Six Steps the SEC Could Take to Create “Fit-for-Purpose” Crypto Regulations – Without Sacrificing Innovation or Critical Investor Protections

As technology evolves, the U.S. Securities and Exchange Commission (SEC) must evolve with it. Nowhere is this truer than in crypto

As technology evolves, so must the U.S. Securities and Exchange Commission (SEC). Nowhere is this truer than in crypto. The market for crypto assets has grown in size and sophistication such that the SEC’s recent harmful approach of enforcement and abdication of regulation needs urgent updating.

While the long-term future of the crypto industry in the U.S. will likely require Congress to sign a comprehensive regulatory framework into law, here are six steps the SEC could immediately take to create “fit-for-purpose” regulations – without sacrificing innovation or critical investor protections.

#1 Provide guidance on ‘airdrops’

The SEC should provide interpretive guidance for how blockchain projects can distribute incentive-based crypto rewards to participants — without those being characterized as securities offerings.

Blockchain projects typically offer such rewards — often called “airdrops” — to incentivize usage of a particular network. These distributions are a critical tool for enabling blockchain projects to progressively decentralize, as they disseminate ownership and control of a project to its users.

If the SEC were to provide guidance on distributions, it would stem the tide of these rewards only being issued to non-U.S. persons — a trend that is effectively offshoring ownership of blockchain technologies developed in the U.S., yet at the expense of U.S. investors and developers.

What to do:

The SEC’s Division of Corporation Finance could issue a no-action letter to a blockchain project seeking to conduct an airdrop of its tokens to its community members, blessing the distribution as not being an offering of securities. This would provide clear guidance to the industry on how to proceed with similar initiatives.

#2 Modify crowdfunding rules

The SEC should revise Regulation Crowdfunding rules so they are suitable for crypto startups. These startups often need a broader distribution of crypto assets to develop critical mass and network effects for their platforms, applications, or protocols.

Currently, Regulation Crowdfunding limits the amount of securities that can be offered or sold by an issuer in a 12-month period to a maximum aggregate amount of $5 million. However, this limit is not adjusted for the nature of the asset being offered, which presents a challenge for crypto startups that typically need to distribute a greater number of tokens to achieve critical mass.

What to do:

The SEC could increase the offering limit under Regulation Crowdfunding for crypto startups that meet certain criteria, such as those building decentralized protocols or applications. This would enable these startups to raise capital more efficiently and reach a wider pool of investors.

#3 Enable broker-dealers to operate in crypto

The current regulatory environment restricts traditional broker-dealers from engaging meaningfully in the crypto industry — primarily because it requires brokers to obtain separate approvals to transact in crypto assets, and imposes even more onerous regulations around broker-dealers who wish to custody crypto assets.

These restrictions create unnecessary barriers to market participation and liquidity. Removing them would enhance market functionality, investor access, and investor protection.

What to do:

The SEC could grant a conditional exemption from certain provisions of the Securities Exchange Act of 1934 to broker-dealers who meet specific criteria, such as having a track record of operating in digital asset markets and adhering to best practices for crypto asset custody. This would allow broker-dealers to engage in crypto activities without duplicative registration and burdensome oversight.

#4 Provide guidance on custody and settlement

Ambiguity over regulatory treatment and accounting rules has deterred traditional financial institutions from entering the crypto custody market. This means that many investors are not getting the benefit of fiduciary asset management for their investments, and instead are left investing on their own and arranging their own custody alternatives.

Providing clear guidance on the regulatory treatment of crypto assets held in custody and the accounting rules that apply to such assets would encourage more financial institutions to enter the crypto custody market.

What to do:

The SEC could issue guidance on the application of federal securities laws to the custody of crypto assets by banks and trust companies, clarifying the regulatory framework and encouraging greater participation in this critical aspect of the crypto ecosystem.

#5 Reform ETP standards

The SEC should adopt reform measures for exchange-traded products (ETPs) that can foster financial innovation. The proposals promote broader market access to investors and fiduciaries used to managing portfolios of ETPs.

Specifically, the SEC could consider proposals to streamline the listing standards for ETPs and permit ETP issuers to bring to market products that provide leveraged and inverse exposure to the underlying assets. These reforms would cater to the needs of sophisticated investors and enable ETPs to remain competitive with other financial instruments in the marketplace.

What to do:

The SEC could propose amendments to Rule 314 of Regulation S-K to streamline the listing standards for ETPs and facilitate the offering of a wider range of ETPs to investors.

#6 Implement certification for ATS listings

In a decentralized environment where the issuer of a crypto asset may play no significant continuing role, who bears responsibility for providing accurate disclosures around the asset