The U.S. Securities and Exchange Commission (SEC) has been gone to significant lengths in an effort to know the crypto asset space. This effort is to be applauded. However, the SEC has did not come to terms with one fundamental aspect of crypto assets and systems.
Namely, properly constructed crypto systems don’t involve “persons” or “entities” and don’t represent a sort of property. For this reason, they are doing not have any analogue within the traditional financial world, nor can they fall into financial regulation.
In the traditional financial world, assets are a claim on a selected property. for instance , a commodity, shares during a company or a debt owed.
Crypto assets, however, aren’t a claim on anything. what’s bitcoin a claim to? Or ether?
Instead, crypto assets are a sort of proof. they’re cryptographic proof that a selected set of mathematical functions has been performed. they’re proof that certain software instructions are performed and of the algorithmic outputs of that software. And crucially, the mathematical functions are performed by nobody especially , they’re performed by the network as an entire .
Property is “ownership determined by law.” Crypto assets aren’t property because they’re not determined by law – they’re determined by maths. This presents some obvious issues when it involves deciding exactly the way to regulate them.
There is no bitcoin
Many people today speak of cryptocurrencies within the shorthand of property. they assert things like “Alice transferred a bitcoin to Bob,” but we shouldn’t let this metaphor confuse us.
In actual fact, there was no bitcoin that existed anywhere and it didn’t move from anybody place to a different .
In “The Matrix,” Neo understood truth nature of the planet when he understood that “there is not any spoon.” Likewise, we will only understand truth nature of blockchain once we recognize that “there is not any bitcoin.”
Instead, what really happened is that Alice proved to Bob that she had certain secret knowledge which she had used that knowledge to perform a mathematical process . But wait, the rabbit burrow goes even deeper.
Even “Alice” and “Bob” are misleading fictions. Alice isn’t necessarily an individual , that’s shorthand too. Alice is basically only an address – an output of a hash function, which will or might not be related to a selected “entity.”
Now, of course, sometimes Alice may be a person. And sometimes Alice created a “token” (another metaphor) and sold it to Bob as an investment. during which case, arguably that was a securities offering and may be regulated by the SEC.
However, the SEC doesn’t stop there. The agency wants to manage what happens to those tokens, as they interact with smart contracts too. In its November 16 “Statement on Digital Asset Securities Issuance and Trading,” the agency says:
“Any entity that gives a marketplace for bringing together buyers and sellers of securities, no matter the applied technology, must determine whether its activities meet the definition of an exchange under the federal securities laws.”
An “entity” here refers to a legal person.
As an example, they use EtherDelta, and specifically its smart contract, saying:
“EtherDelta’s smart contract was coded to, among other things, validate order messages, confirm the terms and conditions of orders, execute paired orders, and direct the distributed ledger to be updated to reflect a trade.”
Here is where taking metaphorical thinking can easily go too far, and where the SEC is introducing vague and problematic language. EtherDelta, as an entity, provided various services (such as a webpage interface for interacting with the smart contract). EtherDelta also developed the smart contract.
But who “provided” the smart contract? Who performed its functions? Not EtherDelta or anyone else especially .
The SEC might regulate the EtherDelta website but to aim to manage the smart contract may be a results of confusion.
The rabbit burrow goes deeper
This confusion gets worse when the SEC talks about secondary markets for these “securities.”
Crypto assets are so new that even many experienced practitioners are confused and think that they represent a definite property. As a result, as an industry, we’ve been far too willing to indulge the SEC view that since something was the merchandise of a securities offering, it remains a security thereafter. Once we realize that there are not any “tokens” and no “property,” we realize that this is often a categorical error.
It becomes easy to ascertain this error when one imagines the subsequent scenario: Bob, having purchased the tokens from Alice sends them to a sensible contract owned by nobody. He has given up claim of ownership – which might mean that no legal entity owns the “security.”
By definition, a security is an “investment contract.” A contract is “an agreement between legal persons, creating obligations that are enforceable by law.”
So for something to be a security, it must, therefore, (a) be between legal entities and (b) be enforceable by law (not math).
Tokens held by smart contracts fail both these tests. they can’t properly be described as securities. However, the SEC is suggesting something radically new: that a group of instructions which involves no agreement, no persons and isn’t enforced by law (but rather by math) can yet still be viewed not even as a contract but as a security. this is often a radical departure from existing law.
Property laws and financial laws believe enforcement by governments. Since there are many governments and their jurisdictions are limited, there’s no truly global system of enforcement that’s appropriate to the borderless world of the web .
A huge potential advantage of crypto assets is that they overcome this problem — by not being a product of law or limited to its jurisdiction.
The SEC, for obvious reasons, would really like to determine jurisdiction over crypto assets. However, this jurisdiction is merely appropriate where there are legally enforceable contracts between legal entities.
For the SEC, or anyone, to not recognize this important distinction may be a recipe for overreach and confusion. it’s the potential to rob many folks for the advantages of a very global, digital method of managing ownership and value.