Trump appointed SEC Commissioner Hester Peirce has become the first senior official at the SEC to thoroughly address the role of SEC in the tokens and ICO space during a speech at the Medici Conference in Los Angeles.
That it isn’t Jay Clayton doing so indicates a changing tune, and that it is Peirce, a member of the Federalist Society, may well suggest an olive branch.
Starting with sandboxes, she made it somewhat clear it is unlikely SEC will have one. The regulator wants to keep a distance, seeing itself as a lifeguard or a policeman of sorts even though this area is very much voluntary contractual exchanges.
“On a beach, the lifeguard watches over what is happening, but she is not sitting with sandcastle builders monitoring their every design decision.
From her perch on the lifeguard stand, she can spot dangerous activity and intervene with a blow of the whistle or, if necessary, a direct intervention.
She always stands ready to answer questions about the rules of the beach. She puts up the red flag to warn of dangerous riptides or sharks.”
The most charitable reading of it is that they do not want to interfere with the creative or innovative process by sitting closely with entrepreneurs.
The least charitable reading of it is that SEC itself is scared of being an innovative regulator. Scared of SEC innovating itself, while overseeing other innovators doing so.
However, a lot more interesting is the admission that, as we have previously said, SEC has not actually done its homework. Which is fine, we’ve always maintained, we were there once too, so the acknowledgement is a welcomed first step.
“Technology’s promise is too great, however, for us to bury our heads in the sand. I am here today to ask you and others to help us learn more about the technology so that we are able to think about the regulatory obstacles that may stand in the way of crypto-technology’s ability to improve our lives. How can I, in a sense, be a better lifeguard?
I have much to learn, but I am an eager student.”
We have no doubt the economics graduate, who then went to Yale for her law degree, to move to SEC in 2000, to now also lecture at George Mason University, can be a great student even at the fine age of 46.
She is however very senior at the SEC, and indeed has decision making powers alongside the other four commissioners, so how well she learns does very much depend on how well her staff does their homework.
Jay Clayton has stated they have no coders at the SEC, only lawyers and economists. Which may mean they lack even the understanding of what open source code is or what a node is. That may change. Peirce says:
“The best path forward is for regulators to approach ICOs and tokens with intense curiosity. We must put in the effort to learn about these new technologies and employ the staff necessary to support our understanding.”
The speech itself provides few direct answers to some of the key questions. Primarily, is ethereum a security or not in the eyes of SEC?
The reason may be because that question is much broader than it looks to potentially account for a category of tokens that may have begun as an ICO but then turn into a currency or a commodity:
“Designating certain ICOs securities offerings does not end the inquiry once and for all. What, for example, are the coins once the environment is completed? Are they still securities, subject to all the regulations that follow securities into the secondary market? Or are they something else? A commodity? A currency? Something in the nature of a Chuck E. Cheese token? When do they change into something new? When the environment is minimally functional? What if its developers make substantial upgrades to its functionality such that the value of the coins increases with the increased access to the new functionality? These are tough questions that still need answers. They are questions that turn on facts and circumstances, but we should strive to provide some guidance.”
Defining minimally functional, or even functional, is indeed difficult. Yet so are many other legal concepts. Which is why ultimately the law falls back on this concept of the reasonable man, which is a conceptual tool to tap into common sense.
Would a reasonable man, some ordinary guy down the street with ordinary levels of intelligence, say Brave Browser is functional? Would he say Golem is functional? MakerDAO Dai? If PeepEth had been through an ICO or if Cryptokitties had been through an ICO, would he say those are functional?
We think the answer is yes, there’s a running network or a running dapp. On the other hand, Cardano for example, or Tron, are not functional because they do not yet have a running network.
What if that network is upgraded further? Here they seem to be thinking whether they should become a commodity once the network is out, or once the roadmap is complete.
Arguably however the roadmap never completes and this is where some tech expertise at the SEC would have been useful.
Most of these dapps or projects are open source code. Once the network is out, anyone can volunteer their time or perhaps get paid or sponsored by some business or company or spend some of their working time to work on the code and suggest improvements.
Someone might come along with a new idea. In bitcoin, for example, it has had a considerable upgrade in the form of the Lightning Network. There are some three companies working on it, each with their own version, but it’s the same protocol.
In ethereum, sharding would be a considerable upgrade and there too there are some three different teams working on it. Then there are completely different teams working on Plasma, Raiden, Dappchains and endlessly on.
The way to see this therefore is an open infrastructure where anyone can build it and anyone can build on top, just as anyone can fork it and create an identical network to it or one similar with some changes and do so very legally without infringing copyrights.
As such, the question of “what if its developers make substantial upgrades,” needs to be considerably refined, if it should apply at all.
Because there wouldn’t be an “its” developers. There would instead be perhaps thousands of developers across the globe dedicating an hour there, or maybe a month here, perhaps just a comma, or perhaps contribute some stupendous and impressive work while having nothing to do with the ICO itself.
We think therefore the question of when a token becomes a commodity should be addressed by only the question of when a network is functional.
Because once the network is functional, like bitcoin or ethereum or even Brave Browser, then there will be changes, there will be improvements, there will be bug fixes, but they would be done by a distributed global community of developers.
