Digital Asset Securities – Common Goals and a Bridge to Better Outcomes
Oct. 12, 2021
Remarks at SEC Speaks
Thanks for having me here today for the annual SEC Speaks. And thank you to Renee for that kind introduction. Before we get into substance, the views I express are my own and do not necessarily reflect the views of the Commission or its staff.
This afternoon, before speaking, I spent some time looking at news coverage of SEC Speaks, as well as getting some highlights from around DC and the world. One of the articles that popped up was about digital assets. These now dominate the headlines. And because I sometimes read Crypto-twitter, I feel like I need to say at the outset that the energy and passion is pervasive and admirable. Likewise, the technology and its potential are positive. I appreciate the time, energy and intellectual curiosity that drives the ongoing development of this technology or, as I typically refer to them, digital assets. I think we can all agree that we’re striving toward common goals – promoting innovation, developing markets that are both accessible and resilient, and providing appropriate investor protections. But I have a message I want digital asset market participants to hear: to move these markets forward there must be a meaningful exchange of ideas between innovators and regulators. And while we share common goals, we may prioritize issues differently and our initial proposed solutions might reflect those distinctions. And that’s ok – even good. Different viewpoints coupled with constructive dialogue will yield better results in the long run.
This has been borne out by the success of our now more than 80 year-old regulatory regime. Prior to the creation of the SEC, retail investors were frequently subject to fraud, undisclosed risks, market manipulation, and, often, lost huge sums of money. The framework that Congress created in response and that has evolved over the years through legislation, rulemaking, and litigation has worked remarkably well and is critical to the success of our markets. Our system doesn’t just benefit investors by offering protections and deterring violations by holding violators accountable. It also benefits the capital markets writ large, by facilitating widespread participation by investors and other market participants. This has allowed markets to perform better, to be more resilient, to more accurately price risk, and to sustain successful innovation. But how should we best ensure those same protections and advantages extend to digital assets and markets within our jurisdiction? Digital assets represent a small but growing portion of the economy, while small businesses in traditional markets have for generations strengthened our economy through their hard work and their commitment to regulatory compliance. So how do we also ensure that our efforts to support innovation don’t preference digital assets projects at the expense of the rest of the market?
The SEC began assessing digital asset issues almost ten years ago. And our approach has been pragmatic and investor focused. One of the SEC’s first actions in this space began in 2013, when the staff identified a Ponzi scheme. The defendant had solicited bitcoin owners to send him their bitcoin in exchange for large guaranteed returns, purportedly generated through the defendant’s bitcoin arbitrage system. Because the investors paid in Bitcoin, though, the defendant argued this fraud did not fall within the SEC’s jurisdiction. Specifically, he argued that the Howey test – a legal test established by the Supreme Court in 1946 to determine whether an offering is a security over which the SEC has jurisdiction – requires an investment of money. Bitcoin, according to the defense, was not money. The court disagreed and held that Bitcoin was a contribution of value for the purposes of Howey, and that the Ponzi scheme fit squarely within the SEC’s jurisdiction. The court focused on how Bitcoin was used, not that it was a digital asset or relied on new technology.
After that case, the Commission looked at this issue more broadly and more visibly. In 2017, at the conclusion of a non-public investigation, rather than bring an enforcement action we issued a public report pursuant to Section 21(a) of the Exchange Act. These reports are infrequent and designed to inform the market about how our agency views particular conduct. The focus of this 2017 21(a) report was a digital asset security offering known as The DAO, or Decentralized Autonomous Organization. That was an explicitly investment-focused, profit-seeking venture that claimed to be decentralized. Through general solicitations to retail investors the venture raised $150 million worth of the native digital asset on the Ethereum blockchain, known as ETH. Although we had not previously applied our regulations to a purportedly Decentralized Autonomous Organization, in the report the Commission explained the legal and jurisdictional basis for doing so, the analytical framework used, and the results of that analysis. That analysis focused not on the technology, but on the economic realities of the transactions, including the expectation of profits and the efforts of the promoters. The DAO, the agency made clear, was a securities offering.
We built on that guidance through the staff’s publication of an analytical framework for digital assets, and through many subsequent no-action letters, staff statements, risk and investor alerts, speeches, and public testimony. We have also continued to pursue enforcement cases within the SEC’s jurisdiction, including, for example, cases for failure to register the offer and sale of digital assets that are securities, for failure to register as a broker or national securities exchange, and for fraud. None of these cases involved new regulations or laws enacted specifically for blockchain projects. Instead, we have applied existing law in a manner consistent with our long practice.
