Editorial: Why the SEC Should Never Touch Crypto Again [Part 2]

In the first part of this series, I discuss the recent charges brought by the US Securities and Exchange Commission 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 references to digital assets by the US government. .

For this segment, we will delve deeper into the implications of the SEC’s actions and explore alternative ways to regulate cryptocurrency that could benefit the industry and its investors.

Digital Asset Committee

There are glaring flaws in the current regulatory landscape and the need for a dedicated digital asset regulator – one that recognizes the unique nature of digital assets, fosters innovation, and protects investors in the dynamic crypto world.

It is increasingly clear that a dedicated committee, perhaps the Digital Asset Commission (DAC) is needed to oversee this rapidly evolving industry and craft accurate regulatory guidelines that promote innovation while protecting investors.

Howey’s test and its limitations

The Howey test, created in 1946, has long been the standard for determining whether an asset is considered a security under US 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 the securities regulations.

The test includes four criteria: investing money, joint ventures, expecting profits, and relying on the efforts of others. The absence of any standard exempts the asset from classification as collateral.

I would 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 functions of these assets. Test assets began at a time when the financial market was dominated by traditional investments such as stocks and bonds, leaving it ill-equipped to deal with the complexities and nuances of digital assets.

In response to the lawsuit filed by the SEC, Coinbase has released the following video showcasing its attempts to follow regulatory guidelines in the United States without success. In it, the company highlights the outdated nature of the Howey test and claims that 1 million jobs are at risk due to the lack of clear regulatory guidelines.

A major limitation of the Howey test is its focus on profit prediction, which does not always align with the motivations of those who deal with digital assets. Users can buy and use cryptocurrencies or tokens for various reasons other than making a profit, such as accessing decentralized applications, participating in governance decisions, or supporting specific projects and communities.

In addition, the role of “the efforts of others” in the context of decentralized networks is often not clear, as these networks depend on the collective efforts of many individuals and entities, which undermines the central oversight usually associated with securities.

Moreover, the Howey Test does not take into account the technological advancements and innovative features that digital assets now have. Concepts like smart contracts, decentralized finance (DeFi), and non-fungible tokens (NFTs) are challenging traditional definitions of securities, and applying the Howey test to these assets could lead to regulatory overreach and stifle innovation.

As the cryptocurrency ecosystem continues to grow and evolve, the limitations of the Howey Test are becoming increasingly apparent, highlighting the need for a more detailed and rigorous approach to regulation that reflects the unique characteristics of digital assets.

The implications of classifying digital assets as securities

According to the SEC’s charge against Coinbase, the platform provided access to the securities held in the crypto-asset, placing it “within the jurisdiction of the securities laws.” If digital assets are defined as securities, platforms such as Coinbase will be subject to stricter regulations, which could hinder innovation and limit consumer access to a wide range of digital assets. A reclassification could have dire consequences for the entire crypto industry, as it would require fundamental changes to the way digital assets are issued, traded, and managed.

Companies issuing digital assets will be required to register with the Securities and Exchange Commission and comply with reporting and disclosure requirements, which can impose significant costs and administrative burdens on both new and existing projects.

In addition, increased regulatory scrutiny may alienate potential investors, leading to reduced funding for innovative projects and stifling ecosystem growth.

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

This could lead to lower liquidity, higher trading fees, and restricted access for retail investors, especially those who live in jurisdictions subject to strict securities laws.

Moreover, this rebranding could affect the development and adoption of decentralized finance (DeFi) applications and other innovative use cases for digital assets, as these applications often rely on the unique characteristics of digital assets to function effectively.

Historically, the SEC has had limited access to staking and DeFi to “accredited investors,” leaving the public out in the open. For reference, one of the criteria for an individual to be considered an “accredited investor” is having at least $1 million in assets. So, it is not a requirement of knowledge or experience, only wealth. If your parents left you $1 million, 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 from companies that sell 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 intent may be to protect investors and preserve market integrity, this approach risks stifling innovation and hampering the growth of a rapidly evolving and potentially transformative sector due to outdated views on digital financial instruments.

The potential impact of the Coinbase SEC lawsuit.

The lawsuit filed by the SEC against Coinbase has significant implications for the cryptocurrency industry as a whole.

If the SEC succeeds in establishing that the behavior of Coinbase and the digital assets it lists are subject to securities regulations, it will set a precedent that could affect other crypto platforms and potentially stifle growth in the sector. However, Coinbase stated that it intends 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 abroad. If the SEC’s allegations are upheld, other cryptocurrency exchanges and exchanges may be forced to reassess their operations and listings, which could lead to a wave of delistings, increase compliance costs, and reduce the pool of assets available for trading. This may discourage new entrants into the market, which ultimately leads to less competition and innovation within the industry.

Moreover, the lawsuit may serve as an incentive for regulatory agencies in other jurisdictions to follow suit and impose similar restrictions on digital assets, potentially affecting the global crypto ecosystem. This can lead to a fragmented market, with different regulatory regimes and asset classifications across different jurisdictions, making it difficult for companies and investors to navigate the industry.

On the other hand, if Coinbase succeeds in defending its position, it may encourage other crypto platforms to challenge existing regulations, which could pave the way for a more favorable regulatory environment for digital assets.

Overtaking XRP, the Coinbase and Binance lawsuits have become the most important legal cases in the industry.

The regulatory framework for digital assets

The regulatory framework for digital assets 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 the DAC, with experts in digital assets at the helm. While Gary Gensler may be teaching students on the topic of blockchain, he has not used any digital assets or dApps.

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

What if this person leads all of the cryptocurrency laws in the US?

A true digital asset framework should include the creation of a digital asset class that recognizes its unique attributes, 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 maturity of the crypto space.

As regulators, such as the Securities and Exchange Commission, continue to address this issue, it is critical that the industry engage in an open discussion about the best way forward and push 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 do know that the SEC or CFTC don’t stand a chance.

Square peg, circular hole.

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

If digital asset securities are determined and administered by the Digital Assets Commission, then the SEC case is at the first hurdle, and retail users have an opportunity to participate in the future of DeFi in the United States.