Original Author: Scott Walker, Bill Hinman
Original Compilation: Luffy, Foresight News
As technology continues to evolve, the U.S. Securities and Exchange Commission (SEC) must also keep pace. This is particularly evident in the cryptocurrency domain. The new leadership and the newly formed Cryptocurrency Taskforce provide the agency with an opportunity to take concrete actions and make adaptive adjustments. Now is the time for action: the cryptocurrency market has grown in scale and complexity to the point where the SEC's previous reliance on enforcement alone, while neglecting regulation, is in urgent need of an update. With professional investment services beginning to enter this emerging industry, there is no alternative but to drive market development, encourage innovation, and protect investors. The principles underlying the relevant securities laws - information disclosure, fraud prevention, and maintaining market integrity - must remain sacrosanct. However, applying these principles in a manner that reflects the unique characteristics of crypto assets requires targeted regulatory reform. This article proposes immediate and readily implementable adjustment measures for the SEC to establish applicable regulatory rules, without sacrificing support for innovation and investor protection. While legislative action to clearly classify crypto assets and regulate secondary markets is essential, these measures will bring immediate benefits to the market. 1. Provide Interpretive Guidance on "Airdrops" and Other Incentive-Based Rewards The SEC should provide interpretive guidance on how blockchain projects can distribute crypto assets to participants without being deemed a securities offering. These distributions, often referred to as "airdrops" or "incentives," are typically provided by blockchain projects for free or at a nominal cost, usually as a reward for early use of a particular network or ecosystem. Such distributions are a key means for blockchain projects to build a community and gradually achieve decentralization, distributing ownership and control to users. This decentralization process offers many benefits. Decentralization can protect investors from risks typically associated with securities and centralized control, and foster network development, thereby enhancing its value. If the SEC can provide guidance on these distributions, it can curb the trend of conducting airdrops only to non-U.S. persons, which effectively transfers the ownership of blockchain technology developed in the U.S. overseas, at the expense of U.S. investors and developers, creating windfalls for non-U.S. persons. 2. Amend Crowdfunding Rules to Regulate Exempt Offerings The SEC should revise crowdfunding rules to more effectively regulate exempt offerings of crypto assets. Current crowdfunding activity limits on fundraising size and investor participation are not well-suited for crypto startups, as these companies often need to more widely distribute crypto assets to achieve sufficient user scale and network effects for their platforms, applications, or protocols. 3. Allow Broker-Dealers to Engage in Crypto Asset and Securities Businesses The current regulatory environment restricts traditional broker-dealers from substantive participation in the crypto space, primarily because it requires broker-dealers to obtain separate approval to conduct crypto asset transactions, and imposes more stringent regulations on broker-dealers seeking to custody crypto assets. These restrictions create unnecessary barriers to market participation and liquidity. Allowing broker-dealers to facilitate transactions in both security-type crypto assets and non-security crypto assets will enhance market functionality, investor access opportunities, and investor protection. On today's crypto trading platforms, non-security crypto assets (such as Bitcoin and Ether) can be traded seamlessly alongside crypto assets that the SEC may deem subject to securities laws. 4. Provide Custody and Settlement Guidance Custody and settlement remain key obstacles to institutional adoption of crypto assets. Unclear regulatory treatment and accounting rules have made traditional financial institutions hesitant to enter the custody market, meaning many investors cannot benefit from professional asset custody services and must self-custody and self-arrange custody solutions. Foresight News Foresight NewsHere is the English translation:This clarity will lay the foundation for institutional confidence, allowing large participants to enter the market, while also enhancing market stability and competition among service providers. Additionally, both retail and institutional investors will receive protections associated with professional, regulated asset management services.
5. Reform Exchange-Traded Product (ETP) Standards
The SEC should take reform measures targeting Exchange-Traded Products (ETPs) to promote financial innovation. These proposals aim to provide broader market access opportunities for investors and custodians accustomed to managing ETP portfolios.
