Cryptocurrency securities classification and why decentralization on all levels is key

By Allen Walters | Publish0x posts | 9 Aug 2019

Avoiding a SEC Security classification is important as US regulations cause exchanges to exclude possible securities cryptocurrencies from the US market. Bittrex geo-fensed about 80 coins. These are not tradeable in the US since a few weeks. Binance is creating a US market and one for the rest of the world. More exchanges might follow.

If a project had a pre-sale or an ICO, there is a big risk for it to be classified as a security. I will explain the rules of the game below. I’m taking the Tezos strategy as an example, since they are la great example of decentralizing on all levels with the SEC in mind.

The rules of the game can be found on the website:

Some relevant parts:

What is a security:

A. The Investment of Money (ICO/ pre-sale/ no working product? —> Check)

B. [In] Common Enterprise (evaluating digital assets, we have found that a "common enterprise" typically exists (—> Check for crypto in general)

C. Reasonable Expectation of Profits (—> Check for crypto in general) [AND] Derived from Efforts of Others 

When a promoter, sponsor, or other third party (or affiliated group of third parties) [..] provides essential managerial efforts.” (!) This is where projects can make a difference in running the risk of being classified as a security. The less central input, the better. The less of a central entity putting in all the work and making all the decisions the better. 

So whenever there is a central entity that does the work and makes all decisions, you’re in the danger zone. Decentralization is what makes the difference:

  • Decentralized development. Tezos scores high here with their voting system for bakers and grant system where anyone can apply for.

Voting system

This is one of the things that make Tezos unique. Due to this design, there will be no hard forks in Tezos. 

In the Tezos design, improvements and changes to be implemented to the blockchain, should be decided on by anyone that choses to join the network. In the case of Tezos, that can be anyone that decides to bake (Baking is the variant of Staking on the Tezos PoS chain.). The decision process for Tezos is designed in such a way, that there are no hard-forks necessary. 

Proposing changes/ improvements can be done by any baker. After a proposal is submitted, there will be a first voting period. If the set quorum is met, the proposal goes into the testing phase. After the testing phase, there is a final vote form implementation. For the full, detailed explanation on this process, see this article

Grants system:

Anyone can apply for grants from the Tezos foundation for the purpose of research and education, improvements of the Tezos ecosystem and efforts to strengthen and nurture the Tezos community. 

  • Decentralized efforts to get exchange listings. The Tezos Commons Foundation (TCF) was chartered by a group of Tezos enthusiasts as a US based non-profit organization with the goal of advancing the Tezos protocol and community. This is a separate initiative from the Tezos community, decentralizing the total efforts that go into the full growth of Tezos on different levels. TCF acts as an independent participant in the Tezos ecosystem and operates with a team and board of directors based on input from the broader Tezos community. One of the things that are pursued by the TCF instead to TF (TF = the main Tezos Foundation), is exchange listings.
  • Decentralized marketing. Same goes for marketing. TCF is doing this instead to TF, which is very positive.

Does this really goes as far as marketing efforts? Yes:

The SEC site specifically mentions promotions and marketing. (Amongst many other points) All these points count for a bigger chance of something to be seen as a security:

  1. Reliance on the Efforts of Others

[…] the stronger their presence, the more likely it is that a purchaser of a digital asset is relying on the "efforts of others":

  • An AP (Third party) is responsible for the development, improvement (or enhancement), operation, or promotion of the network […]
  1. Reasonable Expectation of Profits
  • The digital asset gives the holder rights to share in the enterprise's income or profits or to realize gain from capital appreciation of the digital asset. The opportunity may result from appreciation in the value of the digital asset that comes, at least in part, from the operation, promotion, improvement, or other positive developments in the network, particularly if there is a secondary trading market that enables digital asset holders to resell their digital assets and realize gains.
  • … -
  • The digital asset is marketed, directly or indirectly, using any of the following: The potential profitability of the operations of the network, or the potential appreciation in the value of the digital asset, is emphasized in marketing or other promotional materials.

Note that, once an ecosystem evolves and changes, an asset that set out as a security, could be reevaluated and be dequalified from a previous security qualification. 

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Allen Walters
Allen Walters

Fascinated by blockchain and future proofing cryptocurrency. Discover the tech before it gets relevant. Twitter: @IgnoranceIt

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