Must Haves for Omnibus Market Structure Bill
A High Level Requirements List.
V2 below, comments welcome here.
Tenet 1: Narrow the Coverage of the Bill to Decentralized Models. The scope of any bill should be narrowed such that it only covers truly decentralized systems. For this to work and, in particular, to avoid regulatory arbitrage by decentralized in-name-only models (DINOs), a viable bill will necessarily include good base definitions that serve as a purity test for decentralized systems. If these definitions are not met, the system is out of scope.
Example Baseline Definitions for inclusion in a legislative framework within a ‘Decentralized Cryptosystem’ designation:
Autonomous Network means a Network that does not depend for its continuing operation or availability on, and is not owned, controlled or arbitrarily modifiable by, any single person or single group of Extrinsically Affiliated Persons (as defined below).
Note: legislation should provide a safe harbor for early-stage projects (see Comm. Peirce safe harbor; see Reg X) but should not be eligible for liquid market listing until met. See the definition of an Autonomous Cryptosystem below, which acts as a network maturity threshold.
Note: any legislation should also consider a transitional/ grace period.
Code means a copy of certain software code such that: (a) the software code was designed primarily to be run and facilitate transactions on one or more Networks; (b) the copy is verifiably stored and has its results of execution recorded on the Open Ledger of a Network; and (c) the copy is executable by any Open Client within the execution environment of the Network, provided that: (1) the software code is freely and readily available and licensed to the general public for use, copy, study and modification; and (2) if the copy consists of bytecode, machine code or other non-human-readable code, then the copy was verifiably compiled from human-readable source code that is freely and readily available and licensed to the general public for use, copy, study, and modification.
Cryptosystem means: (a) the combination of a particular Network and an Open Ledger maintained thereby; or (b) the combination of particular Code, a particular Open Ledger on which the Code is verifiably stored and a particular Network which maintains such Open Ledger and executes such Code.
Extrinsically Affiliated means, with respect to any two persons and any Tokens, that: (a) due to arrangements or agreements outside of the Cryptosystem, one such person directly or indirectly controls, is controlled by or is under common control with, the other person in respect of their acquisition, holding, voting, using or disposing of the Tokens; or (b) such persons have agreed to act together for the purpose of acquiring, holding, voting, using or disposing of the Tokens; provided, however, that two persons independently using or agreeing to use the Tokens for their intended purposes within the Cryptosystem (such as by participating in a proof-of-stake consensus process that results in agreement among stakers or validators) shall not be considered Extrinsically Affiliated solely on that basis.
Note: the goal of (a) of this definition is to capture, as broadly as possible, ‘control’ concepts (including direct or indirect power or control over the decisions, management, actions or policies of a person).
Note: the goal of (b) of this definition is to capture contractual relationships, including delegated powers and discretionary management ability as well as collusive relationships.
Network means a peer-to-peer network that: (a) consists of computers running Open Clients which transmit and receive data among each other over the Internet, execute operations on such data and record such data and the results of such operations on an Open Ledger; and permits any Internet-connected computer running the Open Client to obtain an accurate and complete copy of the Open Ledger and freely transmit messages to and read messages from all other Open Clients on such network, in each case, without any permission, authorization, identification or credentialing of such computer or the owner or operator of such computer.
Open Client means: (a) human-readable software code implementing a peer-to-peer networking and data consensus software protocol that allows participants in the network to form consensus regarding the canonical data and to perform transactions involving Tokens on the Open Ledger; and (b) all machine code, bytecode, runtime code and other derivatives of the software referred to in the preceding clause ‘(a)’, provided that the software described in the preceding clauses ‘(a)’ and ‘(b)’ of this paragraph is freely and readily available and licensed to the general public for use, copy, study and modification.
Open Ledger means an electronic database that: (a) is created, stored and updated by a peer-to-peer network of Open Clients; and (b) can be independently verified through cryptographic methods as having been created and updated in accordance with the data consensus protocol embedded in the Open Clients.
Person means any individual person as well as natural and legal entities.
Token means any electronic unit of account or representation of such units that (i) is created, stored, transferred and updated within and by means of a Cryptosystem; (ii) could reasonably be expected to have present or future material pecuniary value; and (iii) does not represent the contractual right to receive any payment or distribution from any person (in respect of any payment of principal or interest on a debt, distribution of profits, assets or dividends, or otherwise).
Tenet 2: Build Antitrust Structural Protections The FTC is the best fit as the principal regulator for crypto. Blockchain technology is the rails of the space but the bill should not cover (or give regulatory cover to) private/enterprise blockchains or chains that do not meet the definition of Autonomous Networks. However, for this space to retain its promise, antitrust protections must be broadly built and enforced at the infrastructure level to *prevent* concentration in practice. These protections will underpin the above definitions of Decentralized Cryptosystems to prevent public permissionless networks from de facto capture and concentration in practice.
As a foundational matter, public permissionless networks should have a regulatory envelope that supports and ensures these networks remain public and permissionless. This means (a) regulating systemically important vertically-integrated centralized actors operating on- and off-chain in crypto-ecosystems, (b) disincentivizing concentration in practice, and (c) having a careful eye to preventing market instability caused by overlaps in traditional markets and the activities of regulated institutional actors within this space posing contagion and/or counterparty risk.
Note: See premises here for regulating vertically integrated actors
Tenet 3: Non-Securities Designation through Token Taxonomy. Within a legislative solution, a key area of focus is clarity around when a securities designation is warranted based on the intrinsic characteristics of the Token. The lack of clarity on this point has perpetuated bad practices within the space and the regulatory framework should instead support value accrual to Tokens and Token holders. Yet none of the proposed legislative frameworks accomplish this goal. Any viable legislative solution should include non-securities designations for certain core categories of Tokens that operate within Decentralized Systems (“Token Safe Harbor”) as well as principles to expand the safe harbor (collectively “Eligible Tokens”).
