Size does matter - A philosophy of securities laws for tokenized networks

Securities lawyer Lex Node published a 4-part series unveiling a new framework for classifying tokens as securities. He explains that cryptoassets share characteristics with a variety of different assets, however, the primary reason people hold them is to share in the potential upside of network growth making them most like equity. While tokens do not fit neatly under the definition of traditional shareholder equity, they do confer certain rights over an ownerless network and therefore can be thought of as a more abstract type of equity.

We have laws governing equity that protect those taking financial risk in order to participate in the upside growth of a company by aligning the interests of those in power with the equity holders and prohibiting malicious behavior. This new form of network equity could benefit from these investor protections, however, abiding by them in the same manner as corporations is excessively onerous. This is mostly in part because of the fact that there is no central company dictating the growth in the network. While many have foundations that play integral roles, the differences between them and for-profit companies make it difficult to comply with the reporting requirements of the Securities Exchange Act. Compliance typically costs over $1 million dollars and tokens would only be able to trade on securities exchanges.

In an attempt to ensure fair and efficient markets without forcing outdated securities law into this new paradigm, a framework is proposed to demonstrate “sufficient decentralization.” A token sold can start as a security until the sale is completed after which it ceases to be one. Part of the terms of completion requires the issuer to complete various steps of their roadmap as they are events in which token holders can expect the value of their token to increase. Once the development of the network includes independent parties performing value add functions and the price of the token is no longer directly associated with the efforts of the issuer who now owns less than 10% of total supply, it ceases to be regulated as a security.

Why it matters:

• Modern-day securities laws hamper innovation in crypto because they force entrepreneurs to forgo taking steps to actively grow the project and apply a hands-off mentality in the name of decentralization. A new framework for thinking about how cryptoassets fall into securities laws could alleviate some of this tension and allow issuers to take direct steps to grow the network in the early days while providing a path to no longer be a security.
  
• Proper regulation can help facilitate more efficient crypto markets by requiring large holders to disclose their position, additional token sales, and any conflicts of interest.
  
• If token issuers can be comfortable talking about the native assets as securities, it will no longer be off-limits to discuss the price which is undoubtedly a crucial topic, especially in PoS networks as it ties to the network's security.