Last week, SEC staff released a Framework for “Investment Contract” Analysis of Digital Assets. While we believe that the intent of this guidance was in line with the agency’s core mission — protecting investors by reducing information asymmetry — we fear it will have the opposite effect.
Open blockchain networks are incredibly transparent, far more transparent than anything SEC disclosure regimes are likely to create. By providing a list of factors without a methodology to weigh them, the staff guidance brings more regulatory uncertainty to the blockchain ecosystem, which will ultimately result in fewer U.S.-based projects. We believe public policy should be made to support these transparency-increasing networks, not stifle them.
Open blockchain networks are among the most transparent economic systems in human history
At the core of open blockchain networks, and the digital tokens used within them, is open source software. If you are reading this, you are using the fruits of open source work performed in every decade since the 1970s. It powers our operating systems, databases, and smartphones, and is relied upon by our financial markets, nuclear reactors, and jet fighters. The most trusted and best-understood systems in the world are open source software.
“Open source” means the code base is made available to everyone, and anyone can contribute improvements, report bugs, or inspect how things work. It also means that decisions about the project happen publicly, in forums where anyone can view or even participate in discussions. Consider how different this is from a traditional company, where key decisions are made behind closed doors by a small group of people, and the only way to ensure transparency is by requiring disclosure.
Open blockchain networks can originate in many ways, but — like all software — almost all of them start with a vision held by a small group of affiliated persons. At this stage, projects may be centralized and risky, and many projects initially raise capital to build their vision in a way that is compliant with traditional securities laws.
But, over time, these networks become more transparent and better-understood. Code is made available for review by anyone, rules of the network and its supply of tokens are publicly known, and online forums become the primary places where diverse groups of contributors determine the future of the project. Over time, there is no more central control and no more information asymmetry.
The SEC should love open blockchains, but the staff guidance discourages their development in the United States
The SEC’s mission is to protect investors from information asymmetry, not to police all economic activity. The Commission itself acknowledges that “[t]he laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.”
Unfortunately, this staff guidance doesn’t center on the SEC’s core mission. Instead, it provides an intimidating list of ways that open blockchain projects might be subject to SEC enforcement actions. Even the factors listed as decreasing the likelihood that a token is a security fixate on whether it’s possible for anyone to make money in connection with a token, not whether projects are run in a fair, transparent, decentralized way.
We want to be very clear: without a methodology to weigh the factors in the guidance, every single open blockchain project is open to an SEC determination that their tokens are securities. This includes projects the SEC has acknowledged as having decentralized to the point where securities laws no longer make sense to apply. Unfortunately, by emphasizing enforcement jurisdiction rather than providing a clear regulatory path for innovators, the staff guidance makes it much scarier for blockchain projects to operate in the United States. Without more concrete guidance, proactive compliance feels impossible (unless, of course, you’re willing to shut down your legitimate project).
Congress is the best hope for good public policy for open blockchain networks
We believe the SEC has the statutory authority to provide a workable framework that would enable the open blockchain networks to thrive while upholding their duty to reduce information asymmetry. Unfortunately, we aren’t expecting there will be an open rulemaking process to find a policy that balances consumer protection and innovation anytime soon. So, where do we go from here?
We’ve been working with some of the most forward-thinking members of Congress on the Token Taxonomy Act. This legislation provides a simple, clear explanation of what is not a security, and it does so in a way that embraces the potential of open blockchains while still protecting consumers. If passed, this would provide the certainty needed for the token economy to thrive. We applaud Rep. Warren Davidson, Rep. Darren Soto, and others for their work on this issue, and we eagerly await the bill’s reintroduction.