A new (digital) age at the SEC

As technology evolves, the U.S. Securities and Exchange Commission (SEC) must evolve with it. Nowhere is this truer than in crypto. New leadership — plus the formation of a new crypto task force — gives the agency an opportunity to take meaningful action and adapt. 

The time for that action is now: The market for crypto assets has grown in size and sophistication such that the SEC’s recent harmful approach of enforcement and abdication of regulation needs urgent updating. There is no other way to promote efficient markets, encourage innovation, and ensure investor protections are adopted as professional investment services begin to operate within this new industry. The principles underpinning the relevant securities laws — disclosure, fraud prevention, and market integrity — should remain sacrosanct. However, applying these principles in a way that reflects the distinct characteristics of crypto assets requires targeted regulatory changes. 

This piece proposes immediate, easily adopted adjustments the SEC should take to create fit-for-purpose regulations without sacrificing innovation or critical investor protections. While legislation is necessary to provide sufficient regulatory clarity regarding crypto asset classification and secondary market oversight, these steps would provide immediate benefit to the market. 

1. Provide interpretive guidance on ‘airdrops’ and other incentive-based rewards

The SEC should provide interpretive guidance for how blockchain projects can distribute crypto assets to participants without being characterized as securities offerings. These distributions are often called “airdrops” or “incentive-based rewards,” and blockchain projects typically conduct them for free, or in exchange for de minimis value, often as a reward for prior usage of the particular network or ecosystem. Such distributions are a critical tool for enabling blockchain projects to build community and progressively decentralize, as they disseminate ownership and control of a project to its users. 

This process of decentralization has multiple benefits. Decentralization can guard investors against risks commonly associated with securities and centralized control and to facilitate the expansion of the network, thereby increasing its value. If the SEC were to provide guidance on distributions, it would stem the tide of airdrops and incentive-based rewards only being issued to non-U.S. persons — a trend that is effectively offshoring ownership of blockchain technologies developed in the U.S., and effectively creating windfall gains for non-U.S. persons at the expense of U.S. investors and developers.

What to do:

• Establish eligibility criteria: Set baseline criteria for crypto assets that are eligible for exclusion from treatment of investment contracts under securities laws in airdrop and incentive-based reward distributions. For example, crypto assets whose market value is substantially derived from (or reasonably expected to be substantially derived from) the programmatic functioning of any distributed ledger or similar technology, or any executable software deployed to a distributed ledger or similar technology, that are not otherwise securities should be eligible for such distributions.

2. Modify crowdfunding rules for exempt offerings

The SEC should revise Regulation Crowdfunding rules to more effectively regulate exempt offerings for crypto assets.

The current limits on capital raising and investor participation in crowdfunding campaigns are ill-suited for crypto startups, which often need a broader distribution of crypto assets to develop a critical mass and network effects for their platforms, applications, or protocols. 

What to do:

• Expand offering limits: Increase the maximum amount that can be raised through crowdfunding to a level consistent with the needs of ventures (e.g., up to $75 million or a percentage of the overall network, depending on the depth of disclosures).
• Exempt offerings: Allow crypto projects to rely on exemptions similar to Regulation D while leveraging the crowdfunding platform’s accessibility to reach more broadly beyond accredited investors.
• Protect investors: Adopt appropriate safeguards such as caps on the amounts any one individual may invest (as Reg A+ currently does) and robust disclosure requirements that encompass the material information relevant to the crypto venture — something present regulations do not address. (For example, while offering disclosures may often address matters such as directors, their compensation, and shareholding details, disclosures around the underlying blockchain, its governance, and consensus mechanisms may be more important for investors in crypto assets.) Tailoring these requirements to digital asset investors can ensure they are well-informed and protected from fraud.

These changes would empower early-stage crypto projects to access a wide pool of investors, democratizing access to promising investment opportunities while preserving transparency.

3. Enable broker-dealers to operate in crypto assets and securities

The current regulatory environment restricts traditional broker-dealers from engaging meaningfully in the crypto space — primarily because it requires brokers to obtain separate approvals to transact in crypto assets, and imposes even more onerous regulations around broker-dealers who wish to custody crypto assets.

These restrictions create unnecessary barriers to market participation and liquidity. Allowing broker-dealers to facilitate transactions in both crypto assets that are securities, as well as those that are not, would enhance market functionality, investor access, and investor protection. It would also recognize that on crypto platforms today, crypto assets that are clearly not securities (such as bitcoin, ether, or fiat-based stablecoins) trade seamlessly against crypto assets that the SEC may consider to be subject to securities laws. 

What to do:

• Enable registration: Develop a clear path for broker-dealers to register for dealing in (and custodying) crypto assets (securities and nonsecurities), with tailored requirements reflecting the nature of these assets.
• Enhance supervisory framework: Establish oversight mechanisms to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations, safeguarding market integrity.
• Collaborate with industry: Work with the Financial Industry Regulatory Authority (FINRA) to issue joint guidance that addresses operational risks unique to crypto assets.

This approach would promote a safer and more efficient marketplace, enabling broker-dealers to bring their expertise in best execution, compliance, and custody to crypto markets.

4. Provide guidance on custody and settlement

Custody and settlement remain critical barriers to institutional adoption of crypto assets. Ambiguity concerning regulatory treatment and accounting rules has deterred traditional financial institutions from entering the custody market. This means that many investors are not getting the benefit of fiduciary asset management for their investments, and instead are left investing on their own and arranging their own custody alternatives.

