The Regulators Are Coming

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🐤 Canary in the Decred hash mine: Part I

TLDR: There’s a 47% chance that Decred is an investment contract and trades like a security when we test it against the new proposed SEC Howe Crypto Framework.

I’ll start off by saying, this is not a noob friendly article. It assumes you know a lot about crypto, SEC crypto regulation news, and the Decred project.

Disclaimer: This is an armchair thought experiment. Please take it with a mountain of salt. If I get something wrong, let me know in a comment. This is mostly just me trying to think my way through the SEC’s recent Framework on evaluating cryptocurrencies to determine if they are investment contracts and/or if they trade like securities.

The Timeline:

On April 3rd 2019, the SEC came out with the following proposed guidance on how to evaluate a cryptocurrency to see if it trades like a security, or if it is an investment contract, using the Howe test as a baseline.

In reaction to this new proposed guidance by the SEC, Poloniex (owned by Circle) is concerned that a number of their listed cryptocurrencies may be trading like securities or were investment contracts. As a result, they are restricting their US customers from trading in ARDR, BCN, REP, GAME, GAS, LSK, NXT, OMNI, and Decred.

The general sentiment around