a16z: In the new era of encryption, what should the SEC do?

Author: Scott Walker, Bill Hinman

Compiled by: Luffy, Foresight News

As technology continues to evolve, the U.S. Securities and Exchange Commission (SEC) must also keep pace with the times. This is particularly evident in the cryptocurrency space. New leadership, along with the newly formed Cryptocurrency Task Force, provides the agency with an opportunity to take concrete action and adapt.

The time for action is now: the cryptocurrency market has grown in size and complexity to the point where the SEC’s previous misguided approach of relying solely on enforcement and neglecting regulation is in need of an update. As professional investment services begin to get involved in this emerging industry, there is no other way to advance the market, encourage innovation and protect investors. The principles that underpin relevant securities laws – information disclosure, fraud prevention and market integrity – should remain sacrosanct. However, applying these principles in a way that reflects the unique characteristics of crypto-assets will require targeted regulatory changes.

This article proposes immediate and easy-to-implement adjustments that the SEC should take to develop applicable regulatory rules without sacrificing measures to support innovation and investor protection. While legislation is necessary to clarify crypto asset classification and secondary market regulation, these initiatives will bring immediate benefits to the market.

1. Provide explanatory guidance on “airdrops” and other incentive-based

rewards

The SEC should provide interpretive guidance on how blockchain projects can distribute cryptoassets to participants without being deemed an offering of securities. These distributions are often called "airdrops" or "incentives," and blockchain projects typically do so for free or for a minimal fee, often as a reward for early access to a particular network or ecosystem. Such distribution is a key means for blockchain projects to build communities and gradually achieve decentralization, whereby they distribute ownership and control of the project to users.

This decentralization process has many benefits. Decentralization protects investors from the risks often associated with securities and centralized control and facilitates the growth of the network, thereby increasing its value. If the SEC can provide guidance on distribution matters, it could curb the trend of airdrops being made only to non-U.S. persons. This trend effectively transfers ownership of U.S.-developed blockchain technology overseas, effectively creating windfalls for non-Americans at the expense of U.S. investors and developers.

Specific methods:

• Establish Eligibility Criteria: Establish basic standards for cryptoassets that are exempt from being treated as investment contracts (subject to securities laws) for purposes of airdrops and incentive-based reward distributions. For example, cryptoassets whose market value derives primarily from the programmatic operation of any distributed ledger or similar technology, or from any executable software deployed on a distributed ledger or similar technology, should qualify if they do not fall within other security classes. class distribution.

2. Modify crowdfunding rules to regulate exempted offerings

The SEC should revise its crowdfunding rules to more effectively regulate exempt offerings of crypto-assets.

The current restrictions on funding size and investor participation in crowdfunding campaigns do not suit crypto startups, as these businesses often need to distribute crypto assets more widely to form sufficient user scale and network for their platform, application or protocol effect.

Specific methods:

• Raise fundraising limit: Increase the maximum amount that can be raised through crowdfunding to a level consistent with the needs of the business (e.g., up to $75 million or a percentage of the entire network, depending on the depth of disclosure).
• Exempt Offerings: Allow crypto projects to rely on exemptions similar to Regulation D while using crowdfunding platforms to reach a wider range of investors (rather than just targeting accredited investors).
• Protect investors: Put in place appropriate safeguards, such as setting individual investment caps (similar to what is currently done under Regulation A+) and establishing detailed disclosure requirements covering material information relevant to crypto businesses. (For example, while offering disclosures may typically address matters such as directors, compensation and shareholding details, disclosures surrounding the underlying blockchain, governance and consensus mechanisms may be more important to crypto-asset investors.) Targeting crypto-asset investments Tailoring these requirements to investors ensures they are fully informed and protected from fraud.

These changes will allow early-stage crypto projects to reach a broad base of investors, while maintaining transparency and enabling unambiguous investment opportunities.

3. Allow broker-dealers to engage in crypto-asset and securities

business

The current regulatory environment limits substantial participation by traditional broker-dealers in the crypto space, primarily because it requires brokers to obtain separate approvals when trading crypto assets and imposes more stringent requirements on broker-dealers wishing to custody crypto assets. Strict supervision.

These restrictions create unnecessary barriers to market participation and liquidity. Allowing broker-dealers to facilitate transactions in securities cryptoassets as well as non-security cryptoassets will enhance market functionality, investor access, and investor protection. On today’s crypto trading platforms, crypto assets that are not securities (such as Bitcoin, Ethereum) and crypto assets that the SEC may determine to be subject to securities laws can be traded seamlessly.

Specific methods:

• Enable registration mechanisms: Establish a clear registration path for broker-dealers to register to engage in (and custody) crypto-assets (both securities and non-securities), with specific requirements based on the nature of those assets.
• Strengthen the regulatory framework: Establish a supervisory mechanism to ensure compliance with anti-money laundering (AML) and KYC regulations and maintain market integrity.
• Working with industry: Working with the Financial Industry Regulatory Authority (FINRA) to issue joint guidance to address operational risks unique to crypto-assets.

This approach will promote a more secure and efficient market, allowing broker-dealers to bring their expertise in best execution, compliance and custody to the crypto market.

4. Provide custody and settlement guidance

Custody and settlement remain key barriers to institutional adoption of crypto assets. The unclear regulatory approach and accounting rules prevent traditional financial institutions from entering the custody market. This means that many investors cannot benefit from professional asset custody services and can only invest and arrange their own custody solutions.

