Federal agents recently arrested Ishan Wahi, a former product manager at cryptocurrency exchange Coinbase, and two others for allegedly orchestrating insider trading that netted over $1.5 million in profits. The Securities and Exchange Commission (SEC) built its case on a subtle but critical argument: 9 out of 25 listed crypto assets are securities, an allegation that Coinbase refuted. Are some of those tokens securities? Gigster spoke to Josh Lawler, a Partner at Zuber Lawler, regarding government regulation in Web3 to get some insights. You can watch the full stream and check out the biggest takeaways from our discussion below.
The SEC alleges in its lawsuit that Coinbase allowed people to trade unregistered security assets. SEC chair Gary Gensler insists that exchanges need to ‘come in and talk to the agency, arguing that per the Howey Test, most digital assets qualify as securities. According to the Howey Test, an asset is a security if users are involved in funding an investment contract with the promise of earning some profits from the efforts of others. Nonetheless, opinion on the subject is divided. While the SEC insists that Ishan Wahi and his co-accused committed securities fraud, Commodity Futures Trading Commission (CFTC) commissioner Caroline Pham thinks otherwise. The court case has introduced a tug of war pitting the SEC against the CFTC on where different digital coins or tokens fall and which agency should regulate them.
According to Josh Lawler, the controversial regulatory treatment of crypto assets and tokens puts hundreds if not thousands of Web3 startups at crossroads. That’s because most Web3 business ideas revolve around issuing or selling tokens to attract potential users with a financial incentive. From data storage to decentralized finance (DeFi) lending protocols or non-fungible token (NFT)-based products, the setup almost always involves buying tokens to make money once the startup delivers on its promise of real-world apps. Lawler avers that the regulatory tug of war over the control of crypto assets results from a lack of a clear law that has seen the SEC crackdown on operators. As startups wait for the dust to settle, industry players are rallying behind efforts from companies like Coinbase that have petitioned the SEC to issue crypto-specific rules that would spare them the wrath of the Howey Test. As regulators grope in the dark seeking new rules and regulations for applications associated with the Web3 technology, Lawler advises startups to observe the following:
There’s no telling when the bills in Congress will eventually become law, and before then, the SEC doesn’t seem ready to cave in and issue crypto-friendly rules. Until then, regulation by enforcement remains the only way the SEC will deal with startups and Web3 companies. Since the legal consequences of issuing unregistered securities include fines and criminal prosecution, Web3 entrepreneurs had better consider taking the effort and expenses involved in registering securities with the SEC.
Shipping out of an unfavorable business environment would be better than seeing your ship sink is another option. The regulatory confusion surrounding crypto saw crypto startups flee India to perceived crypto-friendlier nations when entrepreneurs realized they were always on the receiving end.
As Web3 applications like DeFi and NFTs continue to explode and offer new fascinating opportunities, the question about SEC regulatory oversight and enforcement will persist. Whether some tokens are classified as securities could have serious implications in the industry that has benefitted mainly from little regulatory oversight. Listen to the full discussion between Cory Hymel and Josh Lawler for a deeper dive into the SEC’s warning about Web3 and how you can protect yourself.