But these markets continue to evolve rapidly, and that, understandably, raises questions for new projects or activities about how best to analyze their obligations under the federal securities laws and how best to comply. And it turns out, few digital assets projects have gone through the registration process. Many operate as if they are not subject to regulatory oversight. The result? Often digital asset investors have no way to determine if the prices and market they see is the product of manipulative trading, or if they have received sufficient disclosures about their investment to accurately price for risk. This is not sustainable, particularly as digital asset markets continue to grow and intersect with traditional markets. Given this, we must think about how best to reconcile a regime that has worked consistently for more than 80 years, with products and systems that are evolving rapidly and may not always be an intuitive fit within the existing system. The threshold tests are well-established, but if a digital asset is a security, it is sometimes less clear how developers can integrate digital asset securities into their projects, while still complying with the laws and honoring the principles on which they are based. So what do we do?
There have been many suggested paths forward. For example, several proposals would provide certain digital assets exemptions or safe harbors from registration obligations and other regulatory oversight. Rather than solving for how to make the use of these digital asset securities compliant from the moment investors put their capital at risk, these proposals would define the tokens as outside our jurisdiction, at least for several years. One aspect of these proposals makes a lot of sense to me. Projects should provide the names and biographies of team members. For an industry that promotes transparency, I have been surprised how frequently offerings include secret identities, concealed control persons, and embellished or totally fictional teams. Requiring honest disclosures of the development team on whom investors are relying is a necessary step. However, it is not sufficient by itself.
Although we have perhaps the most successful framework in the world for businesses to raise capital, the projects at which these exemptive proposals are aimed grapple with two unique characteristics. The first is the need to achieve network effects, and the second is the project’s choice to use a token with speculative profit potential to raise funds instead of giving up equity or taking on loan obligations. I’ll address each in turn.
The network effects aspects of digital assets is a fancy way of saying that for some projects, developers need to widely distribute their tokens, generate sufficient interest in their use and exchange, and align incentives of various cohorts to establish a functional network of motivated participants. Essentially, the economic principle of network effects posits that the more individuals you have actively participating in a network, the more valuable the network is. One frequent example is social media, in which the more users are engaged and participating, the more valuable the entire network becomes. But there are many proven ways to achieve network effects that don’t require speculative profit potential. Developers can raise capital in traditional ways and sell or distribute tokens strictly for network use and with no potential for profits, but the vast majority choose not to do so. And while I understand the importance of network effects to new projects, I have seen few examples of investors who purchase tokens seeking speculative profits later becoming committed users of the underlying network. So I remain a bit skeptical that projects can only generate sustainable and valuable network effects primarily from profit-seeking investors, rather than people who actually want to use the network as designed.
In addition, exempting tokens from securities laws would allow developers to raise capital by selling tokens instead of taking out loans or giving up equity. But granting a special exemption to these projects would provide unfair advantages to blockchain related businesses and disadvantage everyone else: participants who raise capital in compliant ways that support healthy markets and informed investors. I am not convinced digital projects should be able to raise money more cheaply, and with fewer burdens, than businesses that employ currently compliant methods. Whatever we do should result in a more level playing field for everyone, not simply shift the advantages.
I also worry that relaxing regulatory requirements in markets prone to investor protection failures, limited investor redress options because of pseudonymity and disintermediation, and market manipulation, cannot sustain investor confidence or yield lasting broad adoption. To sustain growth, markets need more accountability and a consistent set of rules that apply to all.
Had a safe harbor been in place during the Initial Coin Offering or ICO boom of 2017 and 2018, I think the results would have been even worse for investors and the markets. ICOs and other digital asset offerings raised billions from investors, but most never delivered on their promises. Investors suffered the losses. And I think it is not a coincidence that these problematic offerings pre-dated and continued through the beginning of a multi-year downturn in the value of digital assets, sometimes known as the crypto-winter. The price of bitcoin dropped from a high of nearly $20,000 in December 2017, to under $4,000 and did not reach $20,000 again until December 2020. I believe the ICO era excesses, the failure to register, failure to make robust risk disclosures, and failure to ensure fair markets free from manipulation, contributed to investor losses. I also believe those losses dramatically reduced investor confidence, and that depressed the digital asset market for several years.
