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In remarks yesterday at SEC Speaks, Chair Gensler cut right to the chase about crypto tokens:

Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.

Some tokens may not meet the definition of a security — what I’ll call crypto non-security tokens. These likely represent only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value.

This isn’t too surprising given recent enforcement activity. In July, I blogged that Coinbase submitted a rulemaking petition that called on the SEC to adopt rules that provide more clarity on the framework for digital assets as securities.

The fact that Coinbase’s petition is 32 pages long gives you a sense for how complex regulating crypto as a security could be. In his Bloomberg column yesterday, Matt Levine pointed out how difficult it would be for the SEC to simply apply pre-existing disclosure requirements to tokens. Here’s an excerpt:

I do not think that that sort of adaptation is trivial. Think about what you would want to know about a crypto project before investing in it. Some of what you would want to know — things like the qualifications of the founding team, their financial incentives and conflicts of interest, where the money is going, how the project is capitalized, how they see the market, what their business plan is, etc. — is very similar to what you’d want to know before investing in the stock of a company. But a lot would be different. You might care a lot less about the funding and capital structure of the entity that employs the developers to build the project, and a lot more about the structure and tokenomics of the decentralized project itself. You might care a lot about the decentralized self-executing code of that project, since DeFi projects are constantly getting hacked, and you might want some sort of high-level summary of that code and its vulnerabilities rather than just a GitHub repository. In a truly decentralized project, the people issuing the tokens might just not have access to some of the things — biographies of key players, audited financials — that are required in normal stock offerings.

And it’s not like most tokens these days are just sold by project developers for cash to retail investors to raise money to build the projects. This used to be true, in the “initial coin offering” boom of 2017, but the SEC shut that down pretty hard. Now tokens are more likely to be earned (by mining, by staking, by running a hotspot) by ordinary participants, and if developers want to raise money they sell tokens to venture capital firms with long lock-ups. (You can sell securities to “accredited investors,” like VCs, without registering them with the SEC.) Adapting the securities-law framework to crypto would mean looking at how crypto tokens actually come into the hands of retail investors, and thinking about what sorts of protections they need in those transactions.

The SEC understandably believes that tokens should be regulated as securities, but coming up with workable rules is a big undertaking, and there are no signs that a tailored crypto framework is in process.

– Liz Dunshee