Operating within the Decentralized Cryptosystem framework, an example initial Token Safe Harbor would include at least the following categories:
Autonomous Token means any Token operating on an Cryptosystem that (i) enables the user, through the operation of the relevant Cryptosystem, to: (1) pay for the use of aCryptosystem; (2) vote in the governance or control of a Cryptosystem or on parameters or features thereof; or (3) capture, track, access, receive or otherwise benefit from the value of a Cryptosystem (including any Tokens paid into such Cryptosystem as usage fees); and (ii) except for implied rights in connection with clause ‘(i)’, does not represent the contractual right to receive any payment or distribution from any person (in respect of any payment of principal or interest on a debt, distribution of profits, assets or dividends, or otherwise).
Note: this category includes governance tokens, gas tokens and tokens historically captured within the concept of ‘utility tokens’.
Network Generated Tokens means Tokens that may be generated and distributed pursuant to mining or staking, rewards or inflationary or dilutive controls within a Network; provided, that any such new Tokens dilute all Tokens of the same kind equally and shall be issued in accordance with the governance terms or consensus algorithm of a Network and not at the discretion of any Issuer or Insider, in each case acting alone or in concert with Affiliates.
Representational Tokens means any type of Token that: (i) without reduction or dilution of the value of or economic, governance or other powers and benefits of an Autonomous Token, is derived from or designed to represent or to be convertible with (A) such Autonomous Token or (B) the value of or economic, governance or other powers and benefits of such Autonomous Tokens (including pursuant to any ‘liquid staking’ or similar arrangements); (ii) cannot be minted, generated, credited, assigned or otherwise come into existence without staking, converting, depositing, locking, burning or otherwise removing from circulation a proportional amount of the type of AutonomousTokens; and (iii) cannot remain in circulation except while the proportional amount of AutonomousTokens referred to in the preceding clause ‘(ii)’ remains out of circulation.
Note: these include wrapped tokens and LSTs etc.
Expansion Principles: Within the umbrella of Decentralized Systems, the Hinman Test can be used as a baseline to expand the types of Eligible Tokens that are not subject to securities designation.
Note: Nothing suggested in this section prevents the SEC from regulating fundraising activities using Tokens (including literal investment contracts), which is directly within their mandate. However, this will require further rulemaking and for us to work with the SEC. See Reg X for an example framework.
Tenet 4: Develop AML Compliance Framework that Respects Permissionless Networks. We need a legislative consensus on sensible aml/kyc regs that use on/offramps to fiat as chokepoints & law enforcement to focus on bad actors being the counterparties to a P2P transaction and use all the surveillance at their disposal & work with offramps.
Tenet 5: Regulating Liquid Trading Markets. Though this tenet has been given the most attention, all draft bills using the CEA as a framework for crypto legislation are doomed to fail. Instead of copy-pasting an existing regulatory framework predicated on centralization and intermediation, we should build a legislative foundation for the market consisting of (1) the antitrust framework (described above) to ensure appropriate ‘market structure’ exists, (2) the definitions to prevent regulatory arbitrage and ensure the legislative framework preserves the features of this market such that it remains worthy of legislative accommodation. The trading framework can build upon this foundation with a focus on preventing bad acts in the markets.
Listing Eligibility. Define Cryptosystem maturity threshold for listing an Eligible Token:
Example definition of “Autonomous Cryptosystem” – means: (a) the combination of a particular Autonomous Network and an Open Ledger maintained thereby; or (b) the combination of particular Code operating on one or more Autonomous Networks (“Autonomous Code”), a particular Open Ledger on which the Autonomous Code is verifiably stored and a particular Autonomous Network which maintains such Open Ledger and executes such Autonomous Code.
Trading Market Oversight. Pick one regulator (whichever is most resourced/appropriate) to have fraud/market manipulation authority over the market for Eligible Tokens that operate within Decentralized Systems.
Decentralized Trading System Carveout. Draft market regulations that distinguish between centralized businesses that operate like traditional enterprises vs. decentralized (DeFi) and build definitional boundaries around DeFi (may need additional clarity around leverage and swaps here). but if we narrow regulator mandate, they can police for fraud/market manipulation here but it wouldn’t constitute a registration regime. Otherwise, regulate to actual risk (hacks etc).
Do not force permissioning for listings, police the user behaviors.
For Centralized Market Actors.
Trading Platforms. Can list Eligible Tokens only (and if the intrinsic characteristics change, must reevaluate eligibility/potentially delist).
‘Control’ thresholds for autonomy tests (institutions gaining control of X% of liquid market as a factor in determining whether to delist; serves as a deterrent to concentration in practice).
Other Intermediaries & Regulated Actors.
Develop rules for how/when these Centralized Market Actors can use/access Decentralized Trading Systems.
Form SRO(s) & develop additional rules to police trading platforms & develop market surveillance to aid FTC in oversight of market/infrastructure (conflicts; listing; report monopolistic/anti-competitive behaviors such as an exchange with a VC arm mandating the use of affiliated custodial services).
Study overlaps between crypto and traditional markets with an eye to preventing integration that could lead to contagion/ black swan events.
Tenet 6: Omnibus Legislative Clarity. Any legislative effort of this magnitude should be looked at as a one time opportunity to clear up as many regulatory roadblocks as we are able. Running list of examples below:
Tax Clarity - tax rules should be applied based on taxonomy AND use case in order to form coherent tax outcomes.
Reciprocity - rules for how the US framework interacts with other global frameworks, including MiCA.