the custodian’s balance sheet – a practice that is at odds with traditional accounting treatment of custodial assets.)
This clarity would provide greater institutional trust, increase market stability and competition among service providers while improving the protection of retail and institutional crypto investors.
#5 Reform ETP standards
The SEC should adopt reform measures for exchange-traded products (ETPs) that could foster financial innovation. The proposals promote broader market access for investors and fiduciaries accustomed to managing ETP portfolios.
What to do:
Let’s return to the historical test of market size, requiring only that there be sufficient liquidity and price integrity for the regulated commodity futures market to support a spot ETP product. Currently, the SEC’s reliance on the “Winklevoss test” for supervisory agreements with regulated markets that satisfy arbitrary predictive price discovery has delayed approval of bitcoin and other crypto-based ETPs. This approach ignores the considerable size and transparency of today’s crypto markets and their regulated futures markets, and creates an arbitrary distinction in the standards applicable to crypto-based ETP trading applications and all other commodity-based quoting apps.
Allow crypto ETPs to settle directly into the underlying asset. This will result in better fund tracking, reduced costs, greater price transparency and reduced reliance on riskier derivatives.
Impose strict custody standards for physically settled transactions to mitigate the risk of theft or loss. Additionally, allow for the possibility of staking the unused underlying assets of the ETP.
#6 Implement certification for ATS listings
In a decentralized environment where the issuer of a crypto asset may play no significant ongoing role, who bears responsibility for providing accurate information about the asset? There is a useful analogue here to traditional securities markets, in the form of Exchange Act Rule 15c2-11, which allows broker-dealers to trade a security when current information about the security is available to investors.
By extending this principle to crypto asset markets, the SEC could allow regulated crypto trading platforms (exchanges and brokerages) to trade any asset for which the platform can provide investors with accurate and current information. The result would be greater liquidity for these assets in SEC-regulated markets, while simultaneously ensuring that investors are equipped to make informed decisions.
What to do:
Establish a streamlined 15c2-11 certification process for crypto assets listed on alternative trading systems (ATS) platforms, providing mandatory information about the design, purpose, functionality, and risks of the assets.
Require exchanges or ATS operators to conduct due diligence on crypto assets, including verifying the identity of the issuer as well as important information about features and functionality.
Require periodic disclosures to ensure that investors receive timely and accurate information. Also clarify when reporting by an issuer is no longer necessary due to decentralization.
This framework would promote transparency and market integrity while allowing innovation to flourish.
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By taking the above steps now, the SEC can begin to move away from its historic and hotly contested focus on enforcement efforts, and instead add much-needed regulatory guidance. Providing practical solutions for investors, fiduciaries and financial intermediaries will better balance investor protection and the promotion of capital formation and innovation, thereby achieving the SEC’s mission.
A longer version of this article was originally published on a16zcrypto.com.
