The current regulatory approach of the Securities and Exchange Commission (SEC) towards crypto assets is causing harm to investors and stifling innovation within the industry, according to a recent article written by lawyers from crypto and web3 investment firm Paradigm.
The article highlights the unique features of crypto assets that differentiate them from traditional securities, such as decentralized governance, on-chain transactions, and the absence of conventional corporate structures.
These distinctions make the application of the existing securities framework to crypto assets difficult and potentially damaging to the market. The article calls for a more tailored approach to regulation that takes into account the unique characteristics of crypto assets.
The SEC currently relies on the Howey and Reves tests to determine whether a crypto asset should be classified as a security. However, these tests have been criticized for their complexity and lack of clarity when applied to the ever-evolving world of crypto assets.
The legal uncertainty surrounding the classification of crypto assets as securities poses challenges for crypto projects. Many are unsure about how to comply with existing regulations, which may discourage innovation and hinder the growth of the industry.
The article argues that the SEC needs to provide more clarity on the classification of crypto assets, including whether or when they should be considered securities and what type of securities they are.
Furthermore, the authors contend that the current disclosure regime, which was designed for traditional corporate entities, is not appropriate for crypto assets. Many of the existing disclosure requirements are not material or relevant to crypto asset investors.
One such requirement is the disclosure of business and financial information. While this may be applicable to some crypto assets, it may not be material for many others, particularly those without a conventional corporate structure or revenue-generating plans.
The requirement for issuers to provide information about their team and management is also called into question. In many crypto projects, the development team and structure are decentralized, making the disclosure of such information less relevant to investors.
The requirement to disclose the use of proceeds is similarly inapplicable to many crypto assets, as proceeds may not accrue directly to an issuer or may be distributed to a community treasury, rather than the original seller.
In addition to the inapplicability of certain disclosure requirements, the article identifies several missing disclosures that are important for crypto asset investors.
Governance is a key issue, as crypto assets often involve unique, decentralized governance structures. Investors need information about on-chain and off-chain decision-making processes and how code upgrades can be implemented.
Security is another area where current disclosure requirements fall short. Given the prevalence of cybersecurity threats in the crypto industry, investors need more information about code audits, software documentation, and incentives for white hat hackers.
Network or application design is crucial for crypto asset investors, as the underlying technology often determines the asset’s value and functionality. While open-source code is typically available, many investors lack the technical expertise to understand it, necessitating clear, accessible disclosures.
Tokenomics, including initial token allocation, total supply, and future issuance schedules, can have a significant impact on a crypto asset’s value and should be disclosed to investors.
Finally, the article highlights the importance of disclosing the consumptive use or utility of crypto assets, as they are often designed to be used within a blockchain network or application.
The authors call for the SEC to change its approach and collaborate with the crypto industry to develop tailored disclosure requirements that provide crypto users and investors with the information they need.
They argue that the current approach will result in the quality of crypto assets degrading, with direct harm to users, investors, and the market generally. In order to fulfill its mission, the SEC must radically change course and work with the crypto industry to develop tailored disclosure requirements that provide crypto users and investors with the information that they need.