What to do:

• Tailor custody guidance: Provide guidance concerning the custody rule under the Investment Advisers Act to clarify how investment advisers can custody crypto assets, ensuring adequate safeguards such as multi-signature wallets and secure offchain storage. This should also include guidance on staking idle assets and voting on governance decisions for crypto assets in the custody of investment advisers. 
• Set settlement standards: Develop specific guidance on settlement for crypto transactions, including timelines, validation processes, and error resolution mechanisms.
• Establish a technology-neutral framework: Allow flexibility for innovative custody solutions that meet regulatory standards without imposing prescriptive technological mandates.
• Rectify accounting treatment: Repeal SEC Staff Accounting Bulletin 121 and allow the accounting for custodied digital assets to reflect the nature of the custody arrangements rather than a presumption of liability. By background, SAB 121 states, among other things, that, “as long as [a firm] is responsible for safeguarding the crypto-assets held for its platform…the firm should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users” with a corresponding asset. The general effect of SAB 121 moves custodied crypto assets onto the custodian’s balance sheet — a practice that is at odds with the traditional accounting treatment of custodied assets. As a result, and unlike in a typical custodial arrangement, this accounting treatment may have the effect of dragging custodied crypto assets into the custodian’s bankruptcy estate, if the custodian were to go bankrupt. Perhaps worst of all, SAB 121 lacks legitimacy. The Government Accountability Office has found that it was effectively a rule that should have been submitted for Congressional review under the Congressional Review Act, and in May of 2024, the House and the Senate issued a joint resolution disapproving SAB 121, only to have the resolution vetoed by President Biden.

This clarity would provide the foundation for institutional confidence, enabling larger players to enter the market while also increasing market stability and competition among service providers. Furthermore, crypto investors, both retail and institutional, would receive the protections associated with professional, regulated asset management services.

5. Reform ETP standards

The SEC should adopt reform measures for exchange-traded products (ETPs) that will foster financial innovation. The proposals promote broader market access to investors and fiduciaries used to managing portfolios of ETPs. 

What to do:

• Restore market-size test: The SEC’s reliance on the “Winklevoss Test” for market surveillance agreements has delayed approval of bitcoin and other crypto-based ETPs. The test requires that for a national securities exchange, such as NYSE or NASDAQ to trade a commodity-based ETP, the listing exchange must have a surveillance agreement with a “regulated market of significant size” in either the commodity or a derivative thereof. Given that the SEC does not consider crypto trading platforms to be “regulated markets,” this functionally means that ETPs can only exist for those crypto assets that have futures markets (regulated by the Commodity Futures Trading Commission) which have demonstratively high predictive price discovery of the underlying commodity. This approach overlooks the significant size and transparency of current crypto markets. More importantly, it creates an arbitrary distinction in the standards applicable to crypto-based ETP listing applications and all other commodity-based listing applications. Therefore, we suggest reverting to the historical test for markets of significant size: requiring only that sufficient liquidity and price integrity for the commodity futures market exists to support an ETP product. This adjustment would align crypto ETP approvals with standards applied to other asset ETPs.
• Enable physical settlement: Permit crypto ETPs to settle directly in the underlying asset. This will result in better fund tracking, reduce costs, provide greater price transparency, and reduce reliance on derivatives.
• Apply custody standards: Mandate robust custody standards for physically settled transactions to mitigate risks of theft or loss. Additionally, provide for the option of staking idle assets of the ETP.

6. Implement a 15c2-11 certification for ATS listings

In a decentralized environment where the issuer of a crypto asset may play no significant continuing role, a question arises as to who bears responsibility for providing accurate disclosures around the asset. Fortunately, there exists a helpful analog from the traditional securities markets in the form of Exchange Act Rule 15c2-11, which permits broker-dealers to trade a security so long as there is, among other things, current information for the security available to investors. 

Extending that principle into the crypto asset markets, the SEC could permit regulated crypto trading platforms (both exchanges and brokerages) to trade any asset for which the platform can provide investors with accurate, current information. The result would be greater liquidity for such assets across SEC-regulated markets, while simultaneously ensuring that investors are equipped to make informed decisions. Two obvious benefits from this are the trading of digital asset pairs (in which one asset is a security against an asset that is not a security) on SEC-regulated markets, and a disincentive for trading platforms to operate offshore.

What to do:

• Streamline certification process: Establish a streamlined 15c2-11 certification process for crypto assets listed on alternative trading system (ATS) platforms, providing mandatory disclosures about the assets’ design, purpose, functionality, and risks.
• Employ due diligence standards: Require exchanges or ATS operators to perform due diligence on crypto assets, including verifying issuer identity as well as important feature and functionality information.
• Clarify disclosure requirements: Mandate periodic updates to ensure investors receive timely and accurate information. Also, clarify when reporting by an issuer is no longer necessary as it is not informative to a prospective purchaser due to decentralization. 

This framework would promote transparency and market integrity while allowing innovation to flourish within a regulated environment.

Conclusion

The SEC stands at a pivotal moment in determining the future of crypto asset regulation. The creation of a new crypto task force signals the Commission’s intention to change course from the previous administration. By taking the above crucial steps now, the Commission can begin to rotate away from its historic and heavily contested focus on enforcement efforts and add the much needed regulatory dimension of guidance and practical solutions for investors, fiduciaries, and financial intermediaries. This will better balance protecting investors with fostering capital formation and innovation. 

The changes proposed above — ranging from modernizing crowdfunding rules to creating clear standards for custody and ETPs — would reduce ambiguity and support financial innovation in this area. With these adjustments, the SEC can reclaim its purpose and reposition itself as a forward-thinking regulator, ensuring that U.S. markets remain competitive while also safeguarding the public. The long-term future of the U.S. crypto industry will likely require Congress to provide a comprehensive, fit-for-purpose regulatory framework. Until that framework is in place, however, the steps outlined here serve as a way toward appropriate regulation.

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