By: Jai Massari (Lightspark/Harvard Law School Forum on Corporate Governance)
FTX’s collapse reiterates the need for comprehensive U.S. regulation of crypto markets. This regulation must have a solid legal foundation, a key pillar of which is a workable framework to distinguish cryptoassets[1] that are securities from those that are not. A new paper provides this framework, by showing why fungible cryptoassets are not themselves securities under existing U.S. federal securities laws. But also why ICOs and similar token sales should be regulated as securities offerings.
In 2014 the sponsors of the Ethereum Network sold 60 million ether tokens to fund the development of the network, which launched a year later. Because of similarities with a traditional common stock IPO, the ether “initial coin offering,” or ICO, raised a fundamental question: are cryptoassets securities under U.S. federal securities laws? The answer to this question, which we have been debating ever since, determines not only whether and how cryptoassets can be sold to the public but also whether we must hold and trade them under the existing rules and market structure developed over the past 80 years for securities.
The Securities and Exchange Commission’s primary theory on whether a cryptoasset is a security appears to be based upon whether the blockchain project associated with a cryptoasset is, at any point in time, “sufficiently decentralized.”[2] If so, the cryptoasset is not a security. This theory was first proposed by the SEC staff in 2018 to address ICOs, which were then all the rage, and was followed by more detailed staff guidance in 2019. But the theory has not aged well. It is impractical—if not impossible—to apply to today’s real life blockchain projects. It is not supported by existing judicial precedent, including the now crypto-famous Howey Supreme Court case.[3] And it has resulted in market distortions that harm both market participants and long-term innovation in the crypto industry.
An intriguing new paper, The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities,[4] points us to the right path. The paper analyzes the relevant caselaw and concludes there is scant legal basis to treat fungible cryptoassets as securities, and it sets out analytical approach that is far more satisfying. The paper separates capital raising transactions by blockchain project sponsors or other insiders in which a cryptoasset may be sold—which are typically securities transactions—from the treatment of the cryptoasset, which is not a security. This analytical framework addresses the now apparent challenges created by the SEC staff’s approach and appropriately focuses the SEC’s regulatory jurisdiction on capital raising transactions.
The paper’s approach is the right one and should be taken on both by the US Congress as it considers legislation to regulate the crypto industry and by courts as they consider high-stakes cases that hinge on the securities law treatment cryptoassets. Doing so will avoid the flaws of the SEC’s well-intended but flawed current approach. And, together with legislative initiatives to regulate crypto markets and intermediaries, it will better protect market participants and more responsibly support innovation…
