Reassessing Crypto Regulation: Moving Beyond Decentralisation Metrics

This article critiques the current framework for crypto regulation that relies on decentralisation to delineate securities from cryptoassets. It discusses the implications of this approach and suggests a better distinction based on the intrinsic nature of assets rather than network decentralisation. Potential confusion from fluctuating decentralisation and how this may hinder clarity in regulation are highlighted alongside a call for a more effective regulatory framework.

The current challenge for policymakers in crypto regulation revolves around distinguishing securities from cryptoassets. A prevalent notion in Congress and at the Securities and Exchange Commission (SEC) is that the level of decentralization in a blockchain network signifies this distinction. When a network enjoys sufficient decentralization, it is perceived to transition from securities oversight to crypto-specific regulation, although this framework may warrant re-evaluation.

Proponents of the decentralization model argue that a lack of control indicates that no party holds responsibility for SEC registration. Investors in decentralized projects typically cannot rely on the efforts of others, therefore, these assets might not meet the criteria of an “investment contract” established by the US Supreme Court in the 1946 case SEC v. W.J. Howey Co. Gary Gensler, former SEC chair, has indicated that most cryptoassets qualify as securities, thereby focusing regulatory assessments on the decentralization question. Notably, the Bitcoin network is often cited as sufficiently decentralised, while most other protocols have struggled to meet this standard.

There exists considerable disagreement within the crypto industry regarding the SEC’s interpretation of decentralization as it pertains to specific assets. However, federal courts have made little headway on these issues. This stagnation arises because both decentralization and control are nuanced and subjective, requiring detailed factual assessment, which can lead to varying interpretations.

A parallel exists in the securities law realm concerning whether a seller is affiliated with an issuer. This can significantly impact the seller’s liability and restrictions in the market. Generally, control is determined by ownership levels, where exceeding a 20% stake typically categorises the holder as an affiliate. Subtle distinctions arise at lower ownership percentages, highlighting the complexities in defining control and affiliation.

Historically, the crypto industry engaged with decentralization in legal arguments, but the current climate suggests a potentially more straightforward division between securities and non-securities through statutory or regulatory frameworks without dependency on the Howey test. There are four key reasons to reconsider reliance on decentralization: First, centralisation is not inherently indicative of a security, as demonstrated by non-financial products like the iPhone. Second, the challenge in definitively ascertaining decentralisation advocates against its use as a criteria. Networks can experience shifts in decentralisation, adding another layer of potential confusion regarding a cryptoasset’s status. Lastly, a focus solely on decentralisation excludes assets designed to remain centralised, which may have legitimate reasons for their structure.

Instead, a preferable framework might involve assessing the intrinsic nature of the asset itself rather than the underlying network. Traditional equities and debt instruments embody legal and contractual claims on specific business entities or government revenues, which cryptoassets like Bitcoin and Ethereum do not. As a result, the SEC’s existing disclosure requirements lack applicability to most cryptoassets since they do not represent ownership claims requiring examination.

Moreover, regulatory frameworks for securities consider the implications of business capital access, leading to concerns over market stability. This is less vital in the context of speculative crypto trading. Although industry stakeholders seek to monitor manipulative practices in cryptocurrency markets, the SEC does not hold exclusive authority in preventing such activities.

The principle of predictability favours a regulatory approach based on the nature of the asset rather than its decentralisation level. This method streamlines identification of whether an asset constitutes a claim on a business, ultimately fostering a more conducive environment for crypto industry innovation.