So you can’t really hold anyone responsible as you can’t say the network relies on anyone because anyone can just contribute to the code or fork the code. Making it a commons, an open space or open infrastructure.
The commissioner said they should provide guidance on the matter, and indeed they should clarify their view. They should specifically say whether ethereum is or is not a security or whether it is a commodity. They should further say the same regarding functional tokens running on top of eth, such as Brave Browser etc.
But falling short of such explicit statement, she does provide some general guidance in an important paragraph where she says:
“And then there are tokens or coins used in initial coin offerings, or ICOs. These look the most like securities. Their creator sells them as a means of raising funds.
In one potential example, the issuer may want to build an environment in which the coins can be used—potentially as a medium of exchange, potentially as a means of executing or tracking exchanges—and sells the coins before the environment is built.
The proceeds from the sales of tokens are used to build the system in which they will one day function. A coin that has no functionality at the time of sale will likely be cheaper to buy than one that offers entry into a fully realized environment.”
That last aspect is addressing the expectation of profit, but the important part here is a clear distinction of an Initial Coin Offering where money is handed over for a mere promise, and potentially a sale of tokens where there is a built and running environment.
We haven’t seen any ICOs of the latter kind, but of course you can buy different sorts of tokens in games for example, or on some phone apps you can buy emojis which are sort of tokens.
So it isn’t difficult to imagine there can be private investment from VCs for the network to be built and then tokens are sold once the network is up and running.
That also suggests that once the network is built, then it is not a security any longer. It would instead probably be a commodity of sorts that you buy and sell like gold.
How this would work exactly would probably be that you register the ICO with the SEC, then once the network is built you file with the SEC, and so CFTC takes jurisdiction.
In practical terms, it would probably more be the case entrepreneurs limit the token sale to rich individuals and banks only, then once the network is built the coins can trade publicly.
That brings us to another statement by the commissioner which deserves highlighting. She says:
“The law deserves respect, but technological progress should not be bound by the limits of the regulator’s lawyerly imagination.”
Laws are necessary and very much desirable, of course. Even in some ultra libertarian imagined societies, law does deserve respect and is even to be held as a sign of a civilized people.
But we would refine that to say good law deserves respect, not all laws. The previous discriminatory laws against blacks, for example, deserve no respect. Nor the discriminatory laws agains gays which in some places still stand. Nor the previous discriminatory laws against women who were denied the right to vote, or against everyone else but the rich who too were denied the right to vote.
Nor does the discriminatory securities act which exempts the rich and banks while closes the gates to all others deserve any respect.
Such law is barbaric and has no place in a civilized society for instead of putting meritocracy first it places aristocracy first.
That it still stands is probably because no one even knew of it or cared of it for if voters knew of this injustice, congress would have repealed it long ago as now it is not only the rich that can vote, but all of age can.
If there is to be an exception, the exception should be based on the amount raised, not based on wealth. And if this exception does not apply for amounts raised say up to $20 million, or more where each are limited to invest say $1,000 or $10,000, then the Securities Act deserves no respect.
That’s not to say SEC itself doesn’t, this is a matter for Congress as they make the law and they alone can change it, but SEC does have the ability to make the exemption by clarifying their stance.
That ability would be found by applying crowdfunding laws which Congress has passed precisely so as to make an exemption.
ICOs are very much crowdfundings, therefore if they’re raising say $20 million, then SEC should clarify that they should be exempted in line with the will of Congress.
For amounts above $20 million then it does become somewhat of a serious business, so there should be ways to keep them very much accountable and if they’re limited to VCs then it would still be an injustice of sorts, but a bearable one.
Limiting amounts raised below $20 million to only the rich and banks so that they can get even richer while we can’t, would however be unbearable for there would be no justification especially when plenty can raise such amounts through crowdfundings.
That’s perhaps something to be discussed in a new crypto website SEC says they are to launch. Usually in a democracy you expect matters to start with an open consultation, then guidance, but SEC seemingly considers itself a policeman even though these are not criminal matters, but civil and contractual voluntary matters where courts are usually hands off. So they’ve done it a bit backwards.
But late better than never, and with all that said we do welcome this opening of dialogue. We don’t see SEC as an adversary as they do have a role to play. Year long running ICOs that raise billions, like EOS for example, should certainly have considerable requirements.
But on the other hand a food app that wants to tokenize itself by raising only $14 million should not have to pay lawyers first some $5 million to comply with SEC.
Nor should ordinary people be limited from taking calculated risks where the amounts involved are small, like $20 million spread across 10,000 investors. So we repeat back the Commissioner’s closing words:
“My hope is that we can navigate these new waters collaboratively. The SEC’s role is not to hand out permission slips for innovation. Innovation happens—organically through private decisions and irrepressible human creativity.
We at the Commission have a role to play in protecting investors and market integrity by deterring and punishing fraud and setting clear rules.
As we sit atop our lifeguard’s stand and survey the beach, however, let’s not lose sight of the benefits new technology can provide in the area of capital formation, market efficiency, economic growth, and overall societal well-being. Thank you.”