SEC Centralization in an Age of Blockchain Decentralization: Why Emerging Markets Continue to Lead Blockchain Innovation

K. Alexia Hefti and Marvin Hichem Coleby
On July 25, 2017, the US Securities and Exchange Commission (“SEC”) finally released a report on its investigation into the DAO. The SEC found that the DAO violated federal securities laws and that any platforms, including exchanges, that use distributed ledger or blockchain technology for capital raising must take steps to comply with SEC regulations. This includes most, but not all, initial coin offerings (“ICO”). The SEC’s decision represents a stark contrast to the more regulatory-friendly approach to blockchain technologies taken by many emerging market regulators and governments.
A DAO entity v the DAO investigated by the SEC
Quite confusing, yet important to understand, the SEC adopted an intentionally broad definition of a decentralized autonomous organization: ‘a “virtual” organization embodied in computer code and executed on a distributed ledger or blockchain’ (“DAO Entity”). With this approach, many blockchain companies today are likely operating as DAO entities and therefore subject to U.S. federal securities law.
The DAO is an example of a DAO Entity, and is the subject of the SEC’s investigation. The DAO was created by Slock.it and its founders. Its objective is to operate as a for-profit entity that creates and holds assets by selling DAO Tokens, which would be used to fund various projects. Here are some key takeaways from the SEC’s report.
Is the SEC’s approach surprising? Not at all. The DAO Tokens were likely going to be considered securities under applicable US regulations. We now know that any token that satisfies the Howey Test will qualify as a security.
Does the SEC report cast a dark cloud over the global crypto community? Not really. Most companies operating in the space are careful to explicitly exclude US residents from participating due to the risks of unwelcome SEC scrutiny. The report confirms that they are right to do so. Importantly, there is a lot that the SEC did not say, and this leaves room for legal interpretation with respect to different types of tokens, and to crowdsales versus private ICOs.
Does the SEC’s stance limit the potential for blockchain innovation in the U.S.? Absolutely. The report confirms why countries that are ‘crypto-friendly’ like Estonia, Hong Kong, Malta, Mauritius, Singapore, South Africa, Switzerland, among others (see below) will continue to lead the charge in blockchain innovation. The SEC’s rigid regulatory approach to blockchain technologies represents a shift in the global technology industry. While startups build entire business models around achieving exposure to the U.S. market, they may today want to avoid the U.S. market altogether.
Key Takeaways from the SEC’s Decision
(1) The SEC decided not to pursue an enforcement action against the DAO and the Slock.it founders.
The decision not to pursue an enforcement action against the DAO and Slock.it founders is welcoming news to the community. However, it should neither be seen in a positive manner nor as a green light that the SEC will not seek enforcement action for future violations. This decision feels more like a warning to the community. The reason behind the SEC choosing not to seek action is likely because the DAO never actually commenced its business operations funding projects.
(2) Blockchain technologies will need to fit into outdated U.S. legal frameworks.
Innovators in this space would be prudent to become familiar with U.S. securities regulations. The SEC reduced a system of digital signature chains, computational proof verifications, timestamps, complex mathematical algorithms, gas limits and other incredible blockchain technological innovations to a ‘token’ in order to fit it within the definition of a centralized institution governed by inflexible and archaic legislation that was written 80 years ago, before the Internet even existed.
(3) The SEC just limited the potential for blockchain and dapp development in the U.S.
The U.S. is undoubtedly the current leader of the global technology innovation industry. In 2016, the US still accounted for $69 billion in venture capital funding. As a result, many technology startups around the world build entire business models around attracting U.S. venture capital or exposure to American consumers. The SEC’s report represents an alternative trend: Dapps and blockchain technologies may continue to entirely avoid the U.S. as long as regulation remains in flux and registration requirements are overly onerous. Innovators in this space will continue to look to countries that are adopting more flexible approaches to regulation in this space. Ironically, many of these countries are emerging markets where blockchain technology is expected to be particularly transformative.
(4) Emerging economies will continue their leadership role in the space.
Though regulation within the blockchain space is welcome, regulators need to adopt flexible and accommodating approaches to encourage innovation. The U.S. and SEC can learn from countries like Bahrain, Barbados, Brazil, Dubai, Estonia, Hong Kong, Malaysia, Mauritius, Japan, Singapore, South Africa, Sweden, Switzerland, Thailand, United Kingdom and Vanuatu that are exploring creative regulatory environments for blockchain technologies. This list is perhaps surprisingly dominated by emerging market countries that have recognized the novelty of blockchain, both as a technology and regulatory instrument. Their regulatory-friendly approach encourages cryptopreneurs to reach their innovative potential, while operating within the bounds of today’s corporate limits.
The SEC’s report is a chance for many of these countries to continue their leadership role and work with innovators to create more trusted public services, innovative technologies, new industries and employment. For now, the SEC’s decision provides an opportunity for other countries, and emerging market countries in particular, to continue to plough forward in growing opportunities and becoming global centres for blockchain and crypto-innovation.
— — — — — — — — — — — — — — — — — — — — — — — — — — — — — —
Marvin Hichem Coleby is an international lawyer and entrepreneur specializing in venture capital and technology startups. Based in Toronto, and originally from The Bahamas, Marvin focuses on the transformative potential of blockchain technology for innovation in emerging markets.
K. Alexia Hefti is a New York lawyer currently working for a multinational firm specializing in international corporate tax in Toronto, Canada. Originally from Switzerland, home of Crypto Valley, Alexia is interested in the legal and tax implications of blockchain technology.
— — — — — — — — — — — — — — — — — — — — — — — — — — — — — —
Photo Credit: Steven Depolo, via flickr, CC by 2.0
