Practical takeaways from the US draft crypto market structure bill

The house financial services committee put out a massive 162 page crypto markets structure bill. It’s massive because it takes a swing at redefining how US law approaches a whole new asset class, by creating a new asset class: digital assets. These assets can be unique in that they start their life out as a security and change into a commodity like asset as they achieve decentralization.

What are the principles behind the legislation? I’d say they’re:

1. Letting business formation & fundraising occur for token backed businesses
2. Mitigating the edge insiders have and imposing a fairer, more disclosure based, regime
3. Clarifying what decentralization is and when it matters

I’ll get into the draft bill in a bit, but it’s important to note: this is a draft. It’s not final in any way — both in terms of industry feedback and especially party lines. My analysis is based on where I think compromises will be made and what I think is reasonably safe to assume would actually pass into law. Importantly, the draft bill provides a framework for how US lawmakers have been thinking about the industry for the past two years.

Practical takeaways from the US draft crypto market structure bill:

Draws a clear line between commodities and securities for digital assets: The line is ‘decentralization’.

If you’re offering any token that is not decentralized (defined below) it’s considered a digital asset security for all intents and purposes with all kinds of disclosure and limitations (see below).

Decentralization is measured by:

1. During the last 12 months no single person could unilaterally alter the protocol or censor anyone from using, earning or transmitting the digital assets, or materially alter the functionality of the network.
2. During the last 12 months no group owned more than 20% of the outstanding tokens or could vote more than 20%
3. During the last 12 months token issuance was done via the protocol to end users.
4. During the last 3 months no ‘affiliated person’ contributed to the software being updated or functionality.

Essentially, a protocol must be launched, relatively distributed and importantly, not under control of the original team for it to be considered decentralized. If these conditions don’t hold true, the token is a security, not a commodity and can’t be sold to the public.

Do’s:

1. Launch a token to the public after your network is live, distributed and issuing tokens only via protocol emissions (staking, operating a node etc).
2. Airdrops are ok! As long as they’re evenly distributed to users based on actual protocol work.

Don’t:

1. Save more than 20% of the tokens for the team.
2. Change code or alter the protocol 3 months before issuing a token to the public.
3. Issue tokens to the public before the above terms are met!

Some key questions remain with the draft as it’s currently worded:

• What’s ‘materially altered functionality’ in #1?
• If the project is open source how does this impact things?

Treats insiders wearily and imposes more disclosures!

Issuance of tokens by insiders are treated more carefully than current industry practice with a few important impositions in the case of any kind of public issuance, mainly disclosures, but not just:

1. Disclosures for an offering are: project overview, source code, purpose of offering, material risks, distribution plan, previous exempt offerings (as in sales to other investors), who the issuer is, material transactions between the issuer and affiliated persons.
2. Ongoing disclosures! Annual reports and semi annual reports have to be submitted, until 180 days after the year where its become a decentralized network

Who you’re allowed to market to

The bill puts down the rules of the road for who you can market to and how much.

• Selling to accredited investors is allowed up to a $75 million raise.
• Selling to non accredited investors is much harder and an unaccredited investor can’t spend more than 5% of their annual income and they can’t hold more than 10% of the total amounts of unit sold.

Do’s:

1. Sell tokens to accredited investors first before approaching the public, this will enable less public disclosures and more flexibility around capital raises.
2. Prepare disclosure information.
3. You can inquire about interest, but this is considered a solicitation of interest under federal anti fraud laws, so you can ask for a waiting list, but no more.

Don’t:

1. Sell tokens to non accredited investors without taking the investment amount into account.
2. Commit to selling tokens or any other obligation prior to filing with the relevant authority (SEC/CFTC)

Concrete examples of token launches

So you want to launch a token and are wondering what the practical takeaways are? Here’s what I’d say we can learn from the legislation:

1. Early token sales, pre product, to team and investors — in order to raise capital- shouold be treated as securities. This probably constitutes the majority of token sales these days, so beware. You shouldn’t be marketing these, selling them to ineligible purchasers etc.
2. Post product launch and after decentralization of your protocol, token “sales” are possible, but through the protocol itself, and only if the protocol is actually decentralized. Why? This makes your token more commodity like, than security like. Decentralization isn’t easy — there are months of ‘time out’ periods and in terms of distribution of your token, it has to be fairly distributed. 20% is the line in the sand proposed.
3. Proof of stake tokens will have a harder time with this structure than Proof of work.

Since the time of writing, the legislation has been pushed through and some changes have been made. The SEC has also received a provisional judgement in their lawsuit against Ripple which changes the landscape slightly.

I design tokenomics for crypto protocols (all still in launch phase) and am putting everything I’m learning into a super in depth course on Tokenomics. If you’re interested in my free email course on tokenomics, sign up here!