Are SEC’s Rules on Crypto Outdated?
Paradigm, a pro-crypto venture firm, has released the third installment of its publication series. This latest release provides a detailed breakdown and critique of the SEC’s requirements for blockchain projects.
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What's going on?
As we previously reported, Coinbase is taking the SEC to court in order to demand clear regulations for crypto companies. Paradigm agrees with this move and points out that the US Securities and Exchange Commission often treats blockchain projects unfairly and with discrimination.
In response to this criticism, SEC Chair Gary Gensler has been insisting that registration is accessible for everyone and that companies should follow the laws. However, this doesn't reflect reality, as regular startups can be launched much more quickly than blockchain projects. Furthermore, the SEC refuses to provide its recommendations on this matter.
What exactly does the SEC want?
The SEC believes that most tokens fall under the Securities Act of the 1930s, which means that companies must register using one of the four available forms. This involves filling out the necessary paperwork and disclosing all information about the tokens according to SEC regulations.
In the traditional market, this helps investors get all the information about a project before they invest their money. While officials oversee the process of approving the completed form, they can't abuse their power by preventing a company from entering the market. Unfortunately, the SEC's current actions resemble such a situation.
Filling out the paperwork for crypto startups is really tough and expensive. Without a top-notch legal team, it's pretty much impossible. On top of that, the current registration process slaps significant restrictions on distributed tokens, like having to report continuously and not being able to trade them on the secondary market. That makes them pretty much useless in practice.
Even the exemption from registration during the initial distribution isn't helpful. If the SEC decides that they're actually equity down the line, the company would have to register using a different form. So, it's pretty clear that the problem here is that the SEC just doesn't want to update the process, even though other industries have gotten updates.
Examples of failed SEC registrations
To demonstrate the ineffectiveness of the SEC's approach, we can examine a couple of cases where the commission accused startups of illegally selling securities, made them return investor funds, and undergo registration:
1. Paragon Coin Inc. was a Delaware-based company that raised $12 million for using blockchain technology in the cannabis industry. Two years later, they filed their first registration form but ignored a request for more information from the SEC. Soon after, they filed for bankruptcy, citing their inability to handle the legal workload and making critical mistakes in that area.
2. Salt Blockchain Inc. was a Colorado-based company that provided loans secured by digital assets. They raised $47 million from token sales over two years and eventually reached an agreement with the SEC. However, after submitting their registration form, they made multiple changes to it more than four times. While the project continued to operate, the token lost all its liquidity and became useless.
Many people have noted that the SEC has reduced its enforcement actions against ICOs after these failed cases. However, companies like Hiro and YouNow, who opted for a different approach and registered prior to distribution, still faced problems and additional expenses. The leading lawyers of these projects also expressed negative opinions about the current policy of the SEC:
To date, the SEC still has not adopted a single rule with which to govern crypto, has not amended a single disclosure or registration form to reflect the unique aspects of crypto, and has not created a workable process by which digital asset issuers can register their tokens for public sale or trade those tokens in a liquid secondary market.
Requested information is not relevant
The current system for disclosing information during registration is designed for traditional companies. It includes details such as the company's history, financial reports, management structure, and risks. However, this approach is not suitable for decentralized cryptocurrencies for several reasons:
1. Tokens exist independently of the organizations (issuers) that originally created and transferred them to investors. These issuers usually only offer technical support. Sometimes, a project is backed by a professional community without a legal structure.
2. Unlike traditional securities, the value of tokens is determined based on their intrinsic value in the ecosystem, rather than the financial performance of the company. Furthermore, cryptocurrencies operate on a completely different technical basis, allowing them to be owned directly and traded 24/7.
Therefore, the SEC should revise the form by removing unnecessary requests, such as information on revenue or business details about the legal firm. Instead, they should introduce useful requests that specifically relate to tokens.
What should be added?
1. A detailed explanation of how the presence of tokens will affect protocol management and updates, such as the amount of voting power owners will have, whether delegation is possible, who will handle future updates, and more.
2. Potential security risks associated with the protocol for each specific case. Also, it is imperative to have an audit in place as a mandatory requirement for registration approval.
3. A general understanding of the open-source code and its functionalities regarding the token, and how it can continue to operate without relying on the issuer.
4. Statistics on the project's tokenomics, such as the total number of coins, to whom they are being transferred (development team, community, initial investors), how much will remain locked, and so on.
5. Information on the token's utility, its intended purpose, how it will be used, and whether it's a passive investment or a collectible item.
Final words
The SEC's insistence on applying an outdated system to new technological projects is a serious threat to the American cryptocurrency market. Many companies are urging the Commission to change its policy on this issue before the pressure from investors and some American politicians becomes overwhelming. If the SEC fails to act quickly, it could lead to the collapse of the entire market.
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