SEC Commissioner Hester Peirce (“Peirce”) recently delivered an address on digital assets regulation at the Digital Assets at Duke Conference. The two-day meeting brought together regulators, academics, experts, policymakers, and other key stakeholders in the industry to discuss and debate the future of digital assets and distributed ledger technology (“DLT”). Peirce, a frequent critic of the SEC’s current approach towards the industry, used the opportunity to draw parallels between crypto and the slow development of other technologies. Peirce specifically discussed online dating apps—which took years and multiple iterations before achieving widespread adoption and scale. Starting from that parallel, she offered her thoughts on what sensible regulation in the space would look like moving out of 2022. The highlights of her thoughts are below:

Prioritize Private Solutions to Systemic Problems.  Peirce emphasized that in order for digital assets to gain more adoption and trust, DLT developers and industry participants must begin to find more private solutions themselves. In other words, Peirce pleaded for private actors to bolster security and compliance practices, rather than wait for punitive action from regulators.

Prioritize Non-Trading Applications of DLT.  The danger in secondary trading and leveraged trading was a key part of Peirce’s speech. She noted that many of the meltdowns in 2022 were caused by risky leveraged trading on offshore exchanges, inadequate reserves held in the event of liquidity events, poor custody practices, and rampant speculation. Rather than continue building trading applications of DLT, Peirce voiced interest in seeing more applications focused on asset tokenization, smart contracts, payments, and other back office solutions for recordkeeping and data storage.

Restoring Customer Trust with an Increase in Audits.  In addition to promoting applications of DLT unrelated to trading, Peirce advocated for legislation mandating audits of intermediaries and exchanges.

Increased Use of Bespoke Relief.  Of note were Peirce’s comments regarding regulatory sandbox measures. She advocated for a notice and comment system to resolve difficult crypto related issues, as well as an increase in the use of No-Action letters. In particular, she commended a 2019 No-Action letter issued from the Division of Trading and Markets that permitted the development of a three-step settlement process for broker-dealers operating a non-custodial alternative trading system for digital asset securities.

Revisit Legal Analysis and the Application of Howey.  Perhaps most bold were comments Peirce made about the application of Howey to digital assets. Citing a recently published leading article, Peirce hinted that the SEC may be over-regulating certain digital assets that, although issued under conditions mirroring an investment contract, are not investment contracts themselves. She called on Congress to fill in gaps offering clarity to creators of tokens and holders of tokens who wish to transact.

Stop Scaring Traditional Entities and Auditors.  Peirce took issue with Staff  Bulletin 121, which drove custodians away by requiring custodial firms to measure their “safeguarding liability at initial recognition and each reporting date at the fair value of the crypto-assets that the custodian is responsible for holding for its platform users.” To combat flight, Peirce advocates for reforms that would encourage traditional audit and custodial firms to enter the industry.

Be Cautious and Look to Model Legislation.  To help Congress, Peirce pointed to model legislation arising from other jurisdictions, including the European Union’s (EU) Markets in Crypto-Assets legislation.  Peirce also pointed to the groundswell of proposals coming from academics, crypto bills already introduced in Congress, as well as a “Solomonic proposal” to offer firms the ability to choose between the CFTC and the SEC. Though Peirce openly pushed for legislation, she reiterated her preference for caution in the face of calls for more regulation, expressing concern that pushing all market participants into heavily regulated industries may stifle innovation.

Currently, there are a host of crypto related bills wading through Congress yet to receive approval.  At the state level, legislators continue to craft new bills for Special Purpose Depository Institutions (SPDIs).  Commissioner Peirce’s comments are important for their prescriptive tone: it appears that legislation or enforcement over the industry continues to grow more likely as the digital assets market attempts to recover from the volatility of 2022.  Dinsmore attorneys will continue to monitor developments in digital assets regulation and are ready to counsel. 

Tanner Dowdy also contributed to this article.