Original author: Scott Walker, Bill Hinman
Original translation: Luffy, Foresight News
As technology continues to evolve, the U.S. Securities and Exchange Commission (SEC) must also keep pace. Nowhere is this more evident than in the cryptocurrency space. New leadership and the creation of a new cryptocurrency task force provide the agency with an opportunity to take concrete action and adapt.
The time to act is now: The cryptocurrency market has grown in size and complexity to the point where the SEC’s previous approach of relying solely on enforcement and ignoring regulation needs to be updated. As professional investment services begin to engage in this emerging industry, there is no other way to advance the market, encourage innovation, and protect investors. The principles that underpin securities laws—disclosure, fraud prevention, and market integrity—should remain sacrosanct. However, applying these principles in a way that reflects the unique characteristics of crypto assets requires targeted regulatory changes.
This article proposes immediate and easy-to-implement adjustments that the SEC should take to develop appropriate regulatory rules without sacrificing support for innovation and investor protection. While legislation is necessary to clarify the classification of crypto assets and secondary market regulation, these measures will bring immediate benefits to the market.
1. Provide interpretive guidance on “airdrops” and other incentive-based rewards
The SEC should provide interpretive guidance on how blockchain projects can distribute crypto assets to participants without being deemed a securities offering. These distributions are often referred to as “airdrops” or “incentives,” and blockchain projects generally conduct them for free or for very little, often as a reward for early access to a particular network or ecosystem. Such distributions are a key means by which blockchain projects build communities and gradually achieve decentralization, distributing ownership and control of the project to users.
This decentralization process has many benefits. Decentralization protects investors from the risks typically associated with securities and centralized control, and promotes the growth of the network, thereby increasing its value. If the SEC can provide guidance on distribution matters, it can curb the trend of airdrops only to non-US persons. This trend actually transfers ownership of blockchain technology developed in the United States overseas, effectively creating windfalls for non-US persons at the expense of US investors and developers.
Specific steps:
Establish eligibility criteria: Set basic criteria for crypto assets that can be exempted from being treated as investment contracts (subject to securities laws) in airdrops and incentive-based reward distributions. For example, crypto assets whose market value is primarily derived from the programmatic operation of any distributed ledger or similar technology, or any executable software deployed to a distributed ledger or similar technology, should be eligible for such distributions if they do not fall into other securities categories.
2. Modify crowdfunding rules to regulate exempt offerings
The SEC should revise crowdfunding rules to more effectively regulate exempt offerings of crypto assets.
Current restrictions on funding size and investor participation in crowdfunding campaigns are not suitable for crypto startups, as these companies typically need to distribute crypto assets more widely to form sufficient user scale and network effects for their platforms, applications or protocols.
Specific steps:
Increase fundraising amount limits: Increase the maximum amount that can be raised through crowdfunding to a level consistent with the needs of the business (e.g., up to $75 million or a percentage of the entire network, depending on the depth of disclosure).
Exempt Offerings: Allow crypto projects to rely on exemptions similar to Regulation D while leveraging crowdfunding platforms to reach a broader range of investors (rather than just accredited investors).
Investor protection: Appropriate safeguards, such as individual investment caps (similar to what is currently done in Regulation A+) and detailed disclosure requirements covering material information relevant to crypto businesses. (For example, while offering disclosures may typically cover matters such as directors, compensation, and shareholding details, disclosures around the underlying blockchain, governance, and consensus mechanisms may be more important to crypto investors.) Tailoring these requirements to crypto investors ensures they are well-informed and protected from fraud.
These changes will enable early-stage crypto projects to reach a broad investor base, while maintaining transparency and making investment opportunities more visible.
3. Allow broker-dealers to engage in crypto assets and securities business
The current regulatory environment limits traditional broker-dealers’ substantive involvement in the crypto space, primarily because it requires brokers to obtain separate approval when trading crypto assets and imposes stricter regulations on broker-dealers that wish to custody crypto assets.
These restrictions create unnecessary barriers to market participation and liquidity. Allowing broker-dealers to facilitate trading of crypto assets that are securities as well as crypto assets that are not securities will enhance market function, investor access, and investor protection. On today’s crypto trading platforms, crypto assets that are not securities (such as Bitcoin and Ethereum) and crypto assets that the SEC may determine to be subject to securities laws can be traded seamlessly.
Specific steps:
Enabling Registration: Create a clear registration path for broker-dealers to register to do business with (and custody) crypto assets (both securities and non-securities), with specific requirements based on the nature of those assets.
Strengthening the regulatory framework: Establishing a supervisory mechanism to ensure compliance with Anti-Money Laundering (AML) and KYC regulations and maintain market integrity.
Collaboration with Industry: Working with the Financial Industry Regulatory Authority (FINRA) to issue joint guidance addressing operational risks unique to crypto assets.
This approach will promote a safer and more efficient marketplace by enabling broker-dealers to bring their expertise in best execution, compliance, and custody to the crypto markets.
4. Provide custody and settlement guidance
Custody and settlement remain key barriers to institutional adoption of crypto assets. Unclear regulatory treatment and accounting rules have deterred traditional financial institutions from entering the custody market. This means that many investors cannot benefit from professional asset management services and can only invest on their own and arrange custody solutions on their own.
Specific steps:
Issue Custody Guidance: Provide guidance on custody rules under the Investment Advisers Act to clarify how investment advisers can custody crypto assets, ensuring adequate safeguards such as multi-signature wallets and secure offline storage. This should also include guidance on idle asset staking and voting on governance decisions for crypto assets in custody of investment advisers.
