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Home Market Research Cryptocurrency

Legal experts recommend flexible approach for SEC to define tokens as securities

by TheAdviserMagazine
6 months ago
in Cryptocurrency
Reading Time: 3 mins read
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Legal experts recommend flexible approach for SEC to define tokens as securities
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The DeFi Education Fund (DEF) submitted a letter to the Securities and Exchange Commission (SEC) on April 18 proposing five core principles for creating a “token safe harbor” framework to support decentralized finance initiatives while broader regulatory legislation is pending.

The recommendations aim to help the SEC structure a time-limited exemption for token projects developing toward decentralization, offering a regulatory environment that facilitates disclosure without prematurely classifying assets as securities.

Technology-agnostic regulation

The DEF emphasized that any safe harbor should adopt a technology-agnostic approach. The framework should address the risks of activities rather than prescribing rules for specific blockchain models or technical implementations. 

The letter warned against entrenching particular technologies, stating that it could stifle innovation if the SEC inadvertently favors specific consensus mechanisms or architectural designs.

Regarding eligibility, DEF argued that the safe harbor should be open to a wide range of projects that intend to decentralize. Rather than evaluating a token’s status only at its genesis, the SEC should allow already-distributed tokens to qualify, provided they meet decentralization goals. 

It argued that broad eligibility criteria are necessary to ensure the inclusion of projects launched before establishing a clear regulatory framework for future compliance pathways. 

Regarding disclosure requirements, the DEF advocated for carefully calibrated obligations that balance material information needs with the realities faced by early-stage development teams. 

The group suggested disclosures focused on source code transparency, token economics, governance structures, team and insider activities, cybersecurity audits, and development roadmaps.

The DEF also proposed periodic disclosures throughout the safe harbor period, with consideration given to streamlining compliance through API connectivity and blockchain automation. Additional compliance measures, such as lock-up periods for insiders, could help align incentives toward decentralization without overburdening projects.

Clear exit criteria

The letter stressed the importance of establishing a clear “Exit Test” that defines when a project has sufficiently decentralized to no longer be considered a security under US law.

Key criteria for passing the Exit Test would include maximum transparency, permissionless participation, user custody of assets, lack of centralized control, fully automated transaction processes, and the absence of retained economic authority by any single group.

The DEF recommended a realistic timeframe for projects to meet these benchmarks, such as three to four years. Projects that fail to meet the criteria within the initial window can apply for an extended safe harbor period, provided they demonstrate good faith efforts to decentralize.

A critical component of the DEF’s proposal involved protections for secondary market participants.

While a token remains within the safe harbor, intermediaries supporting its trading, such as digital asset exchanges and market makers, should not be required to register as broker-dealers or securities exchanges.

Comprehensive framework needed

The DEF noted that exempting infrastructure providers from traditional securities regulations would reduce legal uncertainty and foster broader participation in decentralized markets.

While supporting the creation of a token safe harbor, the DEF ultimately called for Congress to develop a comprehensive legislative framework for digital assets. 

The organization expressed that durable legal clarity must come from statute rather than temporary regulatory carve-outs. Nevertheless, a well-structured safe harbor could protect investors and developers while the longer lawmaking process unfolds.

The DEF concluded its letter by committing to ongoing engagement with the SEC and the broader crypto community. The organization also indicated that it would be publishing its recommendations publicly to solicit further feedback.

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