Edan Yago is the founder of CementDAO, an effort to bring together the stablecoin in a unified ecosystem. Previously he was CEO and co-founder of the Epiphyte software company and contributed to the creation of the DATA industry associations and the Stablecoin Foundation. The opinions expressed here are his.
The United States Securities and Exchange Commission (SEC) has been significantly completed in an attempt to understand the cryptographic resources space. This effort must be applauded. However, the SEC has failed to deal with a fundamental aspect of cryptographic resources and systems.
That is to say, properly constructed cryptographic systems do not involve "people" or "entities" and do not represent a form of ownership. For this reason, they have no analogue in the traditional financial world, nor can they be subject to financial regulation.
In the traditional financial world, assets are a credit to a specific property. For example, a commodity, shares in a company or a due debt.
Cryptographic resources, however, are not a complaint about anything. What is the bitcoin for? Or ether?
Instead, cryptographic resources are a form of proof. Cryptographic evidence that a specific series of mathematical functions has been performed. They are proof that some software instructions have been made and that software's algorithm outputs. And above all, the mathematical functions are performed by nobody in particular, they are performed by the network as a whole.
Property is "property determined by law". Cryptographic assets are not properties because they are not determined by law – they are determined by mathematics. This presents some obvious problems when it comes to understanding exactly how to adjust them.
There is no bitcoin
Many people today speak of cryptocurrencies in the shorthand of property. They say things like "Alice transferred a bitcoin to Bob", but we should not let this metaphor confuse us.
Actually, it was not bitcoin that existed anywhere and did not move from one place to another.
In "The Matrix," Neo understood the true nature of the world when he realized that "there is not a spoon". In the same way, we can only understand the true nature of the blockchain when we recognize that "there is no bitcoin".
Instead, what really happened is that Alice showed Bob that he had certain secret knowledge and that he used that knowledge to perform a mathematical operation. But wait, the rabbit hole goes even deeper.
Even "Alice" and "Bob" are misleading fictions. Alice is not necessarily a person, she is also a shortcut. Alice is actually just an address, an output of a hash function, which may or may not be associated with a specific "entity".
Now, of course, sometimes Alice is a person. And sometimes Alice created a "token" (another metaphor) and sold it to Bob as an investment. In this case, it was a supply of securities and can be regulated by the SEC.
However, the SEC does not stop there. The agency wants to regulate what happens to those tokens, as they also interact with smart contracts. In its statement of November 16, "Issuing and trading 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."
An "entity" here refers to a legal person.
For example, they use EtherDelta, and in particular its smart contract, saying:
"The EtherDelta intelligent contract was coded for, among other things, validating order messages, confirming order terms and conditions, executing paired orders and directing the distributed ledger to be updated to reflect a trade."
Here's where metaphorical thinking can easily go too far, and where the SEC is introducing a vague and problematic language. EtherDelta, as an entity, provided various services (such as a user interface of a web page to interact with the smart contract). EtherDelta has also developed the smart contract.
But who has "supplied" the smart contract? Who performed his duties? Not EtherDelta or anyone else in particular.
The SEC could regulate the EtherDelta website but trying to regulate the smart contract is a result of confusion.
The rabbit's lair goes deeper
This confusion worsens when the SEC talks about secondary markets for these "securities".
Cryptographic resources are so new that even many experienced professionals are confused and think they are a distinct property. As a result, as an industry, we were all too willing to grant the SEC vision that, since something was the product of an offer of securities, it remains a security later. Once we realize that there are no "tokens" and not "properties", we realize that it is a categorical error.
It becomes easy to see this error when you imagine the following scenario: Bob, after buying the tokens from Alice, sends them to an intelligent contract owned by anyone. He renounced the claim to property – which would mean that no legal entity has "security".
By definition, a security is an "investment contract". A contract is "an agreement between legal entities, which creates obligations that are applicable by law".
Therefore, in order for something to be a security, it must, therefore, (a) be between legal persons and (b) be applicable by law (not mathematics).
Tokens held by smart contracts fail both of these tests. They can not be correctly described as titles. However, the SEC suggests something radically new: that a series of instructions that imply no agreement, no person and is not imposed by law (but rather by mathematics) can still be considered not only as a contract but as a security. This is a radical departure from the existing law.
Property laws and financial laws are based on government enforcement. Since there are many governments and their jurisdictions are limited, there is no true global system of control appropriate to the world without Internet boundaries.
A huge potential advantage of cryptographic resources is that they have overcome this problem, not being a product of law or limited to its jurisdiction.
The SEC, for obvious reasons, would like to establish a jurisdiction over cryptographic activities. However, this jurisdiction is only appropriate where there are legally binding contracts between legal entities.
For the SEC, or anyone else, not recognizing this important distinction is a recipe for overcoming and confusion. It has the potential to rob many of us for the benefits of a truly global digital method of property and value management.
The brand image is missing via Shutterstock