These are some of the reasons I do not think that a safe harbor that permits unlimited capital raising with only limited disclosures, and no registration requirement, is in the best interest of investors. Nor will it be effective at preventing a re-run of the excesses and failures of the recent past. And when investors lose, so do issuers and all the other market participants who seek to profit from their capital, transaction flow, liquidity, and enthusiasm.
Instead of a harbor, my hope is that we can build a bridge. Blockchain technology, and the financial products and services that rely on it, are constantly changing in form, function, and complexity. Given the speed of evolution, I am constantly learning. I’m reading, listening to speeches, and meeting with a variety of thought leaders, including platform developers, investors, trade groups, academics, and fellow regulators. And almost everyone I speak with, including experts, agree that there are aspects to the technology and emerging applications they are still learning too.
I recognize that some complexities are wholly within the discretion of the project development team, and that is true regardless of technology or industry. If you want to start a restaurant that only accepts stock certificates as payment for tacos, for example, that may not be a model that works well with existing frameworks. In that example, it might not be worth the administrative hassle either. So while I do not think there has been a lack of clarity from the SEC, I also don’t claim that it is simple for developers to employ digital asset securities in new blockchain network applications in a compliant manner. I expect that the fact that it may be challenging will not discourage entrepreneurs from using ingenuity and innovative technology to compliantly build the projects of their dreams.
As with all new developments in the markets, digital assets, distributed networks, and how users interact pose new questions. If a business or their counsel is in this position, we stand ready to work with them, but they are best served by taking the lead. The SEC’s staff are fantastic, but limited in number. While industry may desire blanket definitions or that we proactively label all the specific projects, assets, and activities that are within our jurisdiction, that is not how our regulatory framework functions. We also do not have the resources to do that. And most importantly, analyzing regulatory compliance has always been, first and foremost, the responsibility of the enterprise and their counsel. That obligation applies with no less force when people choose to design their business around digital assets and blockchain technology. This approach is also a practical necessity because the business has the best access to the facts and circumstances on which any such analysis depends. That is even more true in the digital asset space where the people behind projects are often pseudonymous, may be based internationally while selling to U.S. investors, and where projects frequently change directions or features in a way that would also alter the regulatory analysis.
But I believe that if market participants accept proactive responsibility for compliance, we can build a bridge that promotes innovation while preserving market integrity and providing the investor protections needed for these new markets to grow. To me, this requires interested parties – including token issuers, exchanges, and others – to conduct their own analysis of their regulatory compliance, and be ready to share that with us. If you likely fall within our jurisdiction, work with us to describe your plan to comply or explain why some exemption is appropriate. If you have concerns that you can only comply with certain requirements because the nature of your project doesn’t completely fit within our existing framework, come to us with detailed plans for how you will offer a comparable level of disclosure, investor protection, market access, and other important protections guaranteed by the securities laws. Do that before moving forward. When projects do this, I encourage our staff to explore solutions, while remaining faithful to the principles underlying our framework. I do not pretend this path is easy, costless, or fast. A fact that, I know, has deterred many market participants. But beyond being legally required, projects that establish they are compliant will enjoy competitive advantages by differentiating themselves, building investor confidence, and reducing uncertainty and contingent legal obligations (including from private rights of action) that come with operating outside the law. As multiple projects choose this path of compliance, market participants can choose to interact only with other compliant projects, and have the potential to create a more resilient market with more loyal and confident investors. Such a market is likely to succeed long term over those offerings that continue to behave as if regulations do not apply to them. And the more help you can offer us, the more we learn. Working together can also free up resources we can then devote to other issues in this space.
In my research, it sometimes seems like the only constant in the digital asset universe may be change. As a firm believer that innovation can yield great benefits for individuals and economies, I’m thinking about where change is occurring, what that means for the SEC, and how we can respond. For example, just a few years ago, a significant majority of bitcoin transactions occurred on exchanges operating in jurisdictions that are not party to our legal treaties, and where we have very little visibility. As China recently banned digital asset exchanges operating within its borders, I went back to look at how that has impacted where bitcoin transactions now occur. Today six of the top 11 centralized bitcoin exchanges by volume are in the U.S., and two others are in Financial Action Task Force (“FATF”) member countries. These exchanges may be less subject to manipulative trading, and could have more reliable anti-money laundering programs. But none of those exchanges has registered with us, so I am not sure we have sufficient visibility to verify any of that. I am still gathering information, but I know we will achieve better results by working together to create positive change and make decisions based not only on where we’ve been but where things are today and where we anticipate they may be tomorrow.
