The first question faced by political decision-makers who respond to the need for judicious cryptography regulations is to distinguish titles from crypto-evaluators. The growing consensus at Congress and the Securities and Exchange Commission is that the line of demarcation between titles and the crypto should be the degree of “decentralization” in the network or blockchain protocol on which the cryptocurrency is issued and recorded.
This thought argues that once a network is sufficiently decentralized – which means that a substantial part of its consensual mechanism is not controlled by a single person or a group – the cryptocurrency migrate from securities to cryptographic regulations.
But it is not clear that this is the best setting to use.
There are good reasons to focus on decentralization. If no one controls a network, there is nobody to carry the burden of the recording of the dry. And as investors cannot reasonably count on the “efforts of others” when they invest in a decentralized project, the cryptocurrency would not respond to the test of the “investment contract” under the decision of the Supreme Court of the United States in 1946 in Dry c. WJ Howey Co.
The former president of the dry, Gary Gensler, counted Howey To say that almost all cryptocurrency are titles. Thus, the question of decentralization was often an objective when evaluating the status of a crypto-assembly. The Bitcoin network was considered a protocol that had reached sufficient decentralization, but almost all the other protocols which are the exam of the dry have not reached this standard.
Many in the industry disagreed with the analysis of the decentralization of the dry, applied to specific cryptocurrency. But the federal courts have made no progress arbitrating disputes. Indeed reasonable arguments can often be made in both directions.
Lawyers in securities answer a similar question when determining if a securities seller is an affiliate of the transmitter.
Affiliation has important consequences: this means that the seller faces the responsibility of subscribers or economically expensive restrictions during the sale of securities on the market.
The answer lights up on the fact that the seller of the controls is controlled by where is under common control with the transmitter. Sellers are sometimes surprised that control, and therefore affiliation, arises at very low property and influence levels.
Although it is generally sure to conclude a holder of less than 10% of the actions of a transmitter is not an affiliate, the response is troubled above this threshold. Once the holder holds more than 20%, the holder is generally, for the dry, an affiliate.
Similarly, if the holder is an officer or an administrator – even without being able to direct the activities of the issuer – this person is generally considered as an affiliate.
At the time of peopleler, the industry often had no choice but to engage on this ground when it claims that a protocol was decentralized enough for its crypto-evaluators to be titles.
But we are no longer at that time. We can now delimit the line between titles and non-security by status or rule without reference to Howey. The question is then to remain attached to decentralization. Four reasons suggest not doing it:
- Howey Aside, centralization is not the mark of security. The iPhone operates at the center of a very controlled and highly centralized ecosystem, but no one would say that it is a reason to regulate it as security.
- The difficulty of saying whether decentralization has occurred against use as a line of demarcation, even if this is useful for other regulatory purposes. If the SEC can say that a network has not reached decentralization, the agency will do so and the industry will return to the swamp of the people.
- Decentralization changes. A protocol that produces it can lose it if the consensual mechanism is the influence of someone. Avoidable confusion would be the result of if a cryptoset is turned into the status of titles.
- A test focused on decentralization necessarily excludes the networks designed to be centralized. Decentralization is an element of a commercial model, where developers can believe that it is the best way to reach the security and resilience of the network. But there are commercial models where developers offer other means to achieve these objectives. This has no sense to consult their cryptocurrency to the regulation of securities because they continue a different path.
A better division line would focus on assets – and the essential nature of what we consider as security – rather than the network where the assets live.
Commercial shares on the New York Stock Exchange and the over-the-counter debt trade have something in common which is not shared by cryptocurrency: these titles represent legal and contractual complaints on the assets, income and profits of a company or government.
Bitcoin, Ethereum and the vast majority of cryptocurrencies merchanting on popular crypto trading platforms do not do so.
This is why the book of DRI disclosure rules is mostly not relevant for crypto. There is not a company that must be examined to understand the value of the investment. There can be a commercial activity, but even when network control is centralized, in a dynamic network, this activity is the product of decisions not coordinated by users.
Similarly, many rules of negotiations for securities are based on the fact that they involve companies. We do not worry about sudden accidents or uncovered sales if everything that counted was speculative trading.
But because a company’s access to capital is assigned by these events, we settle. The decision -makers want to penalize the manipulative activity on the cryptographic markets, but the dry has no monopoly on the deterrence of this conduct.
Predictability is the best reason to base the ditch on the nature of the asset and not its protocol. It is easy to determine whether an instrument is a complaint on the assets, income or profits of a business. Either this is the case, or this is not the case.
An approach that focuses on what the instrument represents, rather than the decentralization presented by its protocol, would thus give a better result for the development of the cryptographic industry.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author information
Joseph Hall is associated with Davis Polk, member of the company’s capital markets group, and head of his interdisciplinary ESG risk practice.
Write for us: Author guidelines