Set settlement standards: Develop specific guidance for the settlement of crypto transactions, including timelines, verification processes, and error resolution mechanisms.
Establish a technology-neutral framework: Allowing flexibility to adopt innovative custody solutions while meeting regulatory standards, without mandating specific technology requirements.
Correct accounting treatment: Repeal SEC Staff Accounting Bulletin No. 121 (SAB 121) so that the accounting treatment of custodial digital assets reflects the actual situation of the custodial arrangement rather than the assumption of a liability. For background information, SAB 121 provides that as long as the company is responsible for protecting the crypto assets held by the platform... the company should list a liability on its balance sheet to reflect its obligation to protect the crypto assets held for the platform users and a corresponding asset. The overall effect of SAB 121 is to record the custodial crypto assets on the custodians balance sheet, which is contrary to the traditional accounting treatment of custodial assets. Therefore, unlike typical custodial arrangements, if the custodian goes bankrupt, this accounting treatment may cause the custodial crypto assets to be included in the custodians bankruptcy estate. Worst of all, SAB 121 lacks legality. The Government Accountability Office found that it is actually a rule that should be submitted to Congress for review under the Congressional Review Act. In May 2024, the House and Senate issued a joint resolution not to approve SAB 121, but the resolution was vetoed by President Biden.
This clarity will lay the foundation for institutional confidence, enabling large players to enter the market, while enhancing market stability and competition among service providers. In addition, both retail and institutional investors will gain the protections associated with professional, regulated asset management services.
5. Reform of Exchange Traded Fund (ETP) Standards
The SEC should adopt reforms to exchange-traded funds (ETPs) to promote financial innovation. These proposals are intended to provide broader market access for investors and custodians accustomed to managing ETP portfolios.
Specific steps:
Reinstate the Market Size Test: The SEC’s reliance on the “Winklevoss Test” for market monitoring agreements has delayed the approval of Bitcoin and other cryptocurrency ETPs. The test requires that for a national securities exchange like the NYSE or NASDAQ to trade a commodity-based ETP, the listing exchange must enter into a monitoring agreement with a “regulatory market of significant size” for that commodity or its derivatives. Given that the SEC does not consider crypto trading platforms to be “regulated markets,” this effectively means that ETPs are only available to crypto assets that have futures markets (regulated by the Commodity Futures Trading Commission) that provide a high degree of price discovery for the underlying commodity. This ignores the significant size and transparency of the current crypto markets. More importantly, it creates an arbitrary distinction between the standards applicable to cryptocurrency ETP listing applications and all other commodity-based listing applications. We therefore recommend reinstating the historical test for a market of significant size: requiring only that commodity futures markets have sufficient liquidity and price integrity to support ETP products. This adjustment would align the approval standards for crypto ETPs with those for other asset ETPs.
Achieve physical settlement: Allow crypto ETPs to be settled directly with the underlying assets. This will lead to better fund tracking, lower costs, greater price transparency, and less reliance on derivatives.
Apply custody standards: Enforce strict custody standards for physically settled transactions to reduce the risk of theft or loss. In addition, provide collateral options for idle assets of ETPs.
6. Implementing 15C2-11 certification for alternative trading system (ATS) listings
In a decentralized environment, the issuer of a crypto-asset may no longer play a significant ongoing role, and the question arises as to who is responsible for providing accurate disclosure information about the asset. Fortunately, there is a similar helpful rule in the traditional securities market, Rule 15c2-11 of the Securities Exchange Act, which allows broker-dealers to trade a security if, among other conditions, investors have access to up-to-date information about the security.
Extending this principle to the cryptocurrency market, the SEC could allow regulated crypto trading platforms (including exchanges and brokers) to trade any asset for which the platform can provide investors with accurate, up-to-date information. The result would be increased liquidity for such assets in SEC-regulated markets while ensuring that investors have the ability to make informed decisions. Two obvious benefits of this would be that digital asset pairs (one of which is a security and the other is not) could be traded in SEC-regulated markets, and that there would be a disincentive for trading platforms to operate overseas.
Specific steps:
Simplified Certification Process: Establish a simplified 15C2-11 certification process for crypto assets listed on alternative trading system (ATS) platforms, providing mandatory disclosures about the asset’s design, purpose, functionality, and risks.
Adopting due diligence standards: Require exchanges or ATS operators to conduct due diligence on crypto assets, including verifying the identity of the issuer and important features and functional information.
Clarify disclosure requirements: Mandate regular updates to ensure that investors receive timely and accurate information. In addition, clarify when, due to decentralization, an issuers reports are no longer valuable to potential purchasers and no longer need to be reported.
This framework will promote transparency and market integrity while allowing innovation to flourish in a regulated environment.
in conclusion
The SEC is at a critical juncture in determining the future of crypto asset regulation. The newly formed Cryptocurrency Task Force signals the Commission’s intent to change course from the previous term. By taking the critical steps outlined above immediately, the SEC can begin to shift away from its controversial enforcement-focused model and add much-needed regulatory guidance and practical solutions for investors, custodians, and financial intermediaries. This will better balance investor protection with the promotion of capital formation and innovation.
The proposed changes above will reduce uncertainty and support financial innovation in the crypto space. With these adjustments, the SEC can reclaim its mission and reposition itself as a forward-looking regulator that ensures U.S. markets remain competitive while protecting the public interest. The long-term future of the U.S. crypto industry will likely require Congress to provide a comprehensive, applicable regulatory framework. However, until that framework is in place, the steps outlined in this article are a path toward appropriate regulation.