 See SEC v. Shavers, et. al., 2013 U.S. Dist. LEXIS 130781 (E.D. Tex. Sept. 18, 2014) (granting summary judgment to the SEC and awarding $40.7 million in damages).
 See id.
 See id.
 See SEC v. W. J. Howey Co., 328 U.S. 293 (1946)(an "investment contract" exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others, and the statutory definition of security includes investment contracts).
 See id.
 See Sec. & Exch. Comm’n, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017) [hereinafter DAO 21(a) Report].
 For conduct that raises novel issues and may also have significant impact for investors and markets, rather than bringing an enforcement action, we may instead use a 21(a) report to explain in detail how we plan to apply the facts and circumstances to our existing laws. See 15 U.S.C. § 78u (2018).
 According to the report, DAO is “a term used to describe a ‘virtual’ organization embodied in computer code and executed on a distributed ledger or blockchain. The DAO was created by Slock.it and Slock.it’s co-founders, with the objective of operating as a for-profit entity that would create and hold a corpus of assets through the sale of DAO Tokens to investors, which assets would then be used to fund ‘projects.’ The holders of DAO Tokens stood to share in the anticipated earnings from these projects as a return on their investment in DAO Tokens. In addition, DAO Token holders could monetize their investments in DAO Tokens by re-selling DAO Tokens on a number of web-based platforms that supported secondary trading in the DAO Tokens.” See DAO 21(a) Report, supra note 6, at 1.
 It also crashed before liftoff due to flawed code and an anonymous user who exploited it to take 3.6 million ETH (then worth more than $55 million) from his fellow investors. See id. at 9. This offering was so prominent that approximately 15% of all then-existing ETH was invested in it. See id. at 9-10. And to undo the harm to such a big percentage of the ETH community, the Ethereum developer and mining community agreed to a hard fork that essentially un-did the investments and the exploit, even though until that point the Ethereum blockchain had been seen as transactionally immutable. See id. But this retroactive investor protection may be unique to the DAO investors. Subsequent exploits and code failures, even those much larger in absolute dollar terms, typically have not garnered sufficient support for another hard fork to rewrite history.
 These are available at the SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”) website. We also memorably highlighted red flags that investors should be aware of through our Howey Coin mimicking of a fraudulent ICO. See Howey Coins, (last visited Oct. 12, 2021). We have taken all these steps in part because clear direct communication supports our efforts to protect investors, ensure fair and efficient markets and facilitate capital formation. Mystery and surprise interpretations of law do not.
 Although our agency has a broad impact and huge markets for which we are responsible, we are a relatively small agency, with approximately 4,400 staff members and oversight responsibility for much of our $110 trillion capital markets, made up of tens of thousands of entities, including registrants, broker-dealers, national securities exchanges, and clearing agencies. And as with the rest of government, our resources are limited. We seek to deploy them as efficiently as possible. We don’t have the time or interest to conceive new violations to investigate. If we pursue an investigation, it is because we in good faith believe there has been a violation of a clear law or regulation. When we bring an enforcement action, we lay out the facts and circumstances and how they apply to our laws, so that defendant and members of the public understand what we allege they did wrong. Courts, who serve an important function as impartial arbiters, have consistently found in our favor in enforcement actions relating to digital asset securities, in which we seek to hold violators accountable. See e.g., SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020); SEC v. Telegram Grp. Inc., 448 F. Supp 3d. 352 (S.D.N.Y. 2020).
 See e.g., SEC v. W. J. Howey Co., 328 U.S. 293 (1946) (the Howey test); Reves v. Ernst & Young, 494 U.S. 56 (1990) (the Reves test); Gary Plastic Packaging v. Merrill Lynch, 756 F.2d 230 (2d Cir. 1985) (reasoning applied facts and circumstances to determine whether conduct was within the ambit of federal securities laws).
 See, e.g., Clarity for Digital Tokens Act of 2021, H.R. 5496, 117th Cong. (2021); Digital Asset Market Structure and Investor Protection Act, H.R. 4741, 117th Cong. (2021); Blockchain Regulatory Certainty Act, H.R. 528, 116th Cong. (2019); Hester Peirce, Commissioner, Sec. & Exch. Comm’n, Public Statement: Token Safe Harbor Proposal 2.0 (Apr. 13, 2021); Andreessen Horowitz, Letter to Senate Banking Committee Regarding Request for Proposals for Clarifying Laws Concerning Cryptocurrency and Blockchain Technologies (Sept. 27, 2021). These are just a few examples among many others.
