Author: Techub selected compilation
Written by: Scott Walker (Chief Compliance Officer of a16z) and Bill Hinman (Former Director of the US SEC’s Department of Finance)
Compiled by: Yangz, Techub News
As technology continues to advance, the U.S. Securities and Exchange Commission (SEC) must also keep pace, and this is particularly evident in the cryptocurrency space. New leadership and the creation of a new cryptocurrency task force provide an opportunity for the agency to take action and make timely adjustments.
Now is the critical time to act. The cryptocurrency market is growing rapidly in size and complexity, and the SEC’s recent enforcement actions and deregulatory approach are in urgent need of updating. As professional investment services begin to operate in this emerging industry, there is currently no other way to promote efficient markets, encourage innovation, and ensure investor protection. Nevertheless, the basic principles of relevant securities laws, including disclosure, prevention of fraud, and market integrity, remain sacrosanct. Targeted regulatory reforms are necessary to better adapt these principles to the unique characteristics of cryptocurrencies.
This article proposes immediate and easily implemented adjustments that the SEC should take to develop regulations that are fit for purpose without sacrificing innovation or investor protection. While legislation is critical to clarify the classification of cryptocurrencies and secondary market regulation, the following steps will bring direct benefits to the market.
1. Provide interpretative guidance on “airdrops” and other incentives
The SEC should provide interpretive guidance on how blockchain projects can distribute cryptocurrencies to participants without being characterized as securities offerings. Such distributions are often referred to as “airdrops.” They are distributed at low cost or for free as rewards to early users or ecosystem participants. They are an important means for blockchain projects to build communities and promote decentralization, and help give ownership and control of projects to users.
This decentralized process brings many benefits, not only effectively protecting investors from the risks of securities and centralized control, but also promoting the expansion of the network, thereby increasing its overall value. If the SEC can provide guidance on allocation, it can curb the trend of airdrops only to non-Americans, which actually offshores the ownership of blockchain technology developed in the United States and creates huge profits for non-Americans at the expense of the interests of American investors and developers.
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Establish eligibility criteria: Set criteria for cryptocurrencies that qualify for exemption from investment contract treatment under the securities laws in airdrop distributions. For example, cryptocurrencies whose market value derives primarily from (or could reasonably be expected to derive primarily from) programmatic functionality of any distributed ledger or similar technology, or any executable software deployed to a distributed ledger or similar technology, and which are not otherwise securities, should qualify for such distributions.
2. Modify the crowdfunding rules for exempted issuance
The U.S. SEC should amend the Regulation Crowdfunding rules to more effectively regulate the exempt issuance of cryptocurrencies.
Current restrictions on capital raising and investor participation in crowdfunding campaigns are not suitable for cryptocurrency startups, which often require broader cryptocurrency distribution to bring about qualitative changes and network effects to the development of their platforms, applications or protocols.
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Expanding offering limits: Raising the maximum amount that can be raised through crowdfunding to a level that matches the needs of startups (e.g., up to $75 million or a percentage of the entire network, depending on the depth of disclosure).
Exempt Offerings: Allow cryptocurrency projects to rely on an exemption similar to Regulation D while leveraging the accessibility of crowdfunding platforms to more broadly reach investors beyond accredited investors.
Investor protection: Appropriate safeguards, such as limits on individual investment amounts (as Regulation A+ currently does), and strict disclosure requirements covering material information about crypto ventures that is not covered by current regulations (e.g., while offering disclosures may often cover matters such as directors, director compensation, and shareholding details, disclosures around the underlying blockchain, blockchain governance, and consensus mechanisms may be more important to cryptocurrency investors). Tailoring these requirements to digital asset investors can ensure they are well-informed and protected from fraud.
These measures will enable early-stage cryptocurrency projects to reach a broad range of investors, democratizing investment opportunities while maintaining transparency.
3. Allow broker-dealers to operate in the cryptocurrency and securities space
The current regulatory environment requires traditional broker-dealers to obtain separate approval before they can trade cryptocurrencies and imposes more onerous regulations on brokers that wish to custody crypto assets, greatly reducing brokers’ enthusiasm for participating in the cryptocurrency space.
These restrictions create unnecessary barriers to market participation and liquidity. Allowing brokers to facilitate trading in cryptocurrencies that are and are not securities will enhance market function, investor access, and investor protection. This also means that on today’s cryptocurrency platforms, cryptocurrencies that are clearly not securities (such as Bitcoin, Ethereum, or fiat-based stablecoins) can be seamlessly traded with cryptocurrencies that the SEC may deem subject to securities laws.
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Allow registration: Create a clear path for broker-dealers to register to trade (and custody) cryptocurrencies (securities and non-securities), with requirements tailored to the nature of these assets.
Strengthen the regulatory framework: Establish a supervisory mechanism to ensure compliance with Anti-Money Laundering (AML) and KYC regulations and maintain market integrity.
Collaboration with Industry: Working with the U.S. Financial Industry Regulatory Authority (FINRA) to issue joint guidance addressing operational risks unique to cryptocurrencies.
The above measures will promote safer and more efficient markets, allowing brokers to bring their expertise in best execution, compliance and custody to the cryptocurrency markets.
4. Provide guidance on custody and settlement
Custody and settlement remain key barriers to institutional adoption of cryptocurrencies. Ambiguities in regulatory treatment and accounting rules prevent traditional financial institutions from entering the custody market. This means that many investors cannot benefit from custodial asset management and are left with the choice of investing their own money and arranging custody alternatives.
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Develop Custody Guidance: Provide guidance on custody rules under the Investment Advisers Act to clarify how investment advisers can custody cryptocurrencies and ensure adequate safeguards, such as multi-signature wallets and secure off-chain storage. In addition, provide guidance on staking and governance voting of idle cryptocurrencies in the custody of investment advisers.
