BitOoda Regulatory Analysis — 10/5/20: Debating the impact of BitMEX on DeFi, while SEC hints at increased openness to tokenization
As we at BitOoda strive to provide our readers with unique insight that goes beyond the crypto news outlets, we typically focus on one or two developments that are particularly relevant to our clients, looking broadly at regulatory trends and connecting dots where possible. This week, we want to follow up on our special-edition piece on BitMEX by looking at the debate on implications for DeFi, but did not want to ignore the bevy of activity related to the SEC’s posture toward digital assets.
Implications of the BitMEX Case for DeFi
The meaning of the enforcement actions against BitMEX in terms of the role of regulation in the derivatives space is obvious. What is less clear is whether the case is bullish or bearish for the future of DeFi.
· On one hand, DeFi is the ready answer to regulatory concern about money laundering given its open protocols, transparent blockchain-based activity, and transactions governed and executed by smart contracts rather than individuals. With a truly decentralized, peer-to-peer, community-managed platform, DeFi networks represent open markets that can and should operate without regulatory oversight.
· On the other hand, DeFi networks are created by developers who build the protocols, infrastructure, and governance structure for the platforms. Those individuals, as well as the platform itself (i.e., the front end) are therefore subject to regulatory scrutiny. The SEC has an existing precedent in its 2018 case against the founder of EtherDelta, who was charged with operating an unregistered national securities exchange. This case showed that SEC does not (or did not, at that time) believe decentralized platforms that conduct peer-to-peer transactions are exempt from regulation.
In our view, we will not be surprised if/when regulators take a closer look at DeFi platforms and participants, as they recognize the potential for these networks to be used for nefarious activity that violates the BSA or other rules, even if the network incorporates KYC. One question regulators will grapple with is when to take appropriate enforcement action against a DeFi effort: during initial development when there are identifiable actors to target (e.g., owners/developers), when there is fundraising/investment activity that may be inconsistent with securities laws, or after a network has launched and is sufficiently decentralized, when there may be no regulatory targets other than the platform/technology itself.
Platforms and protocols that continue to rely on self-custody will likely draw less attention from regulators, and although we agree that decentralized platforms could dispel many regulatory concerns that exist today regarding market risk, manipulation, and unfair trade practices, we expect regulators to make a concerted effort in the coming months to better understand DeFi, with an eye toward identifying potential risks to investors or use of the technology by bad actors.
SEC’s Potentially Changing Views on Tokenization
We have written frequently on the impact of the SEC’s conservative “do no harm” posture on digital assets, the Commission’s internal inconsistencies as Hester Peirce argues for a fundamental new approach, and the agency’s failure to coordinate a comprehensive and logical framework for crypto regulation. While several developments this week give us reason to wonder whether the SEC’s fundamental attitude toward digital assets may be evolving, other recent actions suggest its views remain solidly on the “regulation by enforcement” path.
· In a recent webinar, SEC Chair Jay Clayton stated “It may very well be the case that […stocks] all become tokenized,” and also hinted at his potential support for a Bitcoin ETF. However, SEC’s enforcement action in July against Abra, a platform that let users trade tokenized versions of stocks, indicates otherwise.
· In addition, we are not surprised that a U.S. district judge in SDNY this week ruled in favor of SEC in its drawn-out lawsuit against Kik, finding that the firm’s 2017 token sale represented an unregistered securities offering. This is the latest in a growing list of SEC actions against token offerings, and continues a familiar pattern that also includes the Telegram case.
· On the other hand, the SEC issued a no-action letter stating digital security exchanges that comply with regulations and take measures to assess whether any digital securities they list have been sold legitimately during their lifetimes (e.g., security tokens that were properly registered or eligible for an exemption) may continue to operate.
Given these various statements, letters, and enforcement actions, are we ready to assess that the SEC is pro-tokenization and is ready to stop its campaign against ICOs? Not yet.
Do we believe that the agency is laying down markers that could gradually build a pathway to compliant digital security offerings in the U.S.? Absolutely.
As one of the first and only firms approved to broker secondary-market transactions for digital asset securities and SAFTs, as well as to advise and act as a placement agent on private primary offerings of digital securities, BitOoda is leading the development of compliant solutions and opportunities for clients to broaden their engagement in the digital asset markets. We encourage clients with an interest in exploring tokenization to contact us to discuss how we can help drive your project forward.