Paradigm: SEC inaction makes it impractical for crypto projects to register

Original source: Rodrigo Seira, Justin Slaughter, Katie Biber, Paradigm

Compiled by: OpenAI Translator
Starting a startup requires preparing and submitting many documents and forms, most of which are relatively easy and straightforward. For example, founders must submit a certificate of incorporation to the Secretary of State's office to form a new company. They also need to submit Form SS-4 to the IRS to obtain an Employer Identification Number (EIN).

While many founders work with lawyers during this process, it is simple enough that they can also do it themselves. As a result, thousands of small businesses are formed in the U.S. every day.

SEC Chairman Gary Gensler wants the American public to believe that registering tokens or crypto products with the SEC is just as easy for cryptocurrency founders.

This is not the case.

However, in a recent national television interview, the head of the financial regulatory agency criticized the cryptocurrency exchange Kraken for failing to register its investment products, which led to a settlement agreement with the SEC, requiring the company to pay penalties and shut down the program. He stated, "These companies, Kraken knows how to register. Others know how to register; it's just a form on our website." He did not provide further details. He then added, "They know how to do it. They just choose not to."

Days later, Gensler elaborated on his views in a commentary, expressing regret that "frankly, cryptocurrency intermediaries are not lining up to register with the SEC and comply with the laws passed by Congress." "Perhaps it's simply because their business models rely on non-compliance."

Yesterday, after years of failing to provide guidance or regulatory certainty for Coinbase, the SEC issued a Wells notice to the company. According to Coinbase, the SEC threatened to sue the company for listing what it considers securities (though it would not disclose which) without registering as a securities exchange and for offering unregistered investment products (but it would not say how to register).

Chair Gensler's public statements and actions have two self-serving aspects: they attempt to defend the SEC's unconstitutional expansion of jurisdiction over cryptocurrency by falsely implying that most crypto products and tokens are securities and therefore should register with the SEC, while portraying the crypto industry as composed of individuals who deliberately violate simple rules, akin to children pushing boundaries, deserving of SEC punishment.

However, even without considering whether securities laws apply in the first place, representing a "clear" path to "compliance" in "form" cannot be accomplished on Legal Zoom or through DIY with free online resources. For example, the S-1 form typically requires a team of lawyers and millions of dollars to complete, used when the most mature private companies want to go public or conduct an "IPO." Here it is: try to understand it yourself.

Fairly speaking, the chairman has never explicitly stated that submitting registration forms would be easy or cheap. But his suggestion that crypto companies could register by "filling out forms online" fails for a more direct reason: "come in and register" is not feasible until the SEC adjusts the registration framework to the unique aspects of digital assets. The current registration forms rely on a series of disclosures that are inadequate for the unique aspects of digital currencies and leave investors vulnerable. Registration also involves a series of other regulations that apply to tokens, reporting companies, and other participants in the ecosystem, making the operation of most crypto protocols impossible.

In fact, the reason there are almost no registered token offerings in the U.S. is that the SEC has failed to provide any actionable guidance, issue a single rule, or establish constructive interactions with anyone in the cryptocurrency industry to provide a viable regulatory framework for security tokens.

The example of Coinbase is illustrative. As an SEC-registered company, Coinbase submitted a rulemaking petition to the SEC in the summer of 2022, seeking clarity on many unresolved issues in the digital asset market (including exchange registration and staking). However, the petition went unanswered. Instead, yesterday, the SEC continued to regulate through enforcement, sending Coinbase a Wells notice covering activities the company is seeking clarification on through public rulemaking.

Claiming that crypto projects today can "just come in and register" with the SEC is fictional—if the SEC truly wants to provide adequate investor protection in the crypto asset space, more support is needed to enable them to do so.

We hope that reaching a consensus under the current system on whether it is feasible for crypto projects to register with the SEC can facilitate a genuinely honest discussion on how to regulate this industry, with Congress as a point of engagement. Only then can a pathway for resolving/regulating crypto be provided for the crypto industry, crypto skeptics, policymakers, interest groups, and the American public.

The second part will begin with a general background on the SEC registration process, followed by a review of the history of crypto projects that have attempted to register either as part of SEC settlement agreements or on their own. Understanding the difficulties and failures encountered by most of these projects illustrates that the "path to registration" is currently not viable.

The third part will analyze the current SEC disclosure regime by focusing on the S-1 form. We will argue that the current disclosure framework is fundamentally incompatible with most tokens, as it assumes a relationship between the issuer and the securities that does not exist in decentralized systems. We will discuss the gaps in various disclosure aspects required by the form and the need for clear positions that make registration a viable path and adequately inform investors.

Finally, the fourth part will emphasize how the SEC's current stance claims that most crypto projects need to register while simultaneously making registration impossible, thus exceeding the SEC's authority and amounting to a regulatory ban on cryptocurrencies.

Special thanks to Mike Selig for the review.