a16z: A New Era of Crypto, What Should the SEC Do?

Author: Scott Walker, Bill Hinman

Compiled by: Luffy, Foresight News

As technology continues to evolve, the U.S. Securities and Exchange Commission (SEC) must also keep pace. This is particularly evident in the cryptocurrency space. The new leadership and the newly formed cryptocurrency task force provide the agency with an opportunity to take concrete actions and make adaptive adjustments.

Now is the time to act: the cryptocurrency market has grown in scale and complexity to the point where the SEC's previous reliance solely on enforcement while neglecting regulation is in urgent need of an update. As professional investment services begin to enter this emerging industry, there is no alternative but to promote market development, encourage innovation, and protect investors. The principles underpinning relevant securities laws—information disclosure, fraud prevention, and market integrity—must always remain sacrosanct. However, applying these principles in a manner that reflects the uniqueness of crypto assets requires targeted regulatory reform.

This article proposes immediate and easily implementable adjustments that the SEC should take to formulate applicable regulatory rules without sacrificing support for innovation and investor protection. While legislation is necessary to clarify the classification of crypto assets and secondary market regulation, these measures will bring immediate benefits to the market.

1. Provide interpretive guidance on "airdrops" and other incentive-based rewards

The SEC should provide interpretive guidance on how blockchain projects can distribute crypto assets to participants without being classified as a securities offering. These distributions, commonly referred to as "airdrops" or "incentives," are typically conducted for free or for a nominal fee, often as a reward for early use of a specific network or ecosystem. Such distributions are key means for blockchain projects to build communities and gradually achieve decentralization, distributing ownership and control of the project to users.

This decentralization process has many benefits. Decentralization can protect investors from risks typically associated with securities and centralized control, while promoting the development of the network and enhancing its value. If the SEC can provide guidance on distributions, it can curb the trend of airdropping only to non-U.S. persons. This trend effectively transfers ownership of blockchain technology developed in the U.S. overseas, creating windfalls for non-U.S. persons at the expense of U.S. investors and developers.

Specific actions:

• Establish eligibility criteria: Set basic standards for crypto assets that can be distributed in airdrops and incentive-based rewards without being considered investment contracts (subject to securities laws). For example, crypto assets whose market value primarily derives from the programmatic operation of any distributed ledger or similar technology, or any executable software deployed to a distributed ledger or similar technology, should qualify for such distributions if they do not fall into other categories of securities.

2. Revise crowdfunding rules to regulate exempt offerings

The SEC should revise crowdfunding rules to more effectively regulate exempt offerings of crypto assets.

Current limitations on fundraising amounts and investor participation in crowdfunding activities are not suitable for crypto startups, as these companies often need to distribute crypto assets more broadly to achieve sufficient user scale and network effects for their platforms, applications, or protocols.

Specific actions:

• Raise fundraising limits: Increase the maximum amount that can be raised through crowdfunding to a level that aligns with business needs (e.g., up to $75 million or a certain percentage of the entire network based on disclosure depth).
• Exempt offerings: Allow crypto projects to rely on exemption provisions similar to Regulation D while reaching a broader range of investors through crowdfunding platforms (rather than only targeting accredited investors).
• Protect investors: Implement appropriate safeguards, such as setting individual investment limits (similar to current Regulation A+ practices), and establishing comprehensive disclosure requirements covering important information related to crypto enterprises. (For example, while offering disclosures may typically involve details about directors, compensation, and shareholdings, disclosures regarding the underlying blockchain, governance, and consensus mechanisms may be more critical for crypto asset investors.) Tailoring these requirements for crypto asset investors can ensure they are well-informed and protected from fraud.

These changes will enable early-stage crypto projects to access a broad investor base while maintaining transparency and democratizing investment opportunities.

3. Allow broker-dealers to engage in crypto asset and securities business

The current regulatory environment restricts traditional broker-dealers from substantial participation in the crypto space, primarily because it requires broker-dealers to obtain separate approvals for engaging in crypto asset trading and imposes stricter regulations on those wishing to custody crypto assets.

These restrictions create unnecessary barriers to market participation and liquidity. Allowing broker-dealers to facilitate trading of both securities-like crypto assets and non-securities crypto assets will enhance market functionality, investor access opportunities, and investor protection. On today's crypto trading platforms, non-securities crypto assets (such as Bitcoin and Ethereum) can be traded seamlessly with crypto assets that the SEC may deem subject to securities laws.

Specific actions:

• Enable a registration mechanism: Create a clear registration pathway for broker-dealers to register for engaging in (and custodying) crypto asset (including securities and non-securities) business, with specific requirements based on the nature of these assets.
• Strengthen the regulatory framework: Establish oversight mechanisms to ensure compliance with anti-money laundering (AML) and Know Your Customer (KYC) regulations, maintaining market integrity.
• Collaborate with the industry: Work with the Financial Industry Regulatory Authority (FINRA) to issue joint guidance addressing the unique operational risks of crypto assets.

This approach will promote the establishment of a safer and more efficient market, allowing broker-dealers to bring their expertise in best execution, compliance, and custody to the crypto market.

4. Provide custody and settlement guidance

Custody and settlement remain key barriers to institutional adoption of crypto assets. The lack of clarity in regulatory treatment and accounting rules has deterred traditional financial institutions from entering the custody market. This means many investors cannot benefit from professional asset custody services and must invest and arrange custody solutions on their own.

