It’s Time for a Purpose-Built Disclosure Framework for Crypto

The crypto market participants increasingly find themselves in the cross hairs of elected officials and regulators who are concerned that investors do not understand the assets they are investing in.

Regulators and market participants can address these risks and help restore confidence in crypto assets by coming together to create a standardized disclosure framework that better inform crypto investors about opportunities and risks.

This op-ed is part of CoinDesk's State of Crypto Week, sponsored by Chainalysis. Rob Krugman is the chief digital officer at Broadridge.

Experienced crypto traders rely on a series of dedicated metrics to assess the viability and attractiveness of crypto assets. For example, “network performance” measures how the platform supporting an individual crypto asset works and how fast the platform processes transactions. “Tokenomics” measures things like the initial supply of a cryptocurrency, details on how that supply can change, and other variables that help determine a token’s value.

Without looking at these and other factors unique to crypto, it’s difficult or even impossible to understand and place a valuation on a crypto asset.

However, a new survey from Broadridge surveyed 2,000 crypto market participants in the United States, U.K. and Canada and found the majority use conventional financial metrics when determining what to invest in. This means trying to apply things like cash flows to assess a cryptocurrency.

Nearly half of respondents said they look at the holdings of a crypto project’s management team — like the breakdown of how many tokens go to a project’s founding team versus its treasury — when making financial decisions. But still, only about 28% of investors consider network performance and only 16% look at tokenomics.

The findings suggest that many investors don’t fully appreciate the importance of crypto-native factors critical to understanding crypto assets. The results also point to the more troubling possibility that some current investors may be making decisions based on an incomplete assessment of the risk-return profiles of particular crypto assets.

These conclusions make it more apparent than ever that crypto markets need a disclosure framework to gives investors a better sense of what they’re buying.

No one would suggest that a cryptocurrency functions like a traditional security. And so, a disclosure regime for crypto likely needs to account for crypto-native metrics like network performance and tokenomics and address the key differences between traditional and crypto asset classes.

Moreover, unlike most traditional assets, cryptocurrencies often do not have identifiable or centralized parties responsible for their operations — meaning the parties typically responsible for making regulatory disclosures.

See also: Privacy Isn't Just an Edge Case for Crypto | Opinion

In light of that regulators need to be flexible in their approach towards disclosure recognizing that this asset class does not fit into existing models and take a page from what the U.S. Securities and Exchange Commission (SEC) previously did for "asset backed securities" or how the Commodities Futures Trading Commission (CFTC) treats commodities, by creating a fit-for-purpose disclosure framework.

What exactly would be included in a fit-for-purpose disclosure framework? To answer that question, regulators and the industry can start by translating existing disclosure requirements into crypto-appropriate versions. (Identifying holes and questions that need to be answered)

Broadridge recently went through exactly that exercise, tracking how and where current disclosure rules could apply to crypto and identifying information that would likely provide investors with the best picture of a project’s risks-and-rewards. That painstaking process revealed even the most basic information, such as how to describe  an asset, will differ for crypto. That means not only providing detailed breakdowns of a token, but also of the protocol or app where it resides and its supporting blockchain.

Investors will have to be informed about the consensus mechanism (i.e., proof-of-work or proof-of stake) and the related rewards for that activity (e.g., mining/validation rewards), the token’s governance mechanism  and provide a description of the audit process for the relevant code.

The disclosure will have to include an explanation about the smart contract or rights conferred by the crypto token (e.g., voting, dividend, or other economic rights), information relating to the revenue generated by token and operational costs (gas fees, payments to miners, etc.), and other aspects of the underlying tokenomics in plain easy to understand language.

As regulators create a new framework, the industry shouldn’t merely replicate traditional disclosure practices. The innovations at the heart of crypto create opportunities to transform and improve the ways in which investors and the public receive key information. For crypto assets, the party providing the disclosure could send important information directly to new channels like digital wallets, allowing investors to easily receive disclosures contemporaneous with them being provided to regulators.

See also: IRS Proposed Rule on Digital Asset Broker Reporting Could Kill Crypto | Opinion

Disclosures pushed to investors could have key high-level details displayed in a clear, concise, summarized format with links to more comprehensive information. Because these electronic communications could also contain mechanisms that allow investors to vote on key issues related to the crypto token, the new regime could actually transform disclosure from a one-way communication channel into a new venue for enhanced investor engagement.

Rolling out a universal disclosure policy custom built for crypto assets will help restore investor confidence after a volatile period and unlock the potentially transformative power of crypto.