Right now, the SEC appears to be trying its level best to lose the respect of the crypto industry. Surprise! You’re a Security! The SEC is regulating crypto by enforcement. And it feels arbitrary.
You know how it goes; you want the best cost basis, so you wait for the next sale. But before you know it, the chance has come and gone.
That's why I wanted to put a little note up here to tell you about the biggest sale of the year on DAS tickets. This is your chance!
Just use code NYC250 at checkout for $250 off, and you're set!
“If you destroy a free market you create a black market. If you make 10,000 regulations you destroy all respect for the law.”
— Winston Churchill
Regulation Anarchy in Crypto
One of the top highlights of my 20-year trading career was the day I hacked the annual compliance exam.
This was in the early ‘aughts when internet connections and compliance exams were still relatively new to trading desks, so my hack was not particularly sophisticated: I somehow figured out that if I copy/pasted the exam questions into a word doc, it would show me the answers.
Sharing that tip with a few colleagues made me unusually popular over the next while as the compliance exams kept multiplying: for KYC, AML, money laundering … all subjects completely unrelated to what happens on a trading desk.
But I must have shared my hack with a few too many people: The loophole was closed by the time the next set of exams came around. (Returning me to slightly below-average popularity.)
Still, it was nice while it lasted. And no regrets: Those exams deserved to be cheated on.
The content was irrelevant to us: its only purpose was so that the next time someone did something stupid, management could say to regulators: Hey, I know we messed up, but look how hard we’re trying! We make them do hours and hours of pointless training!
The downside to hours and hours of pointless training, however, is that it made compliance a bit of a joke.
When you make people adhere to arbitrary rules, they lose respect for those rules — as well as the authority imposing them.
That doesn’t have any real consequences on a trading floor (we didn’t have any money to launder or inside-information to act on, even if we wanted to).
But it does matter when the rules and regulations are being set for a whole new asset class.
Right now, the SEC appears to be trying its level best to lose the respect of the crypto industry.
Surprise! You’re a Security!
The SEC is regulating crypto by enforcement. And it feels arbitrary.
Instead of writing a new set of rules as to what makes a digital asset a security, we have to parse every complaint they file to see how the 76-year-old Howey Test is being applied.
The good news is that we have a lot of new information to go on: In last week’s complaint against three Coinbase employees accused of insider trading, the SEC spells out its case for why each of nine crypto tokens the employees traded are securities under Howey.
The bad news is that their reasoning is so broad that almost anything could be considered a security.
And maybe that’s right; maybe every digital asset outside of BTC and ETH really is a security.
But their method of letting us know that still feels arbitrary:
Unlucky: You’re a security because someone happened to front run your Coinbase listing.
Lucky: You’re already listed on Coinbase, so not a security!
Regulation should have less to do with luck and more to do with logic.
But this is where we are, so let’s see what we’ve learned from the latest SEC complaint. (I’ve already used half my word count on that silly trading-desk story, so I’ll be brief!)
Reading the Tea Leaves
Below, in italics, are some lowlights from the SEC’s complaint, followed by my personal takeaways.
Note that everything I know about the law I learned from TV, so this is the furthest thing imaginable from legal advice. But I’m hoping my take will give you a flavor for the current state of crypto regulation without having to read any SEC docs yourself.
On October 20, 2021, the same day as a Coinbase listing announcement, Nikhil messaged Ishan’s foreign phone a dollar sign and the eyes emoji: “$ 👀👀.
Takeaway: Emojis can and will be used against you in a court of law.
Each of the nine companies invited people to invest on the promise that it would expend future efforts to improve the value of their investment.
Takeaway: Protocols are companies? The Howey Test is meant to determine whether an offering is an investment contract. But if protocols are companies, what do we need Howey for? Everything’s a security.
Investors in RLY had a reasonable expectation of profits based on the efforts of others…Rally stated: “Tokenomics play a fundamentally important role in the success or failure of a crypto project.”
Takeaway: Anything with tokenomics (i.e., everything) is well on its way to being a security.
Purchasers of Flexacoin/Amp tokens invested in a common enterprise. In its November 2020 Amp white paper, Flexa explained that “participants stake Amp into pools that secure the network.”
Takeaway: Staking is not a loophole through which protocols can return earnings to token holders.
Amp investors also share a common interest with Flexa’s management team. Flexa explained…that 20% of the total percentage of Flexacoin was reserved for the Founding Team.
Takeaway: Any distribution to team members fulfills the common-enterprise clause of Howey.
The May 2019 Flexacoin white paper devoted an entire section to “Our team.”
Takeaway: If you still have a “team,” you’re probably a security.
Flexa stated [in a Medium post] that “we take our responsibility to the Flexa community very seriously”…Flexa stated in a YouTube video, “we built this network from the ground up” and “we’ve created an open network.”
Takeaway: The SEC will scour YouTube, Medium and Twitter for mentions of “we.”
DerivaDEX claims on its website that the DDX token is a so-called “governance” token for DDX.
Takeaway: The use of quotation marks here suggests the SEC thinks governance tokens are about as real as the Loch Ness monster. You’re either a utility token or a security.
DerivaDEX has posted an audio recording featuring the CEO and the product lead discussing development plans that have no firm timeline.
Takeaway: The complaint refers to the CEO of DEX Labs (the development company) as if he’s the CEO of DerivaDex (the protocol). Iflabs CEOs are conflated with protocol CEOs, probably everything is a security.
All of the development plans that DerivaDEX has described depend entirely on the efforts of its management team and the affiliated entities.
Takeaway: Everything short of voting on pre-written code will be considered “efforts of others.”
XY noted: “Some folks just want to buy XYO Tokens to see if they can make a profit from trading.” XY claimed that was “not the intended purpose of an XYO token.”
Takeaway: Don’t acknowledge that a token could ever go up for any reason. Or even just accidentally.
Shortly before the ICO, XY provided a “Roadmap” with target dates for XY’s plans to develop the business.
Takeaway: Your protocol had better be fully functional, in no need of a roadmap, before a token is tradeable.
XY has obtained listings for XYO on multiple trading platforms and publicized those listings via social media channels.
Takeaway: Don’t even acknowledge your token is tradeable!
Rari has continued to use funds raised by selling RGT to pay Rari’s management team and developers.
Takeaway: All contributors should be volunteers, I guess?
Rari explained that 70% of Rari’s profits would be used to “burn” and buyback RGT tokens.
Takeaway: Buybacks are a form of capital return. (Same as TradFi.)
The Rari CEO stated that the goal … is to “provide exponential returns to RGT holders … Rari stated on their homepage: “The more money you make, the more money we make” … Rari has often referred to participation in the RGT buying programs as an “investment” … and RGT holders as “shareholders.”
Takeaway: Ok, fine. That one’s definitely a security!
The SEC has some legitimate gripes here. Some things really are securities by any reasonable definition.
But applying 76-year-old case law, originally meant for orange groves, on an ad-hoc basis? That’s not the way to regulate a whole new asset class.
Let’s do better before crypto’s lightly regulated free market turns into an unregulated black market.
How soon will the Fed green-light the markets? These 7 charts can help us figure it out (Thread) — Blockworks
We get the first estimate of second quarter G.D.P. on Thursday, and it's quite likely that it will show the second-straight contraction. That is a common definition of a recession, but it is NOT the official one. (Thread) — Ben Casselman
SushiXSwap is live and ready for the multi-chain future. (Thread) — Blockworks Research
It’s crazy how far we’ve come (Infographic) — Greg
The transfer of hundreds of billions of dollars from Boomers to digitally native Millennials & Zoomers will serve as a demographic tailwind for digital assets over the coming decade. — Will Clemente
