Let me start today’s article by saying, I think most people that work for the SEC are good people who genuinely want to make society better. I’ve met many SEC lawyers over the years and they have all been smart, competent and concerned about doing things right.
While I haven’t fully agreed with the SEC’s approach to crypto regulation to date, I do understand the difficult situation it’s faced with. On the one hand, the SEC wants to protect investors. On the other hand, the SEC wants to encourage capital formation and efficient markets. This is a tough balancing act to get right and its difficulty should not be ignored or dismissed.
Until now, one could say that the SEC had done an acceptable job of going after bad actors without stifling innovation. This is in stark contrast to some other US federal agencies that spend their time arresting people for the “crime” of buying and selling bitcoin.
But last month, something happened that changed my opinion about the SEC’s approach to crypto regulation and its ability to manage a conflicting mandate. Read on to find out what happened and why I’ve never been more pessimistic about the SEC’s ability to effectively regulate crypto without killing innovation.
Why major stablecoin Basis shut down
Let’s take a look at the once-promising crypto project, Basis, a stablecoin intended to solve the extreme volatility faced by most cryptocurrencies.
In order to prevent price fluctuations of its token, Basis was designed to operate like a central bank. Essentially, this meant that it would ‘intervene’ to maintain stable prices. When demand for Basis rose, it created more tokens. When demand fell, it would buy back these tokens.
The project was comprised of three separate tokens, all of which played an important role in its ecosystem. Basis tokens were at the core, which were to be pegged to the US dollar. This was supplemented by bond tokens, which would facilitate the seamless and safe auctioning of finances. And finally, share tokens, which would help users redeem bond tokens while deriving their value from dividends.
This sophisticated stablecoin ecosystem had the potential to rival the likes of stablecoin giants such as Tether and MakerDAO, and the core team had raised $133 million in venture capital to make it happen. To all spectators, the project appeared to be poised for takeoff, when suddenly Basis leadership announced that they were voluntarily shutting the project down. All of the project’s funds were returned to investors and the impressive team that was behind the project simply walked away.
Fear and uncertainty of SEC regulation.
In an open letter published on its homepage, the Basis leadership accepted the conclusion of its general counsel that the project’s supplementary bond and share tokens would inevitably be categorized as securities by the SEC.
This would make them subject to the SEC’s onerous demands for registration and compliance. Not only would this cost a fortune, it would also severely affect the project’s activities.
As unregistered securities, the core team would have to take steps to ensure that the bond and share tokens were only made available to “accredited investors.” This would mean creating a “centralized whitelist” of acceptable investors and monitoring each transaction to make sure it matched the SEC’s specifications.
This undermined the fundamentals of the project. Centralized trading restrictions would greatly reduce liquidity in the market, which was essential to maintaining the peg. On top of that, it would allow authorities to censor transactions, contrary to the principles of the project. Ultimately, the team was left with no other option but to shut down.
SEC is killing innovation
Basis was providing a truly innovative solution for the crypto ecosystem. It was not a shady operator trying to defraud investors. Its finances were raised via sophisticated VCs, not through an ICO. Its investors were given transparency and treated with respect. This is precisely the type of project we need within the cryptocurrency industry. And this is what makes the story so tragic.
Basis did not shut down because of poor finances or poor management. It was forced out of business by rigid regulatory constraints that are trying to apply 80 year old case law to a novel technology system.
Though the SEC claims that its application of archaic rules are necessary to protect investors, it’s easy to see how overprotection can often do more harm than good. Basis’ investors were VC’s who understood the stablecoin and wanted to put their money into the project, but they were ultimately denied the opportunity.
Make no mistake, I am all for SEC regulation in regards to shutting down fraudulent activity and scams. This level of oversight helps legitimize the industry while providing a gateway for institutional capital. But, I draw the line when it punishes companies for being innovative and bringing much-needed solutions to the market.
The SEC’s approach to crypto regulation is making legitimate entrepreneurs and VCs nervous as nobody wants to end up on the wrong side of an SEC investigation. But this fear either leads them to shy away from launching new projects or to move to other jurisdictions to start their businesses. Either way, the result is to severely stifle innovation in the US.
What does this mean for Crypto Law Insiders?
Insiders need to understand the rules and play within them. Despite how much we disagree with the SEC’s approach, there is no point fighting the system. If you want to make money and be successful you’ll need to play within the rules set by the SEC.
And the rules are getting stricter!
One very connected Insider told me that the SEC is going to ‘hammer’ existing projects that underwent ICOs. It has already sent out numerous subpoenas to industry participants, and Basis clearly got the message: ‘Innovative financial systems are not welcome in the US.’ So its leadership took the painful and disheartening act of voluntarily shutting down and returning $133 million to investors.
On a personal note, I still have hope that legislators will see the money and businesses leaving the US and decide to enact new laws that will do a better job than those currently in place. But I’m not holding my breath. Instead, I’m helping people find jurisdictions that want crypto innovators. The world is big. Go where you’re wanted.