Author: Phoenix Capital
The Ripple case has achieved a partial victory in the programmatic sales, avoiding being classified as a securities sale; we carefully analyze the logic of the court’s judgment and believe that there may be obvious errors in the determination of facts, which are likely to be overturned later.
We analyze the historical origin and basic connotation of securities law and believe that tokens with the narrative of “project parties doing things” are close to the definition of securities law, so a considerable proportion of tokens in the future may be classified as securities; However, the regulatory demands of the SEC currently go beyond the reasonable scope of securities law.
The probability of staking/yield farming being classified as securities is significantly higher than that of general token sales.
Compared to the regulation of CeFi, the regulation of DeFi is at an earlier stage; in addition to securities law, there are more uncontroversial regulatory issues such as KYC/AML that have not been resolved.
Even if a large number of altcoins are classified as securities, it will not be the end of the industry. Large-cap tokens have the conditions to seek compliance in the form of securities; small-cap tokens may continue to exist in non-compliant markets for a long time, but can still indirectly obtain liquidity from compliant markets. As long as there is a clear regulatory framework, no matter what it is, the industry can find new paths and models for long-term development.
Long-awaited (temporary) victory – Interpretation of the Ripple case
Ripple Labs obtained a partial favorable ruling from the New York District Court on July 13, 2023, and the crypto market responded with a sharp rise. In addition to XRP itself, a series of tokens previously classified as securities by the SEC also soared.
As we will discuss later, we are still far from the era of clear regulation in the crypto industry. But undoubtedly, Ripple Labs’ partial victory is still one of the most important things in the crypto industry in 2023.
Below are some important disputes that have occurred between US regulators and the crypto industry before SEC vs Ripple Labs.
We can see that almost all previous major disputes ended with the failure or compromise of crypto companies.
In a sense, this is the first meaningful victory of the crypto industry in its war with US regulators, even if it is only a partial victory.
There have been many detailed interpretations of the specific content of this court ruling, which we will not go into here; interested friends can read the long tweet by LianGuairadigm Policy Director Justin:
Ok, having gone through the Ripple decision, here’s my takeaway:
Big loss for the SEC’s approach to crypto via focusing solely on enforcement, and this measurably increases the odds of crypto legislation passing this year.
— Justin Slaughter (@JBSDC) July 13, 2023
Everyone can also read the original text of the court ruling in their spare time:
Before we delve into the details of this verdict, let’s briefly introduce the core standard for defining securities in the US legal system, the Howey Test.
Howey Test, Citrus Orchards, and Cryptocurrencies
In order to understand all the disputes over cryptocurrency regulation today, we must go back to the sunny Florida of 1946 and the cornerstone case of securities law, SEC vs Howey.
(The following story synopsis was primarily written by GPT-4)
In the post-World War II era of 1946, W.J. Howey’s company owned a bountiful citrus orchard in the picturesque state of Florida.
To raise more investment, Howey’s company launched an innovative plan that allowed investors to purchase land in the citrus orchard and lease it to Howey’s company for operation. Investors would then receive a portion of the profits. In that era, this proposal was undoubtedly attractive to investors, as owning one’s own land was a captivating prospect.
However, the Securities and Exchange Commission (SEC) did not approve. The SEC believed that the plan offered by Howey’s company was essentially a security, and since Howey’s company did not register with the SEC, it was a clear violation of the Securities Act of 1933. As a result, the SEC decisively decided to sue Howey’s company.
This lawsuit eventually reached the Supreme Court. In 1946, the Supreme Court made a historic ruling on SEC vs Howey. The court supported the SEC’s position and ruled that Howey’s company’s investment plan met the definition of a security, thus requiring registration with the SEC.
The Supreme Court’s judgment on Howey’s company’s investment plan was based on the four basic elements of the so-called “Howey Test.” These four elements are: investment of money, expectation of profits, common enterprise, and profits derived from the efforts of others. Howey’s company’s investment plan met all four of these elements, thus the Supreme Court determined it to be a security.
First, investors invested money to purchase land in the citrus orchard, which met the first element of the “Howey Test” – investment of money.
Second, the purpose of investors purchasing and leasing land to Howey’s company was clearly to expect profits, which aligns with the second element of the “Howey Test” – expectation of profits.
Third, the relationship between investors and Howey’s company actually constituted a common enterprise. Investors invested, Howey’s company operated the citrus orchard, and both worked together to obtain profits. This meets the third element of the “Howey Test” – common enterprise.
