Securities and Exchange Commission (SEC) Commissioner Hester Peirce published an updated version of her “safe harbor” proposal last week, just ahead of Gary Gensler’s confirmation as SEC chair. The old version introduced the concept of a three-year grace period to let a project launch. The new version defines what a successful project would actually look like. I break it down below.
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Cryptocurrency startups could benefit from a three-year grace period to build and launch their projects before they have to worry about federal securities laws. At least, that’s the premise of Hester Peirce’s proposed “Token Safe Harbor.” The second-term commissioner first proposed a safe harbor for cryptocurrency startups last year, which received feedback but wasn’t adopted by the other commissioners. She introduced a revised version on Tuesday, creating some more specific guidance for how a company could verify that its project is operational.
Why it matters
At present, most cryptocurrency startups that wish to raise capital by selling tokens ahead of building or launching must register with the SEC or risk facing an enforcement action. Registration could be costly if a project doesn’t have existing funds, and selling tokens in compliance with federal securities laws carries its own set of burdens. Commissioner Peirce’s proposal would let a startup take three years to create a “decentralized” blockchain network before having to assess whether it is in compliance with securities laws or whether the token still meets the federal definition of a “security.”
In other words, the safe harbor gives projects three years of breathing room, something many founders believe would benefit them. This could let startups come to market the same way the original Ethereum network did, said Lindsay Lin, a partner and counsel at Dragonfly Capital.
“Projects with novel technologies are not free to do what Ethereum did to bootstrap the network (initial coin offering, development, marketing) lest they violate securities laws,” she noted. “This fear creates a moat for grandfathered incumbents, which may be long-term counterproductive for the industry since challenger technologies may not easily break through the regulatory barrier to entry.”
Breaking it down
The most tangible difference between the old version and the new would be the introduction of exit guidance. Under the Token Safe Harbor Proposal 2.0, companies would have to tap outside counsel to evaluate their projects and create a report assessing whether the project meets certain criteria to be considered “decentralized” or “functional.”
If a project meets neither requirement, it would have a few months to sunset and become compliant with federal laws on registering as securities issuers.
As drafted, the revised proposal would let a company continue operating if it meets either definition. In other words, a functional, centralized project could escape the registration requirements.
“You can imagine a more centralized situation where there’s still a functional network,” Peirce told CoinDesk. “I hope to get feedback on that second part because a lot of people on the initial version were really focused on ‘how do we figure out decentralization,’ so maybe people will feel strongly that that second piece should change or is not necessary.”
Her goal is to determine when a project might fall outside the SEC’s jurisdiction and, therefore, would not have to register as a securities issuer.
Still, a project might be incentivized to only become functional and not focus on decentralization, said Grant Gulovsen, an attorney who advises startups in the crypto sector.
He said crypto startups can absolutely benefit from the safe harbor proposal, though he noted that existing crowdfunding regulations (Regulation CF) allow startups to raise over $1 million provided they meet certain conditions.
“I’d be in favor of relaxing the restrictions across the board, but it doesn’t make sense to me from a public policy standpoint to create such an uneven playing field that benefits crypto startups because blockchain, especially given the low threshold required to meet Network Maturity under the Token Safe Harbor’s functional network test,” he said.
Lin told CoinDesk the revisions were mostly “wonderful,” pointing to the disclosure and reporting interval requirements.
However, she said the guidance could be more specific on the exit guidance by defining who can determine whether a project is decentralized or functional, and what might disqualify a project.
“In the end, network maturity will still be a subjective standard. Thus it’d be useful to have more info on how it’ll be judged and what factors are most important,” she said, adding, “Given the consequences are so severe, it’d also be useful to lay out an appeals process. These items don’t necessarily have to be written in the rule itself, but it’d be helpful to have guidance to provide more clarity.”
Lin said she does hope “Network Maturity” might be more clearly defined, or precedents created to more clearly establish.
One of the most novel moves Peirce made was posting the entire updated proposal on GitHub, a popular hosting platform for software where anyone can provide feedback by way of comments or suggest changes through pull requests.
This was “a brilliant idea,” said Gulovsen, who has already posted comments on the GitHub page. “I applaud Commissioner Peirce for posting it on GitHub. It gives legal practitioners, software developers and any interested parties an opportunity to comment directly on the proposal and creates a completely transparent public record.”
The move also allows developers, lawyers and other parties to respond directly rather than have to go through lobbyists to propose suggestions, he said.
Pierce said she posted the proposal on GitHub “to really encourage people to engage with the text and think about how to improve it.”
She also hopes that it will help show new SEC Chair Gary Gensler how much engagement there is, and what issues people believe could be improved.