Specifically:
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Restore Market Size Test: The SEC's reliance on the "Winklevoss Test" for market surveillance agreements has delayed the approval of Bitcoin and other cryptocurrency ETPs. This test requires that for a national securities exchange like the NYSE or Nasdaq to trade a commodity-based ETP, the listing exchange must have a surveillance-sharing agreement with a "regulated market of significant size" in the commodity or its derivatives. Given that the SEC does not consider cryptocurrency trading platforms as "regulated markets," this effectively means that ETPs are only suitable for those cryptocurrencies that have a futures market (regulated by the Commodity Futures Trading Commission) and can provide a high degree of price discovery for the underlying commodity. This ignores the significant scale and transparency of the current cryptocurrency markets. More importantly, it creates an arbitrary distinction in the standards applied to cryptocurrency ETP listing applications and all other commodity-based listing applications. Therefore, we recommend restoring the historical test for markets of significant size: only requiring the commodity futures market to have sufficient liquidity and price integrity to support the ETP product. This adjustment will align the approval standards for cryptocurrency ETPs with the standards for other asset ETPs.
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Enable Physical Settlement: Allow cryptocurrency ETPs to settle directly in the underlying asset. This will result in better fund tracking, lower costs, increased price transparency, and reduced reliance on derivatives.
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Apply Custodial Standards: Mandate strict custodial standards for physically settled transactions to mitigate theft or loss risks. Additionally, provide a collateral option for the idle assets of ETPs.
6. Implement 15c2-11 Certification for Alternative Trading Systems (ATS) Listings
In a decentralized environment, the issuers of crypto assets may no longer play a significant ongoing role, raising the question of who is responsible for providing accurate disclosure information about the asset. Fortunately, there is a similar beneficial rule in the traditional securities market, namely Rule 15c2-11 of the Securities Exchange Act, which allows broker-dealers to trade a security, provided that, among other conditions, investors can access the latest information about that security.
Extending this principle to the cryptocurrency market, the SEC could allow regulated cryptocurrency trading platforms (including exchanges and brokers) to trade any asset for which the platform can provide accurate, up-to-date information to investors. The result would be increased liquidity for such assets in SEC-regulated markets, while ensuring investors have the ability to make informed decisions. Two clear benefits of this approach are the ability to trade digital asset pairs (where one asset is a security and the other is not) on SEC-regulated markets, and the deterrence of trading platforms from operating overseas.
Specifically:
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Streamline Certification Process: Establish a streamlined 15c2-11 certification process for crypto assets listed on Alternative Trading System (ATS) platforms, providing mandatory disclosure on the asset's design, purpose, functionality, and risks.
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Adopt Due Diligence Standards: Require exchange or ATS operators to conduct due diligence on crypto assets, including verifying the issuer's identity and key feature and functionality information.
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Clarify Disclosure Requirements: Mandate periodic updates to ensure investors receive timely and accurate information. Additionally, clarify when, due to decentralization, the issuer's reporting is no longer relevant to potential purchasers and thus no longer required.
This framework will promote transparency and market integrity while allowing innovation to thrive in a regulated environment.
Conclusion
The SEC is at a critical juncture in determining the future of crypto asset regulation. The newly formed Crypto Assets Working Group indicates the Commission's intent to shift from the previous administration's approach, which was heavily focused on enforcement. By immediately taking the key steps outlined above, the SEC can begin transitioning from its historically controversial, enforcement-centric mode to providing the much-needed regulatory guidance and practical solutions for investors, custodians, and financial intermediaries. This will better balance the protection of investors with the promotion of capital formation and innovation.
The reforms proposed above will reduce uncertainty and support financial innovation in the crypto space. Through these adjustments, the SEC can reclaim its mission and reposition itself as a forward-looking regulator, ensuring that the U.S. markets remain competitive while protecting the public interest. The long-term future of the U.S. crypto industry may require a comprehensive, fit-for-purpose regulatory framework from Congress. However, until that framework is in place, the steps outlined in this document represent a pathway towards appropriate regulation.
