“The regulator should be careful not to try to control the development of new technologies.”
– Hester Peirce, SEC Commissioner
SEC Commissioner Hester Peirce delivered a fascinating speech in LA today, addressing the challenges of innovation in the financial services sector while providing insight into her philosophy regarding the emerging initial coin offering marketplace and cryptocurrencies in general. She sees an appropriate role for a regulator as being akin to a lifeguard – taking action when necessary but not monitoring the “sandcastle builders’ every decision.
Peirce, while recognizing the importance of dealing firmly with acts of fraud, appears to be concerned with the SEC’s current approach of rule-making by enforcement action;
“The best path forward is for regulators to approach ICOs and tokens with intense curiosity. We must put in the effort to learn about these new technologies and employ the staff necessary to support our understanding. It is unfortunate that, to date, most of the communications from the SEC on the topic have come from our Division of Enforcement.”
Her statements should be encouraging for participants in the security token sector which, as of recently, have been channeled down the traditional security path as defined by rules created many decades ago when the internet was not even a concept.
Commissioner Peirce asks the tough question out loud;
“That leads us to the burning question: what are these coins, the ones used in ICOs? Are they securities? Are ICOs offerings of securities? To comply with the law, do offerings have to be registered with the SEC or qualify for an exemption? Does the Securities Exchange Act govern trading in the coins after they have been sold by their creator?”
Peirce believes innovation and change is always a challenge for regulators which may be hesitant to adapt.
“Our rules have grown up in response to past technologies. Figuring out whether and how they apply to new ideas is difficult,” said Peirce. “Technology’s promise is too great, however, for us to bury our heads in the sand. I am here today to ask you and others to help us learn more about the technology so that we are able to think about the regulatory obstacles that may stand in the way of crypto-technology’s ability to improve our lives. How can I, in a sense, be a better lifeguard…”
What, functionally, is a security?
Peirce believes that functionality, not form, should help guide policy decisions;
“… Like, for example, tokens. I’m not here, as you might have guessed, to give a speech about arcade tokens. The tokens we’re all so interested in these days aren’t metal and don’t clink. Instead they are…what, exactly? In metaphysical terms, they are sometimes talked about as if they are the gateway to a future that challenges well-established past norms. In physical terms they’re a set of code. In functional terms, well, it depends. And that’s the challenge.”
Cryptocurrencies may function like money or, perhaps, as a means to utilize some sort of service. They may also be considered a commodity or maybe something else. Initial coin offerings, according to Peirce, look the most like securities;
“Their creator sells them [ICOs] as a means of raising funds. In one potential example, the issuer may want to build an environment in which the coins can be used – potentially as a medium of exchange, potentially as a means of executing or tracking exchanges—and sells the coins before the environment is built. The proceeds from the sales of tokens are used to build the system in which they will one day function. A coin that has no functionality at the time of sale will likely be cheaper to buy than one that offers entry into a fully realized environment. After all, which would you pay more for: a token for an arcade that is laid out in broad terms in a white paper, or a token for an arcade where you can play Space Invaders right now? The actual token – its form – would be no different, whether the arcade was built or not, but the functionality certainly would be.”
While the ICO market may currently be defined as securities, Peirce is cautious that this is the best approach;
“I am wary of any blanket designation for all ICOs. Instead, the best path forward, at least for the time being, is to evaluate the facts and circumstances of each offering.”
A knee jerk reaction to innovation, in the face of pressing challenges of global fraud, may harm Fintech innovation. There are “traps” for regulators which they must try to avoid.
“… we must be careful not to let our lack of familiarity with new technology breed anxiety and therefore bad regulation. There is a risk, when something truly innovative comes along, that regulators will focus only on the harms the innovation may bring and miss entirely the opportunity it presents to improve people’s lives. New technology does often bring with it risks; it can take time and experience for developers to build in the proper safeguards. For example, we have seen lots of crypto currency thefts.”
“How can I, in a sense, be a better lifeguard?”
Peirce is clearly willing to accept change and understands the possible economic benefits of allowing innovation to flourish. Yet she is a single voice in a Commission of five. The Chair of the Commission, Jay Clayton, has been on the record stating he has yet to see an ICO that was not a security, but he has also intimated there is a possibility of a true utility token, that may not fall under existing securities law. This potential future may require Congressional action which is, in itself, an exceptional hurdle.
Peirce hopes to be able to navigate these unchartered waters with the assistance of other regulators. She does not believe it is the SEC’s role to “hand out permission slips for innovation,” as innovation must occur outside the confines of government restrictions driven by creative entrepreneurs. Commissioner Peirce is worried that benefits new technology may be hindered by excessive regulatory action or, possibly, misguided legislation. The SEC should not become an innovative industry’s adversary nor should they control crypto development.
“… we must be careful not to let our lack of familiarity with new technology breed anxiety and therefore bad regulation. There is a risk, when something truly innovative comes along, that regulators will focus only on the harms the innovation may bring and miss entirely the opportunity it presents to improve people’s lives. New technology does often bring with it risks; it can take time and experience for developers to build in the proper safeguards.”
This is a must read speech, and is among the best to date, by a US regulator or policymaker.
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