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 established Cryptocurrency Task Force 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 way that reflects the unique characteristics of crypto assets requires targeted regulatory reform.
This article proposes immediate and easily implementable adjustment measures for the SEC, aimed at developing applicable regulatory rules while not 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 minimal 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 of the project 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. This trend effectively transfers the ownership of blockchain technology developed in the U.S. overseas, at the expense of U.S. investors and developers, creating windfall gains for non-U.S. persons.
Specific Measures:
· Establish Eligibility Criteria: Set basic standards for crypto assets that can be distributed in airdrops and incentive-based rewards without being deemed investment contracts (subject to securities laws). For example, crypto assets whose market value is primarily derived from the programmatic operation of any distributed ledger or similar technology, or any executable software deployed to a distributed ledger or similar technology, should be eligible for such distributions if they do not fall into other securities categories.
2. Amend Crowdfunding Rules to Regulate Exempt Offerings
The SEC should revise crowdfunding rules to more effectively regulate exempt offerings of crypto assets.
The current limitations on fundraising size and investor participation in crowdfunding activities are not well-suited for crypto startups, as these companies often need to more widely distribute crypto assets to build sufficient user scale and network effects for their platforms, applications, or protocols.
Specific Measures:
· Increase Fundraising Limits: Raise the maximum amount that can be raised through crowdfunding to levels commensurate with the needs of the enterprise (e.g., up to $75 million or a certain percentage of the entire network, based on disclosure depth).
· Exempt Offerings: Allow crypto projects to rely on exemption provisions similar to Regulation D while reaching a broader investor base (not just accredited investors) through crowdfunding platforms.
· Protect Investors: Implement appropriate safeguards, such as setting individual investment limits (similar to the current Regulation A+ approach) and developing comprehensive disclosure requirements covering key information relevant to crypto enterprises (e.g., while standard offering disclosures may cover matters like directors, compensation, and ownership details, disclosures around the underlying blockchain, governance, and consensus mechanisms may be more important for crypto asset investors).
These changes will enable early-stage crypto projects to access a wide investor base while maintaining transparency and democratizing investment opportunities.
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 domain, primarily because it requires broker-dealers to obtain separate approval to engage in crypto asset transactions and imposes stricter 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-like 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 Ethereum) can be traded seamlessly alongside crypto assets that the SEC may deem subject to securities laws.
Specific Measures:
· Establish a Registration Pathway: Develop a clear registration path for broker-dealers to engage in (and custody) crypto assets (both securities and non-securities), with specific requirements based on the nature of these assets.
· Strengthen the Regulatory Framework: Implement oversight mechanisms to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) requirements, and maintain market integrity.
· Collaborate with the Industry: Work with the Financial Industry Regulatory Authority (FINRA) to issue joint guidance addressing the unique operational risks of crypto assets.
This approach will facilitate the establishment of a safer, more efficient market, allowing broker-dealers to bring their expertise in best execution, compliance, and custody to the crypto market.
4. Provide Custody and Settlement Guidance
Custody and settlement remain key barriers 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 invest and arrange custody on their own.
Specific Measures:
· Issue Custody Guidance: Provide guidance on the custody rules under the Investment Advisers Act, clarifying how investment advisers can custody crypto assets with adequate safeguards such as multi-signature wallets and secure offline storage. This should also include guidance on the pledging of idle crypto assets held in custody by investment advisers and governance decision voting.
· Establish Settlement Standards: Develop specific guidance on the settlement of crypto transactions, including timing arrangements, verification processes, and error resolution mechanisms.
· Create a Technology-Neutral Framework: Allow for the flexible adoption of innovative custody solutions, as long as they meet regulatory standards, without mandating specific technology requirements.
· Correct Accounting Treatment: Rescind SEC Staff Accounting Bulletin 121 (SAB 121) to enable the accounting treatment of custodied digital assets to reflect the actual custody arrangements, rather than assuming the existence of a liability. The background is that SAB 121 stipulates that "to the extent a company is responsible for safeguarding platform users' crypto assets... the company should recognize a liability on its balance sheet to reflect its obligation to safeguard the crypto assets held for the platform's users," with a corresponding asset. The overall effect of SAB 121 is to include custodied crypto assets on the custodian's balance sheet, a treatment that departs from the traditional accounting for custodial assets. This means that, unlike typical custody arrangements, if the custodian goes bankrupt, this accounting treatment could result in the custodied crypto assets being included in the custodian's bankruptcy estate. Worst of all, SAB 121 lacks legal validity. The Government Accountability Office found that it is effectively a rule that should have been submitted to Congress for review under the Congressional Review Act, and in May 2024, the House and Senate issued a joint resolution disapproving of SAB 121, but it was vetoed by President Biden.
This clarity will lay the foundation for institutional confidence, allowing large participants to enter the market while enhancing market stability and competition among service providers. In addition, 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 a broader market access opportunity for investors and custodians accustomed to managing ETP portfolios.
Specific Measures:
· Restore the 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 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 market. 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 suggest 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.
· Achieve 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.
· 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 the 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.
Specific Measures:
· Streamline the Certification Process: Establish a streamlined 15c2-11 certification process for crypto assets listed on Alternative Trading System (ATS) platforms, providing mandatory disclosure on asset design, purpose, functionality, and risks.
· Adopt Due Diligence Standards: Require exchange or ATS operators to conduct due diligence on crypto assets, including verifying issuer identity and key feature and functionality information.
· Clarify Disclosure Requirements: Mandate periodic updates to ensure investors receive timely and accurate information. Additionally, clarify when, due to decentralization, issuer reporting may no longer be relevant or valuable 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, applicable regulatory framework from Congress. However, until that framework is in place, the steps outlined in this article represent a path towards appropriate regulation.
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