#SECWarnsOnChainLendingMayFallUnderSecuritiesLaw

SEC Commissioner: On-chain Lending and Vaults Might Fall Under Securities Law

SEC Commissioner Hester Peirce (widely known as “Crypto Mom”) recently made a statement to note that just because financial operations moved on-chain, it doesn’t free them from Securities and Exchange Commission regulations. The focus for her statement was on crypto vaults, lending protocols, and other such DeFi products.

Key Points

Vaults: If the people managing vaults exercise a great deal of managerial discretion in their selections of yield opportunities or rebalancing the portfolio, the structure could be considered an investment company or common enterprise. The vaults’ operators will then have to comply with securities regulations.

On-Chain Lending: There are times when even the lending protocols might be regarded as engaging in securities activities, and perhaps even their loan agreements themselves could be considered securities. This might happen in the cases of teams setting interest rates, deciding which collateral is acceptable, or setting liquidate thresholds.

No Safe Harbor: Putting operations on-chain has no regulatory benefits in itself. What counts more in determining regulatory status is the nature of the underlying conduct, not its technology-enabled execution.

Engagement encouragement: The commissioner is calling on all market participants to work actively with SEC officials to determine possible ways to amend current regulations and clarify the legal frameworks around DeFi.

Why Is this statement significant?

Compared to recent messages from the SEC, this one is relatively fair. It also makes it clear that the DeFi is not an entirely deregulated market, while it simultaneously gives regulators a path toward cooperation and dialogues rather than an instant enforcement route. It will now serve as an invitation for projects to prioritize compliance when building.

For DeFi projects

Many of these DeFi products including automated lending tools that help users get some yields operate by vaults or by using some lending protocol, these tools might be categorized as investment firms or engage in common enterprises if the operators/ managers or any sort of entity/ governance token holders exert too much control over their decision-making process. Such tools or platforms could then be subjected to some of the same regulations as mutual funds, mutual fund companies, and certain other investment firms including registration, disclosures and prohibitions that limit their investment activities.

Decentralized applications have to strike a balance to maintain decentralization while complying with securities law. A protocol where there is active management or governance involvement would have difficulty to avoid classification as a securities firm and/or have its loans and assets be regulated.

How these regulations interact with current regulations

This move from Commissioner Peirce is another effort by the SEC to apply existing securities laws to innovative technology and products, the SEC also looks at a project for “substance over form” where a product that has the features and functionality of a security will be treated as a security regardless of how it is named or structured. We have seen this occur in past actions against DeFi lending products or even other kinds of decentralized finance products which the SEC believed to be operating as regulated securities exchanges or brokers.

How does it apply to us

For DeFi participants and investors, what this is basically saying is that higher returns typically accompany higher risks. It becomes important for participants to be sure that any lending product or vault that they invest in does not become a security.

Hope for the future

Commissioner Peirce is encouraging discussions, so it means that the door to future innovation is not completely shut. It is possible that through discussions between industry participants and regulators, there could be a way for future innovations in DeFi and the market to move forward. There are more transparent discussions that happen that helps sort through this issues which is in the best interest of both consumers and also to legitimate projects that want to participate and innovat in this new space.

So what next?

According to Commissioner Peirce statement, to make a “compliant” investment, any investment into or by a loan or a vault has to ensure that neither the borrower, lender, or platform providing the service becomes part of a “security firm” through management, governance, or a collective investment strategy that operates as an “investment company” or the borrower or the loans become a “security.” If we understand that and keep those concepts at mind, it will greatly help the whole industry to develop in a proper way and not to run against regulations and future court cases.

What is your take on how DeFi projects should approach this kind of regulatory signal?

‍#SEC #DeFiRegulation #CryptoCompliance @Gate_Square