John I. Sanders, John Lightbourne, and Maria Romero Perdomo co-authored the article, “SEC Chairman Outlines Project Crypto, a New Approach to Digital Assets Regulation”
Moore & Van Allen (MVA) Head of International Capital Markets John I. Sanders, Financial Regulatory Advice & Response Associate John Lightbourne, and Financial Services Associate Maria Romero Perdomo co-authored the article, “SEC Chairman Outlines Project Crypto, a New Approach to Digital Assets Regulation”.
The article:
The capital markets have seen a sharp increase in digital asset-related investments. These have primarily come in the form of digital asset treasury (“DAT”) companies, which are public companies that hold large reserves of digital assets (e.g., MicroStrategy and MARA Holdings), and ETFs (e.g., iShares Bitcoin Trust ETF and ARK 21Shares Bitcoin ETF). Despite strong investor demand for digital asset-related investments and exposure, the SEC’s approach under the prior administration alternated between ambivalence and antagonism and relied primarily on regulation through enforcement actions. The Securities and Exchange Commission (“SEC”) Chairman Paul Adkins has asserted that the approach has led to a “decade of uncertainty”.
On July 31st, Chairman Adkins announced a new approach to digital asset regulation through “Project Crypto”. The project is an initiative by the SEC that is designed to clarify how U.S. securities laws apply to digital assets. In a subsequent speech on November 12th, Chairman Atkins announced that the next phase of the project will focus on creating a token taxonomy that applies the Supreme Court’s Howey test, which is the test applied by courts when determining whether an instrument is an investment contract, and therefore a security for federal security law purposes, to digital assets.
Rather than create agency standards and definitions through regulatory actions, Atkins intends to establish a framework of four digital asset categories:
- Digital Commodities/Network Tokens: Chairman Adkins indicated that these are not, in his opinion, securities where they are intrinsically linked to and derive their value from a programmatic operation of a crypto system that is functional and decentralized.
- Digital Collectables: According to Chairman Adkins these would not be securities because they are designed to be collected and/or used and may represent or convey rights to artwork, music, videos, trading cards, in-game items, or digital representations or references to internet memes, characters, current events, or trends.
- Digital Tools: According to Chairman Adkins these would not be securities because they perform a practical function, such as a membership, ticket, credential, title instrument, or identity badge
- Tokenized Securities: These are securities and represent the ownership of a financial instrument enumerated in the definition of “security” that is maintained on a crypto network
Under the taxonomy, Chairman Adkins does not believe Digital Commodities / Network Tokens, Digital Collectables and Digital Tools would be considered securities, as their value is not derived from the purchaser’s “expectation of profits” from the essential managerial efforts of others. By contrast, Tokenized Securities would be considered securities because the underlying financial instrument is still a security even when issued on a blockchain. Chairman Atkins emphasized that regulation will be based on the economic reality and substance of a transaction, not on the labeling used by issuers.
It remains to be seen how much certainty the final taxonomy will ultimately provide, but it is certainly a welcome development in a very nuanced and complicated space that the SEC has unsuccessfully tried to simply before, specifically through its 2019 guidance.
In any event, those looking to issue digital assets or form funds, DATs, or ETFs that may provide indirect exposure to such instruments, should continue to consult with legal counsel and other experts experienced in both securities laws and digital assets and monitor for further developments as the SEC and CFTC continue to address the regulatory requirements applicable to these types of products.
This article is a summary prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice with respect to the laws of the United States or any other jurisdiction.
For further information about the regulation of digital assets and digital assets-related investments, contact the capital markets, securities, and regulatory teams at Moore & Van Allen PLLC.