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Lately, the SEC has made great strides in trying to understand the cryptocurrency space. It is impressive; however, they failed to come to terms with a fundamental aspect of virtual resources and systems.
(Note: Many opinions expressed and quotations here are those of Edan Yago, the founder of CementDAO, as published on CoinDesk. We are in agreement with Mr. Yago and we wanted to add further analysis of our own)
They failed to realize that properly constructed cryptocurrency systems do not represent a form of ownership and do not involve any person or entity. As a result, they do not have a place in the traditional financial world, they also can not fall within the existing financial regulations.
The difference lies in the definition
In the traditional financial world, assets are defined as a claim on a specific property such as the shares of a company, a commodity or a due debt. On the contrary, cryptographic assets are not a claim of anything.
Instead, virtual resources are a form of proof. In particular, there are cryptographic tests that have been performed a specific series of mathematical functions. These functions are not performed by anyone in particular, but by the network as a whole.
So, while property is "law-determined property", cryptocurrency assets are not properties as they are not determined by law but by mathematics. Now, this is where problems arise from when it comes to the SEC and other regulators trying to figure out how to regulate them.
Digital tokens do not exist
The confusion that afflicts regulators and even most people today is the fact that we tend to refer to cryptocurrencies as properties when we talk about them. For example, let's say "Alex transferred five bitcoins to Rob".
While in fact there was no BTC that existed in the first place and did not move from one place to another. So, it is only possible to understand the true nature of the blockchain when we "Recognize that there are no bitcoins".
Instead what happened is that Alex showed Rob that he had the specific secret knowledge, and he had used it to perform a math operation.
However, Alex and Rob are also misleading fictions. The two do not necessarily have to be people. They can be an address associated with a specific one "entity."
But sometimes Alex is a person who creates a "token" and sells it to Rob. This qualifies as an offering of securities and can be regulated by the SEC.
The problem is that the SEC wants to regulate what happens to those tokens while they interact even with smart contracts.
November 16th a "Statement on the issue and negotiation of securities of digital assets" the agency states:
"Any entity that provides a market to put buyers and sellers of securities together, regardless of the technology applied, must determine whether its assets meet the definition of an exchange under federal securities laws."
A "entity" representing a legal person.
In a recent case against EtherDelta, the agency mentions its smart contract by explicitly saying:
"The EtherDelta intelligent contract was coded, among other things, to validate order messages, confirm order terms and conditions, execute paired orders, and direct the distributed ledger to be updated to reflect a trade."
It is an excellent example of the fact that the SEC takes metaphorical thinking for too long by introducing a vague and problematic language.
As an entity, EtherDelta has provided various services such as the web page's user interface that interacts with smart contracts.
However, although EtherDelta has developed the smart contract, the question is: who provided the smart contract? And who carries out its function? It is not EtherDelta or anyone else in particular.
So the SEC could try to regulate the EtherDelta website, but its attempt to regulate its smart contract is the result of confusion.
Another problem is that cryptographic assets are so new that even experienced professionals confuse them to represent a distinct property.
Furthermore, the industry was too willing to satisfy the SEC's view that, since something was the product of an offer of securities, it remains a security after that.
Once the people involved realize that there is not "Tokens" and no "property" it is then that they will know that it is a categorical error.
It is easy to see this mistake by imagining the following scenario; Rob, who bought Alex's tokens, sends them to an intelligent contract owned by anyone. This means that he has renounced the right to property, which means that no legal entity has "security".
By definition, a security is defined as a "Investment contract". While a contract is "An agreement between legal entities, creating obligations that are enforceable by law".
What is necessary for something to be a security?
Therefore, for something that must be defined as a security, it must satisfy two conditions;
- Being among legal entities
- Being enforceable by law (not math)
Considering the above factors, the tokens contained in an intelligent contract both fail.
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