SEC Commissioner Hester M. Peirce gave a speech on February 8th at the University of Missouri School of Law. The tile of the speech was: “Regulation: A View from Inside the Machine”.
A review of the most important points (scroll to the end for a summary):
- “Any views expressed are my own and do not necessarily represent those of the Securities and Exchange Commission or my fellow Commissioners”.
- “Entrepreneurship and innovation do not have the happiest of relationships with regulation. Entrepreneurs trying to start something new are often much more focused on that new thing than on how it fits into a regulator’s dog-eared rulebook. Regulators, for their part, tend to be skeptical of change because its consequences are difficult to foresee and figuring out how it fits into existing regulatory frameworks is difficult”.
- “Technological progress in the financial industry offers the same mix of hope, promise, and risk that technological progress in other parts of our society offers. As regulators, therefore, we must allow innovation to proceed, even as we put in reasonable safeguards and watch for unanticipated consequences”.
- “The agency’s opportunity to rethink its approach to innovation also arises out of a decade of technological development related to blockchain and cryptocurrencies. This area has challenged many regulators around the world, and the SEC is certainly no exception. We, along with other regulators, are asking how existing rules apply in this space and whether a new regulatory framework would work better. If we act appropriately, we can enable innovation on this new frontier to proceed without compromising the objectives of our securities laws—protecting investors, facilitating capital formation, and ensuring fair, orderly, and efficient markets”.
- “One of the things that makes regulating in this space challenging is that its very essence is decentralization. Decentralization is nothing new; it is at the root of our economic system; free markets draw on the talents and knowledge of people all across society to produce what society needs”.
- “Blockchain-based networks offer a new way of coordinating human action that does not fit as neatly within our securities framework. Satoshi Nakamoto, in the white paper that introduced bitcoin to the world, envisioned a “network [that] is robust in its unstructured simplicity.” Uncoordinated nodes work together toward a common end “with little coordination.” Other blockchain projects likewise seek to build networks that operate organically, without a central organizer. Some projects seek to facilitate various forms of authentication to replace traditional recordkeeping transactions or to allow individuals to interact without using trusted intermediaries. The objective of many of these blockchain projects is to build networks that run on diffuse contributions, rather than to create centralized entities that run networks. In the end, there may not be anyone steering the ship. Yet many of these projects begin in a centralized manner that looks about the same as any other start-up. A group of people get together to build something and they need to find investors to fund their efforts so they sell securities, sometimes called tokens. The SEC applies existing securities laws to these securities offerings, which means that they must be conducted in accordance with the securities laws or under an exemption. When the tokens are not being sold as investment contracts, however, they are not securities at all. Tokens sold for use in a functioning network, rather than as investment contracts, fall outside the definition of securities”.
- “Once “a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosure becomes less meaningful” and offers and sales of tokens are no longer subject to the securities laws”.
- “It is important for the Commission, in conjunction with Congress and its fellow regulators, to offer something more concrete (than enforcement actions) and carefully considered”.
- “While the application of the Howey test seems generally to make sense in this space, we need to tread carefully. Token offerings do not always map perfectly onto traditional securities offerings”.
- “Given the role that individuals play in some token environments, either through mining, providing development services, or other tasks, the SEC must take care not to cast the Howey net so wide that it swallows the “efforts of others” prong entirely”.
- “We might be able to draw clearer lines once we see more blockchain projects mature. Delay in drawing clear lines may actually allow more freedom for the technology to come into its own”.
- “Congress may resolve the ambiguities engendered by Howey by simply requiring that at least some digital assets be treated as a separate asset class. Congressmen Warren Davidson and Darren Soto recently introduced a bill in the House intended to amend the federal securities laws to do just that, provided that the token truly operated in a decentralized network. Such an approach would facilitate more tailored disclosure”.
- “There is also great interest in exchange-traded products based on bitcoin or other cryptocurrencies. As I have mentioned in the past, I am concerned that our approach with respect to such products borders on merit-based regulation, which means that we are substituting our own judgment for that of potential investors in these products. We rightfully fault investors for jumping blindly at anything labeled crypto, but at times we seem to be equally impulsive in running away from anything labeled crypto. We owe it to investors to be careful, but we also owe it to them not to define their investment universe with our preferences”.
- “I am asking for help on getting the regulations right so that innovators and entrepreneurs can spend their time and attention on making better products, providing better services, and revolutionizing the way we interact with one another”.
Summary: In my opinion, this speech makes it clear that there is determination to allow innovasion to proceed by rethinking the approach of the agency and by applying a new regulatory framework, if needed. However, it seems that there is an effort to tread lightly and carefully and perhaps allow for the technology to “come into its own”. The importance of decentralization is vital and some networks work without a central organizer. Moreover, when tokens are not being sold as investment contracts, they are not securities. Tokens sold for use in a functioning network, rather than as investment contracts, fall outside the definition of securities. At the same time, when a network becomes truly decentralized, it is no longer subject to the securities laws. Last but not least, the Congress has an important role to play and can offer more clarity by requiring that at least some digital assets be treated as a separate asset class.
What does this mean for XRP? By applying the commissioner’s statements on XRP, then it is surely NOT a security. The XRP network is not being run by a central entity. Only 6% of the validators are being run by Ripple while only 27% of the default UNL.
At the same time, there are many entities building/using the XRP network and the coins are being used in a functioning network, they are not investment contracts.
Despite the fact that this speech by the Commissioner was quite bullish, we must not forget that these are her personal views and the whole security issue will not be over until the fat lady sings, or in this case until the SEC or the Congress act.
Disclosure: I am not a lawyer nor a securities expert. I have invested in XRP. These are my personal views and not investment advice.