Should Digital Asset Exchanges Be Regulated?

Whether or not digital asset exchanges are regulated remains to be seen. While the SEC has brought a few notable actions against certain entities, the Commission has not yet developed a regulatory framework for this emerging sector. Moreover, the market for digital asset securities is currently unregulated, and therefore offers few opportunities for investors. This has led to significant fines for companies and individuals involved in the market.

The secondary digital has not been a good steward of the digital asset industry. In particular, the agency has not promulgated any clear and concise guidance or rules to facilitate market participation. It has instead rely on nonbinding staff guidance and fact-specific standards gleaned from enforcement actions. These efforts have been met with mixed results. However, recent events have given the agency a few insights into the best path forward.

The first step in establishing a regulatory framework is to determine the appropriate regulatory classification for digital assets. Many of these assets are not securities and may be classified as commodities, albeit with a few notable exceptions. To qualify as a security, an asset must meet a four-part test. One of the most important elements is the type of initial sale transaction. A secondary sale of an asset must meet the same tests as the initial sale. Additional considerations are made when the security is traded for consumptive purposes.

For example, price fluctuations on a secondary trading platform are likely to be relevant to the supply and demand of an asset for consumptive purposes. But the presence of these fluctuations does not mean the asset is a security. That is, not even if the price of the asset is more than the price the investor paid.

A comprehensive regulatory framework will help establish the regulatory foundation for a thriving and stable market structure. This will allow digital assets to attract a greater number of investors and create a more predictable market environment. Furthermore, a well-established rulemaking process will lead to clarity and fair notice for all market participants. Ultimately, such a framework will lead to higher rates of investment capital allocation within the financial markets.

However, a comprehensive regulatory framework may not be the answer to all of the challenges facing the digital asset industry. For example, many market participants may lack the resources necessary to perform the aforementioned legal analysis. Other regulatory obstacles include the lack of a viable business model for a secondary digital asset exchange, and the possibility of conflicting interests between market participants. Additionally, if a market is regulated, the cost of compliance may become prohibitive.

Ultimately, the SEC needs to start the process of regulating digital asset securities and devise a more comprehensive approach to the issue. The Commission could adopt a bright-line approach or tailor a regulatory approach to specific market participants and transactions. Regardless of which path the Commission chooses, the United States must act now to preserve its leadership position in this emerging industry. Otherwise, we will have lost our place as a leader in global capital markets.