Peirce solicited feedback for the original proposal as well, and said the comments she received in the last year showed people do want a safe harbor.
“I think it’s just a piece of the clarity question because whether or not something has to be traded as a security matters for people in the [industry], it matters for broker-dealers,” she said. “We have a pilot program that is available now and that, too, is only available for digital asset securities so we have to be thinking about whether or not things fit within what bucket.”
Regulation by enforcement
Part of the safe harbor idea is to help the SEC move away from “regulation by enforcement,” which is when the regulator brings enforcement actions against what it perceives as wrongdoers and lets the rest of the industry try to piece together what behavior is acceptable.This approach does not provide clear guidance on what is permissible.
“There are always questions around whether we’re leading with enforcement or whether instead of doing that could we provide some regulatory clarity,” Peirce said.
Peirce said she published the proposal ahead of Gensler’s final confirmation votes, noting that he has past experience in the crypto sector.
“I hope he will be thinking about how to provide regulatory clarity with respect to crypto generally,” she said. “I’d like this to be something he considers.”
The Coinbase roller coaster
Last week, U.S.-based crypto exchange Coinbase finally went public, marking Wall Street’s most public acceptance of a crypto startup to date. You can catch all of CoinDesk’s coverage here, but in short: Trading began early afternoon, the price went up a bit, then went down a bit and it’s trading around $330 as of Monday.
The listing reverberated beyond just the U.S. as well – as my colleague Sandali Handagama wrote. Execs at crypto exchanges in different countries see the listing as a signal to the traditional financial world and its members, who may now take the digital asset industry more seriously.
Now, we get to wait and see which company is next and whether that marks a further acceptance of crypto by Wall Street – or, a further acceptance of Wall Street by crypto.
The Biden Bunch
Changing of the guard
Gary Gensler has officially been confirmed as leader of the Securities and Exchange Commission. It only took three months and three different votes. Now, to paraphrase the immortal words of Bill Belichick, we’re on to the Commodity Futures Trading Commission. No official word on who might be tapped to lead the commodities regulator or the Office of the Comptroller of the Currency.
- Binance.US Hires Former Bank Regulator Brian Brooks as CEO: Brian Brooks is joining Binance.US. I was a bit surprised but I guess this isn't wholly unexpected. (Also, no word on where soon-to-be-former CEO Catherine Coley is headed.)
- The NFT Craze Is Helping Nigerian Artists Go Global: Some Nigerian artists are minting non-fungible tokens of their art and finding that this is easier than trying to break into the traditional art market. Sandali Handagama spoke to some of these artists to get their perspective, though, as she notes, NFTs may only benefit artists with established fanbases, not up-and-comers.
- US Policy Adviser Rebuts Peter Thiel: Bitcoin Won’t Undermine USD: Yeah, so the other week Peter Thiel, longtime bitcoin hodler, said China might use bitcoin to undermine the U.S. dollar. It was an odd statement, but last week Alex Wong, a member of the congressionally-funded U.S.-China Economic and Security Review Commission, said this was unlikely.
- Much Wow: Slim Jim Has a Dogecoin Strategy: So Slim Jim, a subsidiary of Conagra Brands, has a Dogecoin strategy, according to my colleague Daniel Nelson. This was somehow CoinDesk’s most-read story last week. More saliently, I’m wondering whether this is an actual sign of acceptance. Dogecoin has been treated as a meme since its creation; now, actual companies that are listed on actual stock exchanges are planning marketing campaigns around significant dates for DOGE fans. Maybe this is what real institutional adoption looks like. Or maybe I'm overthinking this and people just like memes.
- (Los Angeles Times) I talked about IP issues for non-fungible tokens a while back, and some of my colleagues have covered how new or less prominent artists are taking advantage of the form to sell art and make money. The Los Angeles Times looked at artists who tried, but were beaten back by industry – in this case, the comic book industry. While comic book artists have sometimes been able to sell their art at conventions and other locations with no problem, it seems that IP protections will keep them from doing the same in this particular digital format.
- (Motherboard) The FBI received court approval to basically hack computers in order to remove compromised software tied to a Microsoft Exchange Server version. The move was done to protect companies from future hacks, according to the U.S. Department of Justice. I’ve got a few questions about this. Maybe the FBI believed it had no choice but to break into private entities’ computers and patch them, but the fact this was possible both technically and legally is concerning, to say the least.
- (IFLR) I wrote about the revisited Financial Action Task Force draft proposal the other week. Lewis Cohen, a co-founder of DLx Law who’s well known in this industry, published a much more comprehensive analysis of what the draft proposal says and what the implications are. It’s well worth a read if you’re in the crypto sector, particularly if you work on a decentralized finance (DeFi) project.
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See ya’ll next week!