After years of threatening to sue
for listing unregistered securities, the Securities and Exchange Commission is now rumored to have launched an investigation into the company and other exchanges. If it proceeds, the SEC may be on track to make a serious mistake.
Skeptics wonder why Coinbase doesn’t simply register the tokens it sells with the SEC. It’s not that simple. Since its inception, cryptocurrency has confounded regulators because it is unlike any traditional financial instrument. Like regular money, crypto can be used to pay for ordinary goods. Bitcoin is one example, which has a growing base of thousands of merchants who accept payments directly over the currency’s Lightning Network.
Some leading cryptocurrencies can be sent to an app and then used to generate a QR code, which is accepted in 20 national chains like Petco, Chipotle, Office Depot and Regal Cinemas. Last week I used crypto tokens that the SEC has previously alleged were unregistered securities to buy an ice-cream cone and a burrito.
But here’s where things get confusing. Some crytpo tokens appear to function as a type of equity, from which you expect profit. Governance tokens in crypto exchanges, which allow users to vote on changes to how the protocol operates, will share their profit with you. But in a way, profit-sharing tokens aren’t like equity securities at all. The traditional corporate structures—boards of directors, executives, even companies—aren’t present on the other end of the transaction. There’s no one who could file or sign the financial statements for such projects.
There’s even more diversity among tokens. Some are like those you might get from a Chuck E. Cheese to play videogames. These often take the form of tokens used to store data. Imagine if every time you saved a document to the cloud, you needed a token to do so. Payment for data storage is one of the more popular uses of crypto tokens.
Cryptocurrency is so difficult to categorize because many of its variants blur the lines between traditional categories of money, stock and commodities. Most are a bit of each. Some tokens can be used to store data and serve as a form of payment or an investment—all at the same time. The purpose depends on the user’s preference.
Even if cryptocurrency developers wanted to register their projects with the SEC, as traditional public companies are required to, they couldn’t. They don’t have a board, CEO or CFO to file the requisite paperwork with the commission. Nor do they have proxy voting of shares by mail, which the commission still requires companies provide to shareholders.
Consider another facet of crypto that would shock the drafters of the 1933 Securities Act. Imagine if a bank or stock exchange were run by an autonomous, open-source computer code that took deposits and processed loans. Occasionally the code is modified by a few hundred anonymous coders around the world, who collaborate over the internet to keep it running smoothly.
This isn’t some science-fiction movie. Billions of dollars are deposited and loaned out in this way each day. The combined market capitalization of these “decentralized finance” developers would be enough to make them the 18th-largest bank in the U.S.
Tokens that represent an interest in these autonomous computer banks and exchanges are some of the targets of the SEC’s investigations and regulatory inquiries. They are also the same tokens I used to buy my ice cream and burrito last week.
The SEC’s position—that most tokens are securities and must register or face enforcement—is obtuse. It’s also an approach that works to the benefit of the scammers and hucksters who have abused the crypto space.
If the SEC were instead to build a regulatory regime tailored to the needs of crypto investors, as SEC Commissioner
has requested, we would be better able to separate the legitimate crypto projects from the scams. Defendants in SEC actions can now use the nebulous character of crypto tokens to their advantage. When cases are brought against legitimate enterprises, such as Coinbase, that’s a good thing; when brought against fake projects that steal crypto, it isn’t. The morphable character of crypto tokens will confound cookie-cutter application of the regulated security definition.
Innovations require a rethinking of federal securities law. The SEC was 10 years late to the game on delivering financial statements electronically. It was similarly behind the curve in allowing CEOs to share company information over social media. It shouldn’t make the same mistake with crypto.
Mr. Verret is an associate professor of law at Antonin Scalia Law School and a former member of the SEC’s Investor Advisory Committee.
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Appeared in the August 3, 2022, print edition.
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