Regulation
SEC oversight of cryptocurrencies risks regulating public digital systems
During the Cold War, the U.S. government supported the development of an information-sharing network, or ARPANET, intended to withstand a nuclear attack.
Other computer networks formed, and in 1983 the common communications protocol TCP/IP was adopted, giving rise to the Internet. Today’s Internet is a public and open digital infrastructure that we all expect to have the right to access and use.
Early in my career, when I was a financial regulator at the SEC reviewing policy changes at the New York Stock Exchange or at the Federal Reserve overseeing banks like JP Morgan Chase, I did not consider the Internet to be part of my responsibilities as a financial regulator. I certainly have not reviewed the TCP/IP standard as part of a regulatory review of online banking.
However, I see signs from the Securities and Exchange Commission, tasked by Congress with regulating securities, that they deem any public digital infrastructure in the blockchain ecosystem to fall under their financial regulatory authority.
The SEC is said to be investigating whether Ethereum’s native token, ETH, is a security and therefore subject to the requirements of the U.S. Securities Act of 1930 and the exchange listing requirements of the U.S. Securities Exchange Act of 1934.
And earlier this month, the SEC sent a Well’s Notice announcing its intention to investigate Uniswap, which is one of the most open and decentralized automated protocols in the crypto ecosystem.
These actions along with those of the SEC grievance against Coinbase, arguing that decentralized blockchain projects like Solana, Cardano, Filecoin, and NEAR are securities and, therefore, not decentralized, indicate lack of clarity as to whether truly decentralized protocols and the decentralized base-level blockchains in which they are built, such as Ethereum, is a public digital infrastructure that will form the next iteration of the Internet, which many call Web3.
Even more concerning is the fact that the SEC’s misunderstanding of public digital infrastructure is rapidly spreading to US courts. The most recent from U.S. District Court Judge Failla dominant in SEC v. Coinbase has shown indications of agreement with the SEC’s “ecosystem” argument, which states that an underlying blockchain, blockchain participants, and other assets in the ecosystem make tokens on that blockchain more valuable, thus making them securities.
This is a slippery slope because it provides a path for the SEC to regulate the entire ecosystem, well beyond simply stating that tokens are securities. The SEC’s statement also suggests a fundamental misunderstanding about the blockchain ecosystem.
For example, if the ecosystem argument were applied to traditional financial activities, such as trading securities on the New York Stock Exchange, then the SEC would likely regulate the activities of traders who gather on the trading floor, the same building as the New York Stock Exchange. New York. , and also the roads that traders take to reach the Stock Exchange.
There is no limiting principle in declaring what is in the ecosystem – a cautionary principle that Failla emphasized in oral arguments but largely ignored in his ruling.
If the behaviors of participants in that ecosystem are critical to understanding whether the core of the ecosystem is an unregulated security, then the SEC’s ecosystem theory extends its reach to whatever portion of the ecosystem it wishes.
Courts and government agencies must understand that truly decentralized protocols, including underlying blockchains, are public digital infrastructures that should serve the public good as the Internet does today.
Research is starting to support this important concept of decentralized protocols as public digital infrastructure that forms part of the foundation of our digital economy. The crypto ecosystem supports much more than just financial activities, including digital identity, means of social communication, game, Data store, cell phone coverageand public services.
Barring a settlement or change in leadership at the SEC, the SEC v. Coinbase case appears headed for a long road of litigation, headed to the courts of appeals (and perhaps even the Supreme Court).
But this case raises much more than the question of what “security” is. It goes to the heart of the SEC’s regulatory power over the entire digital economy and the public infrastructure that supports it.
This article does not necessarily reflect the views of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
About the author
Linda Jeng is the founder and CEO of Digital Self Labs and a visiting financial technology scientist at Georgetown Law. He was a financial regulator before working in blockchain startups.
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