Specific actions:

• Issue custody guidance: Provide guidance on custody rules under the Investment Advisers Act, clarifying how investment advisers can custody crypto assets and ensuring adequate safeguards such as multi-signature wallets and secure offline storage are implemented. This should also include guidance on staking idle assets and governance decision voting for crypto assets under investment adviser custody.
• Establish settlement standards: Develop specific guidance for the settlement of crypto transactions, including timelines, verification processes, and error resolution mechanisms.
• Create a technology-neutral framework: Allow for flexible adoption of innovative custody solutions, provided they meet regulatory standards, without mandating specific technological requirements.
• Correct accounting treatment: Repeal SEC Staff Accounting Bulletin No. 121 (SAB 121) to allow the accounting treatment of custodial digital assets to reflect the actual custodial arrangements rather than assuming a liability exists. The background is that SAB 121 states, "As long as the company is responsible for safeguarding the crypto assets held on behalf of platform users… the company should recognize a liability on its balance sheet to reflect its obligation to safeguard the crypto assets held on behalf of platform users," corresponding to an asset. The overall effect of SAB 121 is to include custodial crypto assets on the custodian's balance sheet, which contradicts traditional accounting treatment for custodial assets. Thus, unlike typical custodial arrangements, if the custodian goes bankrupt, this accounting treatment could lead to custodial crypto assets being included in the custodian's bankruptcy estate. Worst of all, SAB 121 lacks legitimacy. The Government Accountability Office found that it is actually a rule that should be submitted to Congress for review under the Congressional Review Act, and in May 2024, the House and Senate issued a joint resolution disapproving SAB 121, but that resolution was vetoed by President Biden.

This clarity will lay the groundwork for institutional confidence, enabling large participants to enter the market while enhancing market stability and competition among service providers. Furthermore, both retail and institutional investors will gain protections associated with professional, regulated asset management services.

5. Reform exchange-traded product (ETP) standards

The SEC should take reform measures regarding exchange-traded products (ETPs) to promote financial innovation. These proposals aim to provide broader market access opportunities for investors and custodians accustomed to managing ETP portfolios.

Specific actions:

• Restore market size testing: The SEC's reliance on the "Winklevoss test" for market surveillance agreements has delayed the approval of Bitcoin and other cryptocurrency ETPs. This test requires that for commodity-based ETPs to trade on national securities exchanges like the New York Stock Exchange (NYSE) or NASDAQ, the listing exchange must enter into a surveillance agreement with a "significant size regulated market" for that commodity or its derivatives. Given that the SEC does not consider crypto trading platforms to be "regulated markets," this effectively means that ETPs are only applicable to crypto assets that have futures markets (regulated by the Commodity Futures Trading Commission) and can predict price discovery for the underlying commodity. This ignores the significant scale and transparency of the current crypto market. More importantly, it creates an arbitrary distinction between the standards applicable to cryptocurrency ETP listing applications and all other commodity-based listing applications. Therefore, we recommend restoring the historical testing standard for significant size markets: requiring only that the commodity futures market has sufficient liquidity and price integrity to support ETP products. This adjustment will align the approval standards for crypto ETPs with those for other asset ETPs.
• Allow physical settlement: Permit crypto ETPs to settle directly in the underlying assets. This will lead to better fund tracking, lower costs, improved price transparency, and reduced reliance on derivatives.
• Apply custody standards: Mandate strict custody standards for physically settled transactions to reduce the risk of theft or loss. Additionally, provide staking options for idle assets in ETPs.

6. Implement 15c2-11 certification for alternative trading systems (ATS)

In a decentralized environment, the issuers of crypto assets may no longer play a significant ongoing role, raising the question of who is responsible for providing accurate disclosure information about the asset. Fortunately, there is a similar beneficial rule in traditional securities markets, namely the Securities Exchange Act Rule 15c2-11, which allows broker-dealers to trade a security provided that, among other conditions, investors can access the latest information about that security.

Extending this principle to the cryptocurrency market, the SEC could allow regulated crypto trading platforms (including exchanges and broker-dealers) to trade any asset for which the platform can provide investors with accurate, up-to-date information. The result would be increased liquidity for such assets in SEC-regulated markets while ensuring that investors can make informed decisions. Two obvious benefits of this are that digital asset pairs (one of which is a security and the other is not) can be traded in SEC-regulated markets, and it curbs the incentive for trading platforms to operate overseas.

Specific actions:

• Simplify the certification process: Establish a streamlined 15c2-11 certification process for crypto assets listed on alternative trading systems (ATS), providing mandatory disclosures about the asset's design, purpose, functionality, and risks.
• Adopt due diligence standards: Require exchanges or ATS operators to conduct due diligence on crypto assets, including verifying the identity of the issuer and important characteristic and functionality information.
• Clarify disclosure requirements: Mandate regular updates of information to ensure that investors receive timely and accurate information. Additionally, clarify when, due to decentralization, the issuer's reports are no longer relevant to potential purchasers, thus eliminating the need for further reporting.

This framework will promote transparency and market integrity while allowing for robust innovation in a regulated environment.

Conclusion

The SEC is at a critical juncture in determining the future of cryptocurrency regulation. The newly formed cryptocurrency task force indicates the commission's intent to change the course set by the previous administration. By immediately taking the key steps outlined above, the SEC can begin to shift from its historically controversial enforcement-focused model to provide urgently needed regulatory guidance and practical solutions for investors, custodians, and financial intermediaries. This will better balance the protection of investors with the promotion of capital formation and innovation.

The proposed reforms will reduce uncertainty and support financial innovation in the crypto space. Through these adjustments, the SEC can reclaim its mission and reposition itself as a forward-looking regulatory agency, ensuring that the U.S. market remains competitive while protecting the public interest. The long-term future of the U.S. crypto industry may require Congress to provide a comprehensive and applicable regulatory framework. However, until that framework is in place, the steps outlined in this article are a pathway toward appropriate regulation.