Regulators have to balance protecting consumers with creating an environment that allows entrepreneurs and the private sector to thrive. Regulators can play a crucial role in ensuring that markets are free from distortions due to externalities or information asymmetry.
Regulating entrepreneurship can also hinder business formation and make society less prosperous. The United States Securities and Exchange Commission has been especially hostile to cryptocurrency entrepreneurs and companies. Gary Gensler, Chairman of the SEC, has stated that Bitcoin (BTC), which he considers a commodity, is not as secure as other crypto financial assets.
In an explosive Aug. 19 Op-Ed, he reiterated this line for The Wall Street Journal. He argued that “you can replace ‘crypto” with any asset when it comes to securities regulation.
Instead of “regulating by opinion,” as some crypto enthusiasts prefer to call it, developers, investors, and regulatory agencies (like the SEC) should work together around common standards. These standards can improve the quality of projects and establish best practices that all Web3 participants will be able to benefit from.
Related: SEC launches an investigation into insider trading in exchanges
Mirai Labs cofounder Corey Wilton said to Cointelegraph, “Regulators can be effective when they are also in the trenches alongside the innovators or industry builders.”
This means that regulators and developers must have an open and honest dialogue. Simon Grunfeld, vice-president of Web3 at Cogni, stated that developers need to be familiar with Know Your Customer (KYC), best practices, vendors available, how these KYC services integrate, and how users roles [and] abilities need to be managed.”
Definition of securities
Nearly every article about crypto regulation mentions the Howey Test, which is based on a 1946 Supreme Court decision that established precedents around the definition and classification of security. Gensler has focused on the most important criteria, which is that the investor public expects a return.
Many non-fungible token (NFT), projects are launched and the founders promise large returns to investors that they either falsify or exaggerate. These projects are not securities and should be considered as such, but the problem is that their founders lie to investors and make claims they cannot keep.
The Howey Test defines an “investment agreement” as one that involves (1) money being invested in a common enterprise, (2) profit expectation, (3) and the possibility of obtaining benefits from others. What if the Howey Test were applied to a house? If there is a family enterprise, a household could be considered one entity. Every homeowner makes an investment with the expectation that their house will appreciate in value.
Another argument is that a household cannot be considered a single enterprise. But is there a bright line? But what if there is a large family? What if the family is large but lacks the financial resources? Or what if relatives and friends contribute funds to finance the house. What if there are a few people who rent a larger house to spend some time there and also plan to rent it out via Airbnb while they travel? The problem with the Howey Test? It was created for a very specific and narrow scenario — that of leasing to farmers.
Web3 companies and entrepreneurs have been forced to relocate their operations offshore due to the lack of a clear line between digital assets and securities. Because of the anonymity inherent in the Web3 community, especially in relation to company formation, it is difficult to provide quantitative estimates. However, anyone who spends enough time talking with people in Web3 will quickly realize that they are not in the United States.
Owners and users must be careful, especially in GameFi. Grunfeld stated that there is no way for U.S. regulators in the United States to pursue a U.S. citizen for gaming on illegal sites unless the individual is laundering money or engaging in other illegal activities involving U.S. citizens.
Related: GameFi developers could face heavy fines and difficult time
He said, “Otherwise the individual assumes risk of depositing funds.” These platforms can trick people into believing they are subject to U.S. regulations. The platform is responsible for ensuring compliance with international and local laws. If they open accounts for U.S.-based users, they could be subject to the U.S. Treasury’s long arm.
Markets have a significant role to play in standards. They set a minimum standard for quality. They are the best kinds of standards that arise organically through demand and coordination within a community where members realize everyone is better off adhering to a set best practices. The W3C standards are a common set of organic and open-source standards that covers all aspects of application development.
The W3C standards for decentralized IDs and verifiable credentials have been a key source of coordination and adoption in global educational. Interoperable technologies are essential for organizations, from large public companies to governments, that don’t lock them into particular vendors or systems that may pose a risk (e.g., in the event of a system going down or a company going bankrupt). These standards are essential for global adoption. Without them, innovative technologies will not be adopted globally.
We’re seeing that open-source standards in education offer an opportunity for anyone to examine a technology. This allows them to verify it has been through rigorous tests for security, privacy, and interoperability. This provides clarity for large-scale institutional partners that can bring new technologies to the masses.
Chris Purifoy is chairman of The Learning Economy Foundation. He stated that Web3 education would not be possible without a solid standards-based backbone. “All of the innovation occurring in our industry would eventually turn into a fragmented mess system that does not communicate or exchange no different to the centralized systems from the past.”
Related: CFTC & SEC propose changes to reporting rules for large crypto hedge funds.
Our question in the cryptocurrency market is whether we can create a similar set standards to the W3C standards that provide verifiable credentials on the education market. These standards not only ensure interoperability, but also establish norms and best practice that guarantee minimum quality. This would reduce the need for regulators to scrutinize NFT and other crypto-projects as the overall quality of the projects would be better and there would be fewer “rug pulls”.
While there is no easy solution, both sides must learn to better understand the other’s position. This will only occur when they meet in the middle.
Christos A. Makridis is chief operating officer and chief tech officer at Living Opera, a Web3 multimedia startup. He also holds appointments at Columbia Business School as well as Stanford University. He is a Stanford University doctorate in management and economics.
These opinions are solely the author’s and do not necessarily reflect those of Cointelegraph. This article is intended for informational purposes only and should not be construed as investment or legal advice.