The Securities and Exchange Commission’s (“SEC”) Strategic Hub for Innovation and Financial Technology (“FinHub”) hosted an important public forum on Friday, May 31, 2019 at the SEC headquarters in Washington, D.C ¹. The forum came soon after the SEC issued its Framework for “Investment Contract” Analysis of Digital Assets ² and addressed distributed ledger technology (“DLT”) and digital assets, with an overarching goal of crowdsourcing industry expertise and insight into practical realities and implications of regulating financial technology.

At the forum, panels of experts responded to questions surrounding capital formation, DLT and digital asset trading markets, investment management, trends in DLT innovation, and experiments with identity verification, governance, and legal disputes. While no definitive guidance was given, and no firm commitments were made on behalf of the SEC, a number of noteworthy statements were made by senior SEC staff which demonstrates their commitment to work with the digital assets market and possibly offers a road map to those looking to issue digital assets. In general the law remains the as it is with the same gray areas and barriers to the issuance of digital assets.

Nevertheless, the vast majority of participants came away with the view that the SEC is genuinely committed to understanding and helping this market, “Clearly they have been listening to what those in the community – and their counsel – have been saying to them and they’ve put a lot of effort into understanding this space,” said Joshua Ashley Klayman, managing member of boutique law firm, Klayman LLC. Klayman further commented on the openness of the SEC staff in not prescreening any questions or topics from attendees.

Panelist Jay Baris of Shearman & Sterling LLP suggested that regulating technology on a platform-by-platform basis is impracticable due to how quickly technology becomes outdated. Instead, Baris suggested a principles-based approach that utilizes a combination of physical and procedural safeguards.

The FinHub moderators were particularly interested in addressing the nagging issue of satisfying auditing requirements and determining whether the enhancement of risk controls lies in better technology, or alternatively, more regulation.

Director William Hinman, head of the Division for Corporate Finance, articulated the SEC’s willingness to grant more detailed “no-action” letters going beyond those they have already issued, particularly for ICOs (“Initial Coin Offerings”) that are no longer selling tokens.

Panelists at the forum further addressed potential pathways for the future of DLT and digital assets, such as the possibility of programming digital assets to enable regulatory compliance, using smart contracts to refer back to legal documentation of contractual language for purposes of dispute resolution, and ways user control and data can be utilized in identity verification to only access the information necessary to verify an account without revealing the private information of said account.  From many of the panels it was also apparent that although DLT technology is still in the early stages of development and in most cases there are many obstacles to commercial implementation which were generally not mentioned ³, there is a real commitment to continuing to develop this space from a broad spectrum of industry leaders including from Ernst & Young which discussed its recently released zero-knowledge proof (“ZKP”) private transaction protocol called “Nightfall” based on the Ethereum ⁴.

The SEC is committed to supporting crypto and DLT, it will continue to prioritize consumer protection and maintenance of the U.S.’s leadership role in financial markets. As a result, state-level regulation of money transmission and custody may be a much greater hindrance to development of crypto-currency than federal security laws and focused efforts to change laws should be shifted accordingly.

The SEC’s FinHub staff will continue to delve into these topics and other related concerns in local peer-to-peer meetings with FinTech communities to be held in Chicago on June 28, 2019 from 10a.m. to 4p.m. Additionally the SEC is looking to hire at least one Digital Asset Expert for its Visiting Scholars Program to further increase their in-house expertise ⁵

Co-Author: Kim Simmons

[1] https://www.sec.gov/news/press-release/2019-59

[2] https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets

[3] https://www.forbes.com/sites/andreatinianow/2019/06/02/left-unsaid-at-the-fintech-forum/#5ec5496d2426

[4] https://www.ey.com/en_gl/news/2019/04/ey-releases-zero-knowledge-proof-blockchain-transaction-technology-to-the-public-domain-to-advance-blockchain-privacy-standards

[5] https://www.sec.gov/sec-seeking-digital-asset-experts-for-visiting-scholars-program