Develop settlement standards: Develop specific guidance on the settlement of cryptocurrency transactions, including timelines, verification processes, and error resolution mechanisms.
Establish a technology-neutral framework: Provide flexibility for innovative custody solutions that meet regulatory standards without imposing prescriptive technical mandates.
Correct accounting treatment: Repeal SEC Staff Accounting Bulletin No. 121 to allow for accounting treatment of custodial digital assets to reflect the nature of the custody arrangement rather than the assumed liability. According to SAB 121, among other things, "as long as the 'company' is responsible for protecting the cryptocurrency held by its platform... the company should list liabilities on its balance sheet to reflect its obligation to protect the cryptocurrency held by its platform users" and list the corresponding assets. Simply put, SAB 121 aims to transfer custodial cryptocurrency to the custodian's balance sheet, a practice that is contrary to the traditional accounting treatment of custodial assets. Therefore, unlike typical custody arrangements, this accounting treatment may drag the custodial cryptocurrency into the custodian's bankruptcy estate if the custodian goes bankrupt. Perhaps worst of all, SAB 121 lacks legitimacy. The Government Accountability Office found that it was actually a rule that should have been submitted to Congress for review under the Congressional Review Act. In May 2024, the House of Representatives and the Senate issued a joint resolution not to approve SAB 121, but the resolution was vetoed by President Biden.
The aforementioned clarity will lay the foundation for institutional confidence, enabling large players to enter the market, while enhancing market stability and competition among service providers. In addition, cryptocurrency investors, both retail and institutional, will gain the protections associated with professional, regulated asset management services.
5. Reform of ETP standards
The SEC should promote financial innovation through reforms to exchange-traded products (ETPs). These proposals would provide broader market access for investors and trustees accustomed to managing ETP portfolios.
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Restore the market size test: The SEC’s reliance on the Winklevoss Test for market oversight agreements has delayed the approval of Bitcoin and other cryptocurrency-based ETPs. The test requires that when a national securities exchange (such as the New York Stock Exchange or Nasdaq) trades a commodity-based ETP, the listing exchange must enter into a supervision agreement with a “regulated market” for the commodity or its derivatives. Given that the SEC does not consider cryptocurrency trading platforms to be “regulated markets,” this means that ETPs can only target cryptocurrency assets that have futures markets (regulated by the CFTC) that are highly predictive of price discovery for the underlying commodity. This approach ignores the huge size and transparency of the current cryptocurrency market. More importantly, it is arbitrary in the standards that apply to cryptocurrency-based ETP listing applications and all other commodity-based listing applications. Therefore, we recommend restoring the market size test, requiring only that there is sufficient liquidity and price integrity in the commodity futures market to support ETP products. This adjustment will align the approval of cryptocurrency ETPs with the standards for other asset ETPs.
Allow physical settlement: Allow cryptocurrency ETPs to be settled directly in the underlying asset. This will better track funds, reduce costs, increase price transparency and reduce reliance on derivatives.
Applicable custody standards: Strict custody standards are applied to physical settlement transactions to reduce the risk of theft or loss. In addition, options are provided to pledge idle ETP assets.
6. Implement 15c2-11 certification for ATS list
In a decentralized environment, the role of cryptocurrency issuers may become less important over time, raising the question of who is responsible for providing accurate asset information. Fortunately, there is a similar rule in effect in traditional securities markets, namely Exchange Act Rule 15c2-11. This rule allows broker-dealers to trade securities as long as investors can obtain the latest information about the securities.
Extending this principle to the cryptocurrency market, the SEC could allow regulated cryptocurrency trading platforms (including exchanges and brokers) to trade any asset as long as the platform provides investors with accurate and up-to-date information. In addition, in such regulated markets, assets will be more liquid and investors will be able to make informed decisions. There are two obvious benefits to doing so. One is that digital asset pairs (one of which is a security and the other is not) can be traded on markets regulated by the SEC, and the other is that trading platforms can be restrained from operating overseas.
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Simplified Certification Process: Establish a streamlined 15c2-11 certification process for cryptocurrencies listed on alternative trading system (ATS) platforms, mandating disclosure of the asset’s design, purpose, functionality, and risks.
Adopting due diligence standards: Require exchanges or ATS operators to conduct due diligence on cryptocurrencies, including verifying the identity of the issuer and information on important features and functions.
Clarify disclosure requirements: Specify regular updates to ensure that investors receive timely and accurate information. Also, clarify when issuers are not required to report. In a decentralized environment, reports are not valuable to potential purchasers.
This framework will promote transparency and market integrity while allowing innovation to flourish in a regulated environment.
in conclusion
The SEC is at a critical juncture in determining the future of cryptocurrency regulation. The creation of a new cryptocurrency task force signals the SEC’s intention to change the approach of the previous administration. By taking the above key measures immediately, the SEC can begin to shift its historically controversial enforcement focus to providing much-needed regulatory guidance and practical solutions for investors, custodians, and financial intermediaries. This will strike a better balance between protecting investors and promoting capital formation and innovation.
From modernizing crowdfunding rules to establishing clear standards for custody and ETPs, the changes recommended above will reduce regulatory ambiguity and support financial innovation in this area. Through these adjustments, the SEC can reaffirm its purpose and reposition itself as a forward-thinking regulator that protects the public interest while ensuring that the U.S. market remains competitive. The long-term future of the U.S. cryptocurrency industry may require Congress to provide a comprehensive regulatory framework, but until that framework is in place, the suggestions given in this article are a way to achieve appropriate regulation.
