Thesis: While regulation is important to protect investors, the SEC's approach to crypto regulation creates uncertainty that discourages innovation.
As a long-time crypto enthusiast and believer in individual liberty, I've closely observed the discussion around governing this new technology space. A recently shared dissenting opinion from two commissioners at the SEC (US Securities and Exchange Commission) is definitely worth diving into as nothing provides a clearer view into the machinations of the archaic regulatory institutions than direct comment from those involved.
Regulators face tricky questions around this innovation. Securities laws written decades ago don't neatly fit modern crypto. Without clear rules, are we encouraging a freewheeling digital Wild West? Or quashing the next Internet before it starts?
In the following sections, I'll objectively outline issues around the SEC's actions against a prominent crypto exchange - Shapeshift. I'll also consider alternative approaches and debates around balancing oversight with permissionless progress.
By understanding multiple viewpoints, my hope is we can have an informed discussion on this complex topic.
Background on ShapeShift and Securities
ShapeShift's business model from 2014-2021 involved operating an online platform that allowed users to directly exchange different cryptocurrencies without needing accounts. ShapeShift would hold inventories of various crypto assets and act as the direct counterparty for both buyers and sellers in transactions on its platform. By taking a small spread between the price it would buy and sell crypto assets at, ShapeShift was able to profit from facilitating these exchanges and provide the service to thousands of daily users.
The SEC defines what constitutes a security based on various securities laws and precedents. A key test used by the SEC is the Howey Test established by the 1946 Supreme Court case SEC v. W.J. Howey Co. This test defines an "investment contract" as a security if there is an investment of money in a common enterprise with profits derived primarily from the efforts of others.
The SEC considers some cryptocurrencies that meet this definition via their offer and initial token sale to be "investment contracts" and therefore securities under its regulations.
SEC enforcement action against ShapeShift
https://www.sec.gov/files/litigation/admin/2024/34-99676.pdf
The SEC's 2024 enforcement action against ShapeShift deserves significant criticism. By waiting nearly a decade after ShapeShift began operating its platform in 2014 to bring an enforcement case, regulators opened themselves up to valid questions around why it took so long to take action.
More concerning than the timing itself is that the SEC order provided no specifics on which of the 79 cryptocurrencies traded by ShapeShift between 2014 and 2021 were deemed securities requiring registration.
This lack of clarity in the SEC's decision has sparked an ongoing philosophical debate around the best approach for regulating novel digital assets like cryptocurrencies. Supporters of the SEC might argue that its case-by-case legal analysis of individual crypto offerings provides regulators the flexibility needed to assess new and complex financial instruments on their own merits.
However, this lack of upfront guidance creates regulatory uncertainty that threatens to chill innovation in the cryptocurrency industry. If entrepreneurs building applications and services involving crypto assets cannot understand which types might face an enforcement action years down the line, it could discourage many from embarking on new projects and developing this emerging technology sector.
Without clear rules to classify crypto assets, the risk of undertaking a project only to receive a surprise "cease and desist" order later looms large.
This threat of tardy and opaque enforcement actions, as exemplified by the ShapeShift case, may negatively impact the development of cryptocurrency technologies without necessarily providing clear benefits to investor protection. While securities regulations aim to safeguard the public, it might be argued that the SEC should strive to craft policies that balance these objectives with allowing room for innovation as markets evolve. Overly broad or ambiguous applications of securities laws run the risk of smothering promising new industries before they have a chance to truly develop and demonstrate their utility.
If implemented transparently and focused on bad actors rather than borderline businesses, a principles-based, case-by-case approach need not discourage innovation. However, the SEC will need to clarify its analysis and reasoning more fully to alleviate concerns raised by cases like the one against ShapeShift.
Alternative regulatory approaches
Examples of Clarity from Other Jurisdictions
Some regulators internationally have provided classification guidance that offers a degree of clarity for the industry. For example, many countries designate Bitcoin as a commodity rather than a security.
Several European Union agencies have published reports outlining their views on the legal status of different crypto assets.
Singapore and other Asian nations have developed tailored regulatory and licensing frameworks for certain market activities involving digital assets.
Potential Models for Increased SEC Transparency
There are also potential models the SEC could explore to increase transparency in its approach. Publishing an official regulatory primer outlining how it analyses various factors like those in the Howey Test could aid classification of novel assets.
The SEC might clarify the typical weight given to different factors in its case-by-case analysis. Publishing redacted versions of past enforcement orders could help illuminate the agency's reasoning. Early and meaningful engagement with industry during rulemaking processes may also help identify workable solutions.
The fact that Crypto companies only find out they've "broken the law" when the SEC drops an enforcement action on them is disingenuous at best and outright extortion at worst.
Conclusion
Overall, as digital assets and the services surrounding them continue to develop rapidly, regulators face difficult challenges in crafting policies that can adequately adapt. The SEC seems to be playing a very shady and downright underhanded game in the way it is treating US crypto entrepreneurs.
Both increased international coordination and meaningful engagement between agencies and the crypto industry will be important to achieve workable solutions.
I hope this essay provided useful insights into the complex issues at play. To continue the discussion, please share this analysis with others in the crypto community. Please consider subscribing to receive future examinations of trends in blockchain technology and digital currencies.