 Including the Clarity for Digital Tokens Act of 2021 and Commissioner Peirce’s Safe Harbor 2.0 proposals.
 In those networks, the value comes from user engagement, which can drive investor interest but does not derive from it.
 Staying with the social media example, many of these businesses have waited until after they had broad user engagement before they sold securities to the public. They did not depend on their investors to also be the users of the network in order to achieve self-sustaining network effects. And this choice does not appear to have constrained or limited their viability or ability to scale.
 See Andrey Kartsev, Best and Worst of ICO Gold Rush: How Technology Created a Market and Greed Doomed It (Sept. 2021) (published in Alendria, a blog on coinmarketcap.com)
 See Mathias Fromberger & Lars Haffke, ICO Market Report 2018/2019: Performance Analysis of 2018’s Initial Coin Offerings (Dec. 31, 2019) (finding that for ICOs in 2018, within six months only 8% traded above their ICO price, and 70% had lost substantially all their value by 2019).
 That three year slump is particularly significant given that Bitcoin is only 12 years old.
 And I am not alone. My fellow Commissioners and staff have all devoted considerable attention to these issues, as have many offices and divisions within the SEC. We have invested significant resources to understand the issues, provide meaningful guidance, and respond to inquiries. Last year we elevated our FinHub, which has existed since 2018, into a standalone Office from its original position within the Division of Corporation Finance. We have issued guidance, risk alerts, spoken and written on the issues and engaged in no action discussions and issued no action relief. Our public actions feature prominently on portions of https://www.sec.gov and https://www.investor.gov devoted to digital assets and FinTech. We recently issued a statement (including Commission level no action relief and a request for public input) for special purpose broker dealers who custody digital asset securities, and are considering other proposals. See Commission Statement and Request for Comment: Custody of Digital Asset Securities by Special Purpose Broker-Dealers, Release No. 34-90788 (Apr. 27, 2021) [hereinafter Commission Statement & RFC re Custody by Special Purpose BDs]. Especially relative to its size, we have devoted significant resources to providing clarity to this market.
 Fortunately, we do not need perfect knowledge to make choices focused on protecting investors and promoting fair and efficient markets. We can foster compliant innovation without knowing in advance the ultimate end state for the technology. But we’ll need to remain flexible in our approach so that we can calibrate our efforts as technology and markets evolve and our knowledge expands.
 The SEC has often acknowledged this complexity, including in the Commission Statement and Request for Comment as to Custody of Digital Asset Securities by Special Purpose Broker-Dealers. See Commission Statement & RFC re Custody by Special Purpose BDs, supra note 23, at 3.
 The SEC has fewer employees today than it did in 2016, even though over the last five years traditional markets have greatly expanded in number of participants, size, and complexity. And that’s to say nothing of the complexities introduced by the digital asset markets, and the resources we have devoted to understand and respond there.
 One digital asset listing service identifies 7,100 different tokens, and that number continues to expand. See CoinMarketCap, (last visited Oct. 12, 2021). The resources needed to launch a token in a non-compliant way are dramatically lower than the resources needed to assess and ensure a token offering is compliant with all applicable U.S. laws.
 The identity of those who consult with FinHub is non-public, but it is notable that only a fraction of the 7,100 tokens and many other projects that relate to them have sought such a consultation.
 Conversely, some digital asset market participants, developers and promoters operate as if regulations don’t apply to them. That approach is less likely to inspire confidence in investors, and pretending as if rules don’t apply is not protection against an enforcement action that is worse for everyone than complying up front. Even though it is not easy, ultimately it is easier to get the registration and compliance part right at the start, rather than having to potentially litigate a dispute later.
 Over the last several months, my staff and I have engaged with numerous experts, attorneys, developers, and thought leaders to learn more about decentralized finance, or DeFi, so that I can better understand the diverse issues that the growth of this market may raise. And I want to express my appreciation to those who have shared their time, information, ideas, and even their criticisms. I have an open door and welcome the chance to learn and discuss this emerging market, and not just the necessity, but also the value of including robust safeguards and a commitment to compliance.
 Paul Vigna, “Most Bitcoin Trading Faked by Unregulated Exchanges, Study Finds,” Wall Street Journal, Mar. 22, 2019.