The US CFTC (Commodities Futures and Trading Commission) argues many digital assets are merely derivatives traded on unregulated exchanges. Responsibility lies with the software developers and governance token-holding voters.
Digital assets, however, are not derivatives in the original meaning Congress contemplated when it passed securities regulations.
And, even if they were, a disclosure-based regime, as authors of Securities Law intended, would suffice to weed out illicit crypto players.
If we assume most tokens are securities, we must also admit these represent an entirely new type of security, for which an entirely new framework seems best.
Any such regime must be firmly disclosures-based, whereby firms and projects need simply to be transparent by making the required disclosures.
It would not be permission-based, in which executive agencies pick and choose winners and losers, most often based on who has the money to pay regulatory fees.
Instead, the emphasis of regulators should be on 17 A of the Securities Law of 1933, which makes it unlawful to “employ any device, scheme or artifice to defraud” and “obtain money or property” by the use of material misstatements or omissions or to “engage in any transactions, practice or course of business which operates or would operate as a fraud or deceit upon the purchaser.”
By merely focusing on 17 A, US regulators could go a long way toward protecting consumers and investors, persecuting criminal elements – all while encouraging innovation.
Permissioning versus disclosure regimes
The initial idea behind securities laws was that one could sell a security by merely producing a quality disclosure about the nature, risks, team and conflicts of interest with the security.
Over the years, securities law devolved into a more authoritarian permissioning regime, which requires submission to costly audits with which only the most monied entities can comply. The SEC could pick and choose who could and could not take part.
The crypto industry must therefore advocate for a disclosure regime, lest the SEC pick and choose which crypto firms can exist and which cannot, based on who has money.
The importance of safe harbors
Crypto has introduced a novel asset with different risks. As long as people accurately disclose information and update required information as needed, they should be permitted to issue a digital asset.
Such ‘safe harbors’ are so important to protecting innovations and the developers behind them.
A safe harbor provides in a statute or regulation protection from legal liability or other penalties when an entity meets pre-described conditions.
In order to enjoy safe harbor protections, crypto developers might disclose information such as a software protocol’s auditors, the audit’s results, conflicts of interest, token distribution, security protocols and points of centralization and other risks.
A good first step would be to pass a law where developers make certain voluntary disclosures in exchange for safe harbor.
If they break other laws using the technology – such as using blockchain to traffic narcotics – they would face the appropriate charges if caught.
Once such a regime were established, patterns of abuse might emerge, where further needed disclosures can be required.
The fate of DeFi depends on a disclosures regime
Regulators today are governing crypto through enforcement, which amounts to a DeFi-destroying permissioning regime.
Crypto regulations must respect civil rights as well as the difference between mere software and a financial services intermediary. They must maximize the value of innovation, rather than discourage it.
DeFi allows scalable, private, peer-to-peer transactions to occur – all of which are protected by civil rights.
Blockchain represents a scalable way to raise money, engage in transactions and more. If the US takes a hardline approach, the industry will move offshore – another blow to a beleaguered national economy.
Federal securities law generally requires issuers to disclose to investors all material information they need to make sound investment decisions.
Federal securities laws provide that investors harmed by misleading statements or the omission of material facts can seek a remedy through litigation. Thus, disclosure requirements are at the heart of federal securities regulation.
The Securities Act of 1933 refers to the ‘truth in securities‘ law. It focused on disclosure, requiring securities for public sale to provide truthful information about risks, etc.
As Supreme Court Justice Louis Brandeis stated, “Sunlight is said to be the best of disinfectants – electric light, the most efficient policeman.”
A disclosure regime, instead of a permissioning regime, is the right approach for the US when it comes to the new and exciting crypto industry.
