“Hey there, baby, I could use just a little help” (Bruce Springsteen)
Hester Peirce, a commissioner at the U.S. Securities and Exchange Commission, came to Chicago last Thursday to talk about her proposal for a temporary safe harbor for certain cryptocurrency token issuers. Quoting Bruce Springsteen’s Dancing in the Dark, Peirce said she hopes her proposal will spark some fire among her fellow commissioners for providing a way to develop utility token-based networks without being impeded by securities laws.
Speaking at the Fourth International Blockchain Congress, Peirce addressed one of the digital asset and cryptocurrency industry’s chief concerns – how to raise development funds by issuing tokens that later will be used in the project’s operation without running afoul of U.S. securities laws.
While the digital asset industry might benefit from some regulatory relief and a dose of legal certainty, it is not clear that Peirce’s proposals will find a ready audience outside the SEC. Under her proposal, developers will still be required up front to provide information about the development team and its project plans and to make timely disclosures of material changes and developments. Even in the safe harbor provided by Peirce’s proposal, token issuers would remain subject to the anti-fraud provisions of the securities laws.
Today, ICO issuers are hamstrung by what Peirce characterized as a “regulatory catch-22” created, at least in part, by the SEC’s application of the Howey test. The test has been used to define investment contracts since the 1940s. Developers may not be able to distribute their tokens to potential users of their platforms because the tokens may be “investment contracts” subject to the U.S. securities laws since, among other things, many token buyers do so hoping to profit from the managerial efforts of others.
Digital asset tokens, however, are different from investment vehicles: their use is integral to the functioning of the network that is developed. Tokens need to be in the hands of developers and users so the platform can devolve into the decentralized networks that projects rely on. As Peirce noted, “ . . . proving that tokens have utility prior to being distributed to a widespread user base is difficult.”
Quoting Bruce Springsteen, Peirce said, “ ‘you can’t start a fire without a spark.’ It does not hurt to get the ball rolling.” Find out what else she said about her proposal for a temporary safe harbor for certain cryptocurrency token issuers.
Peirce proposes that the initial group of developers be given three years grace from application of the securities laws so they can get their projects up and running. The grace period would toll from the date of the first token sale. And projects would have to notify the Commission formally of their intention to take advantage of the exemptions.
At the end of the grace period, the tokens would cease to enjoy the protections of the safe harbor and would have to have attained sufficient maturity – meaning either that the network is so decentralized that it is not controlled by a single entity or group or the the network is fully functional. Otherwise, it seems, the tokens will risk being subject to securities laws after the three years are up.
Peirce paid considerable attention in her speech to how these safe-harbored tokens should be distributed.. She said that it is important that purchasers and other holders of tokens have sufficient information about the project to be able to know what their tokens might be worth. To address the “information asymmetry” where the development team has better information than outside token holders, Peirce proposes requiring disclosure of source code for the network and transaction history.
The project would need to disclose the total number of tokens issued, how and when future tokens will be supplied, how or when tokens will be burned the mechanics of the network, and the governance protocol for the network. All of the required information must be freely available on the project’s website.
Peirce also talked about how tokens issued under her proposed safe harbor would enjoy relief from certain exchange regulations. Platforms where the tokens are traded would not have to be registered securities exchanges people dealing in the tokens would not have to be registered broker-dealers. The proposal would, however, require the development team to take steps to assure the liquidity of secondary market trading of their tokens.
Reaction to Commissioner Peirce’s proposal on Thursday morning at the Blockchain Congress was warm but muted. Reactions in the cryptocurrency news channels have also been positive, but again with few signs of enthusiasm. Interest in issuing tokens in the U.S., after all, has receded greatly from its 2017 and 2018 pace due in part to the fall in cryptocurrency prices but also to the SEC’s vigorous enforcement efforts against many projects.
At any rate, Peirce’s safe harbor proposal is far from being adopted by the SEC. As she emphasized in her remarks, it is her proposal and not the Commission’s. She said that she wants to get it right, and she is looking for input from the digital asset industry. Next steps are in the dark.
Hester M. Peirce was appointed a commissioner at the SEC on January 11, 2018, along with Robert J. Jackson Jr. The two appointments gave the SEC its full complement of commissioners, clearing the way for the body to recommence rulemaking.
Peirce’s work has been published in such outlets as the Hill and American Banker, and she is a regular contributor to Real Clear Markets. She is the editor of, and a contributor to, the book Reframing Financial Regulation: Enhancing Stability and Protecting Consumers, published by Mercatus in 2016.