In the ancient Greek history of Oedipus, great rewards awaited travelers capable of solving difficult puzzles, but a powerful sphinx posed the puzzles and devoured those who failed to resolve them. Likewise, in the old crypto timy, around 2017, blockchain technology revolutionized finance and other areas. But two challenges were about to take advantage of its full potential: (1) the securities laws that do not easily map decentralized systems, and (2) a securities regulator hostile to digital assets, which often posed serious risks for those who tried to resolve the first challenge.
Today, the sphinx has resolved to be more useful, but the puzzles remain. The Cryptic Crypti and Exchange Commission (“SEC”) cryptography working group said that the agency’s previous regime had created “an environment hostile to innovation” and is committed to working with industry participants to develop reasonable regulations. Although promising, important challenges remain. American laws on securities are a mixture of statutes adopted by the congress and the rules adopted by the SEC. The working group has reported the will to make it make it more feasible thanks to new rules and exemptions. The statutes, however, present most of the challenges and only the congress, and not the dry, can change them.
You will find below a primer on the most common puzzles facing the developers of tokenized titles.
Regulatory considerations
For the tokenized titles, the developer creates tokens on a chain which each represent a share of equity in a company or another security, or another asset which offers the right to cash flows. This tokenization can open up possibilities – such as the instant settlement, the fractionalization of actions and the daily dividend – which make the product more efficient or functional than its tradfi counterpart.
Even if the dry can be more receptive to the ideas of token titles, it does not have the power to modify the laws. Consequently, the tokenized securities projects will always have to resolve or avoid the puzzles of these present laws.
The Act on Investment Companies
If a token gives its holder an economic exposure to the assets that the developer has pooled, this token project could be an investment company covered by the investment companies law, which regulates companies, such as investment funds, which invest in securities and allow investors to obtain exposure to investments through actions they issue.
This enigma existed long before the crypto, and most chose to navigate there by avoiding being classified as an investment company in the first place. Indeed, the requirements imposed by the law on investment companies do not work well with commercial models which involve more than the purchase and sale of securities. There are substantial restrictions on debt increases and equity, loans and even business with affiliates. For those who are unable to avoid triggering these requirements, exemptions may be available.
Brokers under the SECURITIES EXCHANGE ACT
Anyone who buys and sells titles for others or is ready to buy and sell titles for his own account may be a broker or a dealer. There is no luminous line rule to qualify as a broker, but the SEC and the courts consider as indicated if you provide liquidity, invoice costs related to the price of trade, actively find investors or play a role in the holding of customer funds or securities.
Although there is no practical way of currently negotiating digital assets as a broker, the dry could use its existing authority to trace a realistic path to do so. In the best of cases, it will take time and always come with compliance obligations.
Exchanges under the EXCHANGE ACT SECURITIES
Although it does not look like an exchange of traditional titles, a platform using intelligent contracts to bring together the commands of token titles of several buyers and several sellers for correspondence and execution could be considered one, depending on its structure.
Currently, only brokers can negotiate exchanges and exchanges cannot hold customer accounts or securities of custody customers. Even if the dry is able to rework these rules, certain requirements would undoubtedly persist.
Swaps based on security under the SECURITIES EXCHANGE ACT
If tokenized security gives its holder an exhibition to the economic performance of one or more titles, it may have crossed the complicated world of safety -based exchanges. Generally, tokens that provide for the exchange of future payments depending on the value of security (or events relating to this security) without Transport property rights are likely to be exchanges. Security -based swaps are under the joint jurisdiction of the SEC and the Commodity Futures Trading Commission. There are many requirements for them, the most notable rules prohibiting retail investors from purchasing Swaps.
AML and KYC
Companies involved in the trade or transfer of token titles must also take into account the applicability of anti-balance laws and your customer. The compliance requirements depend on the role played in transactions, but may include the collection and verification of the name, the date of birth and the address of customers.
The puzzles must be worked, not around
Resolving these puzzles is not an end in itself. During the design of any token securities project, developers make economics, technology and regulatory framework. These areas are intertwined because technology can make the economy possible and decide where a project is the regulatory framework. But because these considerations are so interdependent, developers should analyze them in a holistic way from the start. Leaving regulatory considerations for the end can turn into a JENGA game where the problematic parties are only abolished to overthrow the advantages and objectives of the economy and technology. The puzzles posed today are not simply obstacles to the many advantages of blockchain technology, but crucial parts of the response.
The opinions expressed in this article are those of the authors and do not necessarily reflect the views of Skadden or its customers.
