Crypto firms shouldn't fear being regulated as securities
Scrappy founders have thrived in recent years with startups that aim to address some of the systemic unfairness of legacy economic systems.
The most exciting of these have incorporated cryptocurrency tokens to write an ethos of access and opportunity into their code itself, giving rise to the maxim “code is law.”
From a technical perspective this is true: Encoding the rules and responsibilities governing a security removes the need to trust in other people, who are capable of error or malfeasance. Eliminating this weakness is a major rationale behind cryptocurrency development.
But this approach misses a major truth: Code is not law. I learned this in my time as a securities attorney in traditional finance. In that role, and later when I joined AngelList, I realized how essential regulations were to the operation of the markets. And I recognized the degree to which these same rules could restrict access to high-quality investments, perpetuating existing wealth inequalities.
In the U.S., investment in private securities — the ability to own shares in companies that don’t trade on public exchanges — is limited to those known as accredited investors. To qualify, an individual must earn at least $200,000 for three consecutive years or have a net worth of at least $1 million. In other words, only those who are already wealthy are allowed to invest in the next Google or Apple before they IPO. It is, largely, the regulatory side that lets the rich get richer and keeps everyone else out.
When my family immigrated from Vietnam to the Bay Area, I grew up next door to the glittering wealth of the tech industry but, like most people in Silicon Valley, as an outsider and not a participant. It was clear that only the ultra-wealthy had the access required to invest in baby unicorns at their early stages — creating a closed loop that left most people out. I never lost the memory of my teenage self wishing I could invest early in Amazon and Google. And I saw the potential for a more accessible and inclusive world of venture capital.
In working to deliver a tokenized way for retail investors to share in the wealth created by startup growth, we saw that a key area where previous attempts at tokenization had failed was in understanding and adapting to legal and regulatory requirements. Indeed, some in the crypto space feel that any acknowledgement of regulations’ legitimacy — especially those that regard tokens as securities, not utilities — is a surrender to an unacceptable status quo.
That isn’t true. Like it or not, the definition of a security applies to tokens as much as other instruments.That’s why it’s crucial to understand and optimize the legal side of the equation if we want to see successful, widespread tokenization.
And securities laws, in spite of their shortcomings, exist for very good reasons: to regulate the fair exchange of units of ownership, to protect individuals from fraud or exploitation and to identify bad actors and hold them accountable. In many cases, these laws can and should apply to tokens. It’s true that blockchains offer powerful new ways to provide safeguards and benefits to large numbers of investors. But at bottom, where they still represent a stake in the winnings of a for-profit enterprise, it is entirely appropriate for them to be subject to securities law.
Nor are regulators the immovable Luddites some technologists paint them to be. The truth is that understanding the legal basis of, and justifications for, rules that govern securities is essential to creating the regulatory environment that allows tokenized projects to flourish.
Ultimately, tokens will thrive by adapting to, and helping to improve, the regulatory landscapes of the countries where they trade. It’s no secret that bureaucracies can move painfully slowly, and that they are sometimes loath to challenge their own long-held assumptions. But I am confident that well-designed tokens, with the right legal understanding and regulatory know-how, are the right way to move tokenized securities from the insurgent margins into the financial mainstream. And that will be a win for everyone.