Specific methods:

• Introduce custody guidance: Provide guidance on custody rules under the Investment Advisers Act, clarifying how investment advisers can custody crypto assets and ensure that adequate safeguards such as multi-signature wallets and secure offline storage are in place. This should also include guidance on staking of idle assets for cryptoassets managed by investment advisers and voting on governance decisions.
• Set settlement standards: Develop specific guidance for settlement of crypto trades, including timing, verification processes, and error resolution mechanisms.
• Establish a technology-neutral framework that allows for the flexibility to adopt innovative hosting solutions that meet regulatory standards without imposing specific technology requirements.
• Correct accounting: Repeal SEC Staff Accounting Bulletin No. 121 (SAB 121) so that accounting for custody digital assets reflects the actual status of the custody arrangement rather than assuming the existence of a liability. As background information, SAB 121 provides that “to the extent that a company is responsible for protecting cryptoassets held by a platform… the company shall present a liability on its balance sheet to reflect its obligation to protect cryptoassets held for users of the platform.” , corresponding to an asset at the same time. The overall effect of SAB 121 is to place custodial crypto assets on the custodian’s balance sheet, a practice that goes against the traditional accounting treatment of custodial assets. Therefore, unlike a typical custody arrangement, if the custodian becomes insolvent, this accounting treatment may result in the custodian crypto assets being included in the custodian's bankruptcy estate. Worst of all, SAB 121 lacks legitimacy. The Government Accountability Office found that it was actually a rule that should be submitted for congressional review under the Congressional Review Act, and in May 2024, the House and Senate issued a joint resolution not to approve SAB 121, but that resolution was blocked President Deng vetoed it.

This clarity will provide a foundation for institutional confidence, allowing large players to enter the market, while enhancing market stability and competition among service providers. In addition, investors, whether retail or institutional, will receive the protection associated with professional, regulated asset management services.

5. Reform exchange-traded open-end index fund (ETP) standards

The SEC should adopt reform measures for exchange-traded open-end index funds (ETPs) to promote financial innovation. The proposals are intended to provide wider market access to investors and custodians accustomed to managing ETP portfolios.

Specific methods:

• Reinstate market size testing: The SEC’s reliance on the “Winklevoss Test” for market monitoring protocols has delayed the approval of Bitcoin and other cryptocurrency ETPs. The test requires that, for a national stock exchange like the New York Stock Exchange (NYSE) or NASDAQ (NASDAQ), to trade a commodity-based ETP, the listing exchange must be associated with the commodity or its derivatives. "Regulated markets of significant scale" sign monitoring agreements. Given that the SEC does not consider crypto trading platforms to be “regulated markets,” this effectively means that ETPs are only suitable for cryptoassets that have futures markets (regulated by the Commodity Futures Trading Commission) that allow for a high degree of price discovery predictions for the underlying commodity. This ignores the significant scale and transparency of the current crypto market. More importantly, it creates an arbitrary distinction between the criteria applicable to cryptocurrency ETP listing applications and all other commodity-based listing applications. Therefore, we recommend reverting to historical testing standards for markets of significant size: only requiring commodity futures markets to have sufficient liquidity and price integrity to support ETP products. This adjustment will align the approval standards for crypto ETPs with those for other asset ETPs.
• Enable physical settlement: Allow crypto ETPs to be settled directly with underlying assets. This will lead to better fund tracking, lower costs, greater price transparency and less reliance on derivatives.
• Apply custody standards: Enforce strict custody standards on physically settled transactions to reduce the risk of theft or loss. In addition, pledge options are provided for ETP's idle assets.

6. Implement 15c2-11 certification for Alternative Trading System (ATS)

listings

In a decentralized environment, where the issuer of a cryptoasset may no longer play a significant ongoing role, the question arises as to who is responsible for providing accurate disclosures about that asset. Fortunately, there is a similarly helpful rule in the traditional securities markets, Exchange Act Rule 15c2-11, which allows broker-dealers to trade a security if, among other conditions, investors have access to the security. Latest information on securities.

Extending this principle to the cryptocurrency market, the SEC could allow regulated crypto trading platforms (including exchanges and brokers) to trade any asset whose platform can provide investors with accurate, up-to-date information. The result will be increased liquidity for such assets in SEC-regulated markets while ensuring investors have the ability to make informed decisions. Two obvious benefits this brings are that pairs of digital assets (where one asset is a security and the other is not) can be traded on SEC-regulated markets, and it suppresses incentives for trading platforms to operate overseas.

Specific methods:

• Simplified certification process: Establish a streamlined 15c2-11 certification process for cryptoassets listed on alternative trading system (ATS) platforms, providing mandatory disclosures about the asset’s design, purpose, functionality and risks.
• Adopt due diligence standards: Require exchanges or ATS operators to conduct due diligence on cryptoassets, including verifying issuer identity and important feature and functionality information.
• Clear disclosure requirements: Mandate regular updates to ensure investors receive timely and accurate information. In addition, clarify when due to decentralization, an issuer’s reports are no longer of reference value to potential purchasers, and reporting is no longer required.

This framework will promote transparency and market integrity while allowing innovation to flourish in a regulated environment.

in conclusion

The SEC is at a critical juncture in determining the future of crypto asset regulation. The newly formed Cryptocurrency Task Force signals the committee’s intention to change course from its previous iteration. By taking the critical steps listed above now, the SEC can begin to shift away from its controversial enforcement-focused model of the past and add much-needed regulatory guidance and practical solutions for investors, custodians, and financial intermediaries. This will better balance protecting investors with promoting capital formation and innovation.

The proposed changes above will reduce uncertainty and support financial innovation in the crypto space. Through these adjustments, the SEC can regain its mission and reposition itself as a forward-looking regulator ensuring that U.S. markets remain competitive while protecting the public interest. The long-term future of the U.S. crypto industry may require Congress to provide a comprehensive and applicable regulatory framework. However, until such a framework is in place, the steps outlined in this article are a pathway towards appropriate regulation.