Lastly, the profits from this investment plan primarily came from the efforts of Howey’s company. Investors only needed to invest money to reap the benefits, which satisfies the fourth element of the “Howey Test” – profits derived from the efforts of others.
Therefore, based on these four elements, the Supreme Court ruled that Howey Company’s investment plan constituted a security and needed to be registered with the SEC.
This ruling had far-reaching implications and formed the widely referenced “Howey Test,” which defines the four basic elements of an “investment contract”: investment of money, expectation of profits, common enterprise, and profits derived solely from the efforts of others. These four elements are still used by the SEC today to determine whether a financial product constitutes a security.
For purposes of the Securities Act, an investment contract (undefined by the Act) means a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.
The above is the exact definition of securities in the Supreme Court’s opinion in 1946, which can be broken down into the following four commonly used criteria:
The law is truly fascinating. It often uses abstract and simple principles to guide the complex and ever-changing specific matters in the real world, whether it’s an orange grove or cryptocurrency.
Why do we need securities laws?
In fact, it doesn’t matter how securities are defined. There is no substantial difference between calling something a security or not. The key is what legal responsibilities are derived from the economic nature of securities, which is why something with the four attributes of the Howey Test needs an independent legal framework to supervise it.
The Securities Act of 1933, which was created more than a decade before the Howey Test, clearly explains why securities laws are needed.
Often referred to as the “truth in securities” law, the Securities Act of 1933 has two basic objectives:
1) require that investors receive financial and other significant information concerning securities being offered for public sale; and
2) prohibit deceit, misrepresentations, and other fraud in the sale of securities.
The starting point of securities laws is very simple – it is to ensure that investors can obtain enough information about securities and be free from deception. Conversely, the responsibilities imposed on securities issuers are also simple, with disclosure being the core requirement. They must disclose important information related to securities in a complete, timely, and accurate manner.
The reason securities laws have such a goal is that securities, due to the source of investors’ returns being the efforts of a third party (active LianGuairticiLianGuaint), give the third party unequal access to information and influence over the price of securities. Therefore, they have an obligation to disclose to ensure that this inequality does not harm investors.
Commodity markets do not have similar regulatory requirements because there is no such third party, or in the context of crypto, it is easier to understand as the “project party.” Gold, oil, and sugar do not have project parties. The crypto market generally favors the CFTC and dislikes the SEC, but this is not because regulators have personal preferences and therefore have different attitudes towards crypto. The difference in regulating commodities and securities is based on the inherent nature of the two financial products. Since there is no project party with unequal advantages, the regulatory framework for commodities is naturally much more relaxed.
The fundamental reason for the existence of securities laws is the presence of third parties or project parties with information and influence advantages; the fundamental purpose of securities laws is to curb the infringement of the interests of investors by third parties/project parties; and the main means of implementing securities laws is to require project parties to make complete, timely, and accurate information disclosure.
Is the project party equivalent to securities?
While studying the history of US securities laws, I came across a simple and effective criterion for determining whether a token is a security, which is whether investors care about whether the project party is doing something.
If “the project party is doing something” is meaningful to investors, it means that the return on this investment is influenced by the actions of the project party, which obviously meets the four criteria of the Howey Test. Based on this, we can easily understand why BTC is not a security because BTC does not have a project party. The same goes for meme coins. They are just numbers on the ledger under the ERC-20 protocol without a project party doing something, so naturally, they are not considered securities.
If there is a project party doing something, and whether the project party is doing well or not, doing something or not, whether it is technical upgrades, product iterations, marketing, or ecological cooperation, if it can affect the token price, then the definition of securities is established. Because of the presence of project parties, they have information that other investors do not know and have a greater influence on token prices, so they need to be regulated to ensure that they do not do anything harmful to the interests of investors. “What the project party does is important” → “The project party can manipulate the market” → “The project party needs to be regulated by securities laws”. This is a simple legal reasoning.
If you agree with this logic, you can judge for yourself which tokens in the crypto industry are reasonably deemed securities.
We believe that if investors have expectations or concerns about “the project party doing something”, then the token is highly consistent with the definition of securities. From this perspective, it seems reasonable that a significant proportion of tokens are deemed securities.
**However, the current SEC wants more. From Gary’s public statements, he has only acknowledged that BTC is not a security. For most other tokens, he firmly believes that they should be classified as securities, while a few tokens, such as ETH, currently have a relatively ambiguous attitude.** Recently, the CEO of Coinbase also mentioned in an interview that before the SEC sued Coinbase, they demanded Coinbase to delist all tokens except BTC, but Coinbase refused.
We believe it is unreasonable to classify pure meme coins that do not have a project party operating or highly decentralized payment tokens as securities; **the SEC’s demands go beyond the reasonable scope of securities laws**, which also makes it more difficult for the industry and the SEC to reach a simple reconciliation.
Returning to the SEC vs Ripple Labs ruling, let’s briefly highlight a few key points:
XRP itself is not a security, and it requires analysis of the specific sales of XRP (i.e., the sales process, methods, and channels) to determine whether it constitutes the sale of securities. We will elaborate on this later. *A token is just a token. A token is NEVER a security.*
The court analyzed three forms of XRP sales: institutional sales, programmatic sales, and others. Ultimately, it determined that institutional sales constitute securities, while the other two do not.
The reasons for determining that institutional sales constitute the sale of securities:
The reasons for determining that programmatic sales do not constitute the sale of securities:
Ripple Labs did not make any direct commitments to these investors, and there is no evidence in Ripple Labs’ promotional materials that suggests widespread dissemination among these investors.
These investors have a lower level of complexity and cannot demonstrate a sufficient understanding of how their actions could affect the price of XRP.
It is not difficult to see that the core argument for the court’s determination that programmatic sales do not constitute the sale of securities is based on the fourth prong of the Howey Test, which means that these investors did not expect to profit from Ripple Labs’ efforts.
The XRP buyers did not expect to profit from Ripple Labs’ efforts because:
In this case, investors are unsure whether they are buying from Ripple Labs or other XRP sellers. The majority of XRP trading volume does not come from Ripple Labs’ sales, so most XRP buyers do not directly invest their funds in Ripple Labs.
This ruling by the district court does not have final enforceability. It is almost certain that the SEC will appeal. However, it will go through a lengthy legal process, and we may have to wait months or even years to see the outcome of the new appeal ruling. During this time, the court’s ruling will substantially guide the development of the industry.
Setting aside our position as cryptocurrency investors and looking only at the legal logic, we believe that the court’s determination that programmatic sales are not securities is not very persuasive.
Here are two articles from senior legal professionals who hold similar opposing views. It is recommended to read them when you have time, as our analysis also draws on some of their perspectives.
First, we need to note the original text of the Howey Test, which states ‘…expect profits solely from the efforts of the promoter or a third party…’. It explicitly points out that profits can come from the promoter or a third party, meaning that it is not important who the seller is or whether the source of the efforts is the seller or the promoter. As long as there is such a third party, it is sufficient for the investor to recognize that the appreciation of the asset comes from the efforts of a third party. Therefore, the court’s mention of blind buy/sell and the fact that the buyer does not know whether they are buying XRP from Ripple Labs or someone else is irrelevant to the Howey Test.
The essence of the problem is whether the investors in programmatic sales are aware of the correlation between the rising price of XRP tokens and the efforts of Ripple Labs.
The main argument of the court is that 1) Ripple Labs did not directly promote to retail investors, and there is no evidence that their materials (whitepapers, etc.) were widely disseminated among retail investors, 2) Retail investors do not have the cognitive ability of institutional investors to recognize the correlation between XRP tokens and the technical, product, and marketing efforts of Ripple Labs.
Firstly, this is a factual issue, not a logical one, and we cannot complete the argument here. XRP is an old project, and we do not have a clear sense of the cognitive ability of retail investors at that time.
But from our limited experience, for the majority of tokens with project teams, retail investors are able to realize that the project team’s upgrades in technology, early deployment on the mainnet, better usability of the product, increased total value locked (TVL), more ecological cooperation, and promotion by key opinion leaders (KOL) all have an impact on the price of the tokens they hold.
In the world of crypto, KOLs, Twitter, and small or large Telegram groups have become the bridge between most project teams and users, the territory for promoting to retail investors. In small or large projects, we often hear discussions about “community”. Most project teams have a token marketing/community team responsible for contacting exchanges around the world, hiring KOLs, and helping promote the progress and major events of the project.
We believe that the factual determination of programmatic sales in this court ruling is biased, and we agree with the views of many legal professionals that there is a high possibility that this part of the ruling will be overturned in the future.
(Just one week after the completion of this article, on the day of its planned release, we happened to see that in the case of SEC vs Terraform Labs, the new judge refused to adopt the reasoning of SEC vs Ripple Labs – the reasoning being that regardless of where investors buy the tokens, it does not affect the expectation of the investors regarding the project team’s efforts in influencing the token price.)
“Whatever expectation of profit they had could not, according to that court, be ascribed to defendants’ efforts,” he wrote. “But Howey makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary resale transaction has no impact on whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.”
Off-topic – Airdrops that do not require payment can also be considered securities sales. This is from an article by John Reed Stark. In the late 1990s Internet bubble, several companies distributed free stocks to users via the Internet. In subsequent legislation and litigation, these actions were deemed to be securities sales. The reason is that although users did not pay money to exchange for these stocks, they provided other forms of value – including their personal information (which had to be provided during registration to receive the stocks), and helping the companies distributing the stocks gain attention, forming a substantial exchange of value.
SEC Enforcement Director Richard H. Walker said at the time, “Free stock is really a misnomer in these cases. While cash did not change hands, the companies that issued the stock received valuable benefits. Under these circumstances, the securities laws entitle investors to full and fair disclosure, which they did not receive in these cases.”
A token is just a token. A token is NEVER a security.
As Coinbase CLO LianGuaiul pointed out, this is actually the most important sentence in the entire judgment that was not fully understood by everyone.
XRP, as a digital token, is not in and of itself a “contract, transaction, or scheme” that embodies the Howey requirements of an investment contract. Rather, the Court examines the totality of circumstances surrounding Defendants’ different transactions and schemes involving the sale and distribution of XRP.
Even in the Telegram case, which has a different interpretation from the Ripple case, the judge made a similar statement. This is a highly consistent view from the two judges in these two cases:
The security in this case is not simply the [digital token, the] Gram, which is little more than alphanumeric cryptographic sequence . . . . This case presents a “scheme” to be evaluated under Howey that consists of the full set of contracts, expectations, and understandings centered on the sales and distribution of the Gram. Howey requires an examination of the entirety of the parties’ understandings and expectations.
Both judgments unanimously state an important point:
A token is just a token—it is never the case that XRP is sometimes a security and sometimes not. The token itself can never be a security.
What may constitute a security is the entire set of behaviors (‘scheme’) involved in the sale and distribution of tokens. It is not a question of whether a specific token is a security or not, but rather whether a specific token sale behavior is a security. We can never reach a conclusion on whether it is a security solely by analyzing a specific token, but must analyze the overall situation of the sale behavior (‘entirety of …’, ‘totality of circumstances’).
Even judges with significant conflicts in their opinions insist on judging whether it is a security based on the sales situation rather than the token itself. This consistency also represents a higher possibility of continued adoption of this legal logic in the future than judgments against programmatic sales, and we also believe that this judgment indeed has stronger logical reasoning.
A token is just a token. A token is NEVER a security.
Digital tokens and stocks are fundamentally different. Stocks themselves are contracts signed between investors and companies, and the transactions in the secondary market represent the transactions and transfers of this contractual relationship. On the other hand, as the judge said in the Telegram case, digital tokens are just alphanumeric cryptographic sequences, and they cannot constitute contracts on their own. They can only have the economic substance of a contract in specific sales contexts.
If this legal view is adopted by all subsequent courts, then in the future, the SEC’s burden of proof in the prosecution process will be significantly increased. The SEC cannot obtain regulatory authority over all actions such as the issuance and trading of a token by proving that a token is a security. It needs to prove one by one that the totality of the circumstances of each token transaction constitutes a securities transaction.
The Court does not address whether secondary market sales of XRP constitute offers and sales of investment contracts because that question is not properly before the Court. Whether a secondary market sale constitutes an offer or sale of an investment contract would depend on the totality of circumstances and the economic reality of that specific contract, transaction, or scheme. See Marine Bank, 455 U.S. at 560 n.11; Telegram, 448 F. Supp. 3d at 379; see also ECF No. 105 at 34:14-16, LBRY, No. 21 Civ. 260 (D.N.H. Jan. 30, 2023)
In the Ripple case, it is also explicitly stated that **the court cannot determine whether the secondary sales of XRP constitute securities transactions, and they need to evaluate the specific circumstances of each transaction in order to make a judgment. This poses great difficulties for the SEC to regulate secondary transactions and may be impossible to achieve; in a sense, it gives the green light to secondary trading of tokens.** Coinbase and Binance.US also relisted XRP quickly after the penalty was announced.
Again, it is too early to consider this as a definitive legal rule based solely on the opinion of this precedent; however, **the legal logic of “A token is just a token” does indeed increase the legal obstacles that future SEC regulation of secondary exchanges will face.**
Looking to the Future – Where Are the Risks and Opportunities?
The Sword of Damocles Hanging over Staking
ETH staking is one of the strongest fundamental tracks in the industry since 2023; however, the regulatory risk of staking service is still the Sword of Damocles hanging over this super track.
In February 2023, Kraken agreed to settle with the SEC and closed its staking service in the United States. Coinbase, which was also sued for its staking service, chose to continue the fight.
If we go back to the framework of the Howey Test and analyze objectively, staking service is indeed considered a security for valid reasons.
Kraken chose to settle. So, what are Coinbase’s reasons for persisting in claiming that staking service is not a security?
Coinbase has put forward an interesting argument, stating that “staking users are not investing, but rather being compensated for the contribution they make to the blockchain network.”
This argument may be appropriate for independent stakers. However, as delegated stakers, they do not directly perform tasks such as validating transactions and ensuring network security. Instead, they delegate their tokens to other node operators to perform these tasks using their tokens. Stakers are not direct laborers; in fact, they are much like the purchasers of the orange grove land in the Howey case, owning the land/capital (ETH) and entrusting others to cultivate it (node operation) to obtain returns.
Capital contribution itself is not labor, as the income obtained from capital contribution is capital gains, not compensation.
The situation of decentralized staking services will be more complex, and different types of decentralized staking may ultimately receive different legal judgments.
The four criteria of the Howey Test are mostly similar in centralized staking and decentralized staking, but the difference may lie in whether a common enterprise can exist. Therefore, the pledging model that puts all users’ ETH into the same pool, even if it is decentralized, obviously meets the four criteria of the Howey Test very well.
In SEC vs Ripple Labs, it seems difficult to protect staking services, just like the argument that Ripple won the Programatic Sales case (where both the buyer and seller do not know each other and there is no direct marketing).
Because apart from the situation of directly buying cbETH/stETH in the secondary market, in the case where the pledger pledges ETH to Coinbase/Lido and obtains cbETH/stETH at the same time, it is obvious that 1) the buyer knows who the issuer is, and the issuer knows who the buyer is, 2) the issuer clearly promotes the source of the income.
Similarly, in addition to staking on PoS chains, **various stake/lock token yield products in DeFi also have a high probability of meeting the definition of securities**—if it is difficult to establish the relationship between the token price and the project’s efforts for pure governance tokens, the logic is clear and simple in the scenario of staking to earn yield; at the same time, even the reason that programmatic sales were not recognized as securities in the Ripple case is difficult to establish here—
1) Users hand over tokens to the project-developed staking contract, and the staking contract returns income to users, with the income coming from the project’s open contract;
2) Moreover, in the process of interaction between users and the staking contract, the contract also involves directly promoting and explaining income (promotion), which is difficult to justify using the reasons of XRP programmatic sales.
Overall, for projects that provide staking services (in PoS chains, in DeFi projects), due to 1) clear income distribution, and 2) direct promotion and interaction with users, the possibility of being recognized as securities is further increased compared to projects in the general sense of “projects being carried out by project parties”.
Securities law is not the only regulatory risk
Securities law is the focus of this article, but it is necessary to remind everyone that securities law is only a small part of the entire regulatory framework for crypto—of course, because it is the stricter part, it deserves special attention. Whether a token is ultimately deemed a security or a commodity or something else, there are more fundamental legal responsibilities that are common and many regulatory agencies other than the SEC and CFTC will be involved. There are many contents involved here, which deserve another lengthy article. We will only briefly give an example for everyone’s reference.
This is the KYC-related responsibility with anti-money laundering (AML) and counter-terrorist financing (CTF) as the core. Any financial transaction must not be used for money laundering, terrorist financing, and other financial crimes, and any financial institution is responsible for ensuring that the financial services it provides are not used for these financial crimes. In order to achieve this goal, all financial institutions must take a series of measures, including but not limited to KYC, transaction monitoring, reporting suspicious activities to regulators, and maintaining accurate records of historical transactions, etc.
This is the most fundamental and undisputed basic law in financial regulation, and it is also a field regulated by multiple law enforcement agencies, including the Department of Justice, Treasury/OFAC, FBI, SEC, etc. Currently, all centralized crypto institutions also comply with this law and conduct necessary KYC on all customers.
The main potential risk in the future lies in DeFi. Whether DeFi needs and is possible to comply with similar regulations as CeFi, requiring KYC/AML/CTF; and whether this regulatory model may harm the foundation of the blockchain value, which is permissionless.
From a basic principle, financial transactions occur in DeFi, so it is necessary to ensure that these financial transactions are not used for money laundering and other financial crimes, so the inevitability of regulatory laws is unquestionable.
The challenge lies mainly in defining the regulatory subject. Essentially, these financial transactions are based on the services provided by a piece of code on Ethereum. So, should it be the Ethereum nodes running these codes or the project developers who wrote the codes that should be regulated? (This is why there was controversy over the arrest of the Tornado Cash developer.) Furthermore, the decentralization of nodes and the anonymity of developers make it more difficult to implement this supervisory approach. This is a problem that legislators and law enforcement agencies must solve, and it is questionable how they will solve these problems; but there is no doubt that no regulator will allow money laundering and arms trading on an anonymous blockchain, even if such transactions account for less than one-thousandth of blockchain transactions.
In fact, on the 19th of this month, four senators from the U.S. Senate (two Republicans and two Democrats, so it’s a bipartisan bill) introduced the Crypto-Asset National Security Enhancement and Enforcement (CANSEE) Act, which requires DeFi to meet the same legal obligations as CeFi:
In an effort to prevent money laundering and stop crypto-facilitated crime and sanctions violations, a leading group of U.S. Senators is introducing new, bipartisan legislation requiring decentralized finance (DeFi) services to meet the same anti-money laundering (AML) and economic sanctions compliance obligations as other financial companies, including centralized crypto trading platforms, casinos, and even pawn shops. The legislation also modernizes key Treasury Department anti-money laundering authorities and sets new requirements to ensure that “crypto kiosks” don’t become a vector for laundering the proceeds of illicit activities.
How to ensure the enforcement of AML/CTF in DeFi transactions is a regulatory challenge that the industry must face beyond securities law; in addition, whether tokens are classified as securities or commodities, there are also strict requirements to prohibit market manipulation. How these issues will be resolved in the crypto industry is also a challenge that the industry must face in the future.
Here are some common forms of market manipulation:
Pump and Dump: This involves buying a security at a low price, artificially inflating its price through false and misleading positive statements, and then selling the security at the higher price. Once the manipulator sells their shares, the price typically falls, leaving other investors at a loss.
Spoofing: This involves placing large buy or sell orders with no intention of executing them, to create a false appearance of market interest in a particular security or commodity. The orders are then canceled before execution.
Wash Trading: This involves an investor simultaneously buying and selling the same financial instruments to create misleading, artificial activity in the marketplace.
Churning: This occurs when a trader places both buy and sell orders at the same price. The orders are matched, leaving the impression of high trading volumes, but no net change in ownership.
Cornering the Market: This involves acquiring enough of a particular asset to gain control and set the price on it.
Front Running: This occurs when a broker or other entity enters into a trade because they have foreknowledge of a big non-publicized transaction that will influence the price of the asset, thereby benefiting from the price movement.
If Cryptos Lose – Securities Laws Won’t Kill Altcoins
我们没有足够的法律和政治知识去预测这些法律争端最终的结果，但客观的分析让我们意识到大部分代币被认定为证券是符合美国证券法的逻辑的。So we must reason or imagine what the future of the crypto industry would look like if most tokens were classified as securities.
There Will Be Some Tokens That Choose to Comply with Securities Regulations
First of all, purely from an economic cost perspective, the compliance costs of going public are not so frightening. For large-cap tokens with FDV 1bn+, they are economically viable.
A simple comparison of market capitalizations reveals that there are many tokens whose market capitalizations can be compared to listed companies, especially tokens with FDV 1bn+. There is every reason to believe that they are capable of supporting the compliance costs of a listed company.
There are ~2000 companies with market capitalizations of $100mn-1bn in the US stock market, and ~1000 companies with market capitalizations of $1bn-5bn.
In the current bearish market environment for altcoins, crypto also has around 40-50 tokens with FDV > 1bn and ~200 tokens with FDV 100mn-1bn. It can be expected that in a bull market, there will be many more tokens in the market capitalization of 100mn+/1bn+.
We can also refer to some research on the compliance costs of listed companies. One relatively reliable estimation is the SEC’s calculation of compliance costs for small and medium-sized companies:
Their research shows that the average cost of achieving regulatory compliance to enter the marketplace as an IPO is about $2.5 million. Once they are established, small-cap companies can expect to pay about $1.5 million in ongoing compliance costs every year.
The conclusion is that the listing cost is approximately 2.5 million, and the annual recurring cost is approximately 1.5 million. Taking into account inflation over the years, estimates of 3-4 million for IPO and 2-3 million for annual recurring costs sound reasonable. Additionally, this figure is, of course, positively correlated with the size of the company itself. Microcap companies with several hundred million dollars should be lower than this average. This is certainly not a small amount of money, but for large projects with teams of hundreds of people, it is not an unacceptable cost either.
What is relatively more uncertain is how to solve the compliance issues in the history of these projects.
Stock listing will require auditing the historical financial situation of the company. Tokens are not equity, so the disclosure requirements and listing for stocks should be different and require new regulatory frameworks for clear definitions. However, as long as there are clear rules, there are ways to adjust and handle it. Companies with historical financial issues can also obtain listing opportunities through methods such as restating historical financial statements.
Although the cost of compliance can be acceptable, it is also quite high. So, do project parties have the incentive to do it? This question obviously cannot have a simple answer.
First of all, compliance will indeed increase a lot of burdens and reduce a lot of room for action for many project parties. They cannot engage in “market value management,” insider trading, false advertising, and must announce token sales, etc. This does touch on the fundamentals of many business models.
However, for project parties with particularly high market capitalization, obtaining a broader market liquidity, accessing more deep-pocketed investors, and obtaining comprehensive regulatory approval are important conditions for them to move to the next level in terms of market value growth and project development.
“Illegal exploitation can be intense, but the pool of retail investors is small; legal exploitation requires restraint, but the pool of retail investors is large.”
As the project scales up, the potential benefits of non-compliant operations versus the opportunities brought about by a compliant operation in terms of a broad market and capital access, the balance is increasingly tilting towards the latter. We believe that leading public chains/layer 2 and leading blue-chip DeFi projects will take this step and move towards a completely compliant operating model.
The long-term coexistence and mutual dependence of compliant and non-compliant ecosystems
Of course, most project parties cannot and will not embark on the path of securities compliance. In the future crypto world, there will be a clear boundary between compliance and non-compliance, but they will also constitute closely interconnected parts.
This coexistence pattern already exists today, but the influence of the compliant ecosystem in the crypto world is still relatively small. With a clear regulatory framework, the influence and importance of the compliant ecosystem will increase. The development of the compliant ecosystem will not only significantly increase the overall scale of the crypto industry but also provide liquidity to the non-compliant ecosystem through the form of rising mainstream asset prices.
Large projects are becoming compliant, while small projects can still enjoy the liquidity overflow of the compliant market even if they remain in the non-compliant market; the two markets complement each other ecologically, and the Securities Law will not be the end of crypto.
Peace is more important than victory
On the judicial side, the SEC vs Ripple case has not yet been concluded, and the SEC vs Coinbase/Binance has just begun – it may take several years for these lawsuits to settle.
On the legislative side, since July, there have been multiple crypto regulatory bills submitted in both houses, including the Financial Innovation and Technology for the 21st Century Act, Responsible Financial Innovation Act, Crypto-Asset National Security Enhancement and Enforcement – there have been more than 50 crypto regulatory bills submitted in both houses in history, but we are still far away from a clear legal framework.
The worst outcome for the crypto industry is not that most tokens are eventually classified as securities, but the time and space lost, as well as the wasted resources and opportunities, due to the long-term lack of a clear regulatory framework.
The escalation and intensification of conflicts between regulators and the crypto industry is good news, because it means that the time for conflicts to converge and ultimately be resolved is getting closer.
The announcement of Ripple Labs’ judgment was on July 13th, and the next day, July 14th, is the anniversary of the French Revolution, which reminds me of the turbulence and unrest in France after the revolution. But it was during that chaotic period that the cornerstone of modern law, the French Civil Code, was eventually established. We look forward to seeing that, despite the current confusion and turmoil in the crypto industry, it will eventually find its direction and solution, and establish a set of norms and codes that can coexist harmoniously with the external world.