“If you think the Howey Test doesn’t apply to crypto tokens, then you don’t understand securities law.”
That’s what Aaron Kaplan of Prometheum told us in a discussion last week.
Considering we’ve spent the last several months trying to better understand this subject ourselves, his statement really caught our attention. What, in particular, caught our attention about it? Well, it’s pretty much the exact opposite of everything our friends in the blockchain biz have been telling us.
We’ve asked everybody we know and respect in the crypto camp–Can you tell us about the Howey Test? Does it make sense to call crypto transactions investment contracts? IS ETHEREUM A SECURITY? What comes next? What of doughnuts? What? For the Love of God!
Two things:
But to make a long and repetitive story short, word ‘round the crypto campfire is that it doesn’t make sense to call crypto tokens investment contracts, that the SEC doesn’t really know what it’s doing, and that we need an act of Congress to move the ball forward on all of this.
Apparently, that’s all a steaming pile of bullshit.
We’re paraphrasing, but that’s what we got from our conversations with Prometheum.
Where Do You Get Off?
Prometheum says that:
This view completely contradicts so much of what we’ve heard from crypto issuers and exchanges, especially those that find themselves in the crosshairs of legal and regulatory action today,
So just where the hell does Prometheum get off making such an outrageous claim?!
Actually, they can get off wherever they want as far as the regulators are concerned. That’s because Prometheum is the very first SEC registered broker-dealer and FINRA member firm approved to operate as a Special Purpose Broker-Dealer (SPBD) for digital asset securities.
Oh snap! (Sorry. I came from the ‘90s.)
Translation–that’s a pretty strong retort to the doubters.
But the real point here–it’s actually possible to custody and transact digital assets by using the very same framework for investor protections that has existed in traditional securities for nearly a century. Depending on your perspective, this is either a late-breaking headline or old news.
Well Isn’t That Special?
Prometheum says it’s old news, and not just because most of these rules have existed since about the time the Lindy Hop went out of style–but also because the SEC has been pretty clear about all of this as it relates to crypto.
Kaplan points to a December 23, 2020 statement from the SEC–-sometimes referred to as the Christmas Rule–that offers pretty explicit conditions for becoming a Special Purpose Broker-Dealer (SPBD) with the legal right to custody digital asset securities. I would have gone with Yule Rule but…whatever…it’s not important.
Still, Yule Rule…so much better. Never squander an opportunity to rhyme. Anyway, Prometheum seized the opportunity, leveraged the Yule Rule and successfully established itself as a Special Purpose Broker-Dealer.
According to the SEC, the Yule Rule:
Prometheum is the very first financial entity to navigate this process and achieve registered SPBD status in the digital asset space. So clearly it is possible.
This sparked our curiosity.
Maybe They Missed the Memo
Most of us have heard the rumors that Coinbase and the SEC tangled in the boardroom before meeting in the courtroom. They couldn’t agree on the terms of registration for the second largest crypto exchange by volume. Or so we are left to assume. As talks broke down, there was some speculation that the Commission simply failed to provide sufficient guidance toward compliance.
We don’t know if this is true. We weren’t there.
But we asked Aaron Kaplan why Prometheum was able to navigate the registration process while so many others have struggled to do so. With no comment on any particular entity, Kaplan explained that “Prometheum worked within the legal frameworks as laid out by the SEC.”
We’re just going to assume that some of the other entities that are now trying to prove their position in court did not agree to not agree to work within these legal frameworks.
To the point, it may not be that the SEC is falling short on providing guidance, but that some crypto entities—again, not mentioning any names—will only sign on the dotted line according to their own terms.
Of course, that’s not how regulation works.
The Proposed Safeguarding Rule
How regulation works is that the SEC proposes rules, the public gets an opportunity to comment, then the SEC considers these comments when codifying a final version of the rule. Once that happens, we all have to follow that rule.
Speaking of which, in February 2023, the SEC proposed an amendment to the requirements for becoming a qualified custodian of your customer financial assets.
Custody requirements, in brief, are the regulatory rules governing institutions that are legally allowed to custody customer assets. Historically, those assets have included funds and securities, and the rules have required investment advisors to hold funds in banks with federal or state chartering.
The amendment would have a direct impact on the requirements for custody of digital assets and would, in essence, require crypto exchanges to register with the SEC.
February’s proposed amendment doesn’t change the rules for becoming a qualified custodian. But it does expand their scope, now requiring a wider range of financial entities to be recognized as qualified custodians. While the rule does not explicitly mention digital assets, the language is made more expansive such that many crypto exchanges will now indeed be required to register with the SEC as qualified custodians.
This represents another strand in the SEC’s efforts to bring cryptocurrency under the same regulatory umbrella as traditional markets. It also dovetails with a parallel line of legal actions.
With the comment period ending this past spring, this rule is more than likely in an advanced stage of behind-the-scenes finalization.
So anybody who is likely to be impacted by this rule must surely know by now that it’s coming.
The Straw Man Project
So why do so many leaders in the crypto space refuse to fall in line?
If the SEC has been laying the groundwork for at least the last three years, and the language has been pretty clear, and the writing on the wall has been explicit, why do so many crypto entities resist?
Innovation! Innovation, they say. The SEC is on a bloodthirsty quest to murder innovation, and regulatory oversight is their weapon of choice.
Prometheum calls bullshit on this claim. Again…paraphrasing.
But we agree that innovation is not born from lawlessness. It comes through an evolutionary process, one that sees us better integrating digital assets into traditional financial markets. This isn’t about rewriting the rules to fit the agenda of a wildly exciting but also wildly untamed financial beast. This is about using the rules we have to tame the beast so…wait, I had something for this…
Oh yeah…so that we can trust the beast to roam free, grow, and proliferate without occasionally coming back to eat our children.
After all, we shouldn’t need another cautionary tale after FTX. That beast bit the head off the entire crypto market and paddled its way to the Caribbean.
Let’s all at least agree that there’s nothing particularly innovative about embezzlement. Scumbags have been doing that to investors forever. And that’s the whole point of this thing.
It Was Never About the Gears…
It’s about the investors…the everyday investors who were pretty excited about cryptocurrency before the shit hit the fan in 2022. Everybody who had a dollar invested in this highly speculative and deeply volatile marketplace took a hit, some more directly than others.
And in the time since, we’ve had tons of illuminating conversations with people from all walks of the crypto-sphere. The vast majority of those operating in the crypto space have expressed discomfort with the SEC’s current approach.
We’ve dissected the regulatory implications. We’ve discussed the importance of innovation. We’ve addressed the inconsistent legal interpretations around Howey.
But it seems we never get the answer we want when it comes to investor protections.
If the SEC’s approach is wrong, and the judges are reading precedent incorrectly, and we can’t take a step toward safer crypto markets without new laws, how long must we wait for these laws? When do we get the safeguards that protect us against the FTXs of the world?
And how many investors will be harmed in the meantime? How much innovation will be lost when everyday investors fear to tread in this space?
Prometheum’s very existence provides a strong case that there is no good excuse for making investors wait. Not only do investors deserve these protections, and not only will those protections actually accelerate rather than stifle innovation, but these protections already exist within the existing regulatory framework.
If somebody tells you otherwise, it’s worth asking who lines their pockets.
Dave Lauer is a co-founder and CEO of Urvin Finance, where he leads the team in building Urvin Terminal. Prior to founding Urvin Finance, Dave spent over a decade advocating for financial market reform after quitting his job as a high-frequency-trader.