How to Talk to Your Legislator About the Crypto Safe Harbor

Yesterday, Rep. Patrick McHenry (R-NC), the ranking member of the House Financial Services Committee, introduced a bill that would provide a “safe harbor” for crypto startups looking to raise capital through token sales. The bill is based on safe harbor rules laid out by U.S. Securities and Exchange Commissioner Hester Pierce, a longtime crypto ally.

The proposal is a nuanced attempt to square the circle at the heart of crypto network funding. The quandary goes something like this: If the token for a new network is classified as a security from the start, only institutional players and venture capitalists will be able to buy it. That makes it less likely that the network will have a truly decentralized user base or development community. On the other hand, you can’t give crypto carte blanche on securities regulation or you’ll wind up with rampant fraud, as we saw during the initial coin offering (ICO) boom in 2017.

David Z. Morris is CoinDesk’s chief insights columnist.

The Pierce/McHenry proposal would give new crypto startups three years to build and sell tokens without having them classified as securities. The goal would be to reach a level of “sufficient decentralization” during that window, allowing them to earn classification as a commodity – the conventional wisdom around bitcoin and ethereum – rather than a security. On the whole, it’s a proposal that seems very in tune with the way crypto networks grow.

But the proposal also includes a lot of the kinds of safeguards the SEC should want. In exchange for safe harbor, it requires projects to provide certain disclosures, including naming core team members. It also sets at least two key technical hurdles: Projects must have open-source code and be viewable with a block explorer. Those provisions would in themselves be huge anti-fraud measures, allowing projects to be fully community-vetted on ideas, execution and operations. Outright frauds like BitConnect or OneCoin would be unlikely to make it past the starting post.

After three years in this “safe harbor,” projects would have to evaluate their own progress toward decentralization and file a report with the SEC. If they fail to meet certain standards, such as development from outside of the core team, they then would have to register as a security within another three months. That would effectively be an admission that the growth of the system still depended mainly on the work of the core development team, meaning it would fail the Howey Test that defines a security.

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Endorsements of the McHenry bill have come from industry groups, including the Chamber of Digital Commerce and Coin Center. It’s unclear what its political chances are, at least while Democrats still control both houses of Congress. But its introduction is an opportunity for politically motivated individuals and organizations to engage with their legislators on crypto. If you want to call or email, here’s contact information for the Senate and House offices.

You probably won’t get to talk to a human being (much less a senator), but the offices do track the volume of inbound comments they get on bills. Voicing support for the McHenry/Pierce crypto safe harbor proposal is one way to (maybe) help stave off what seems poised to become a much more aggressive regulatory regime under SEC Chairman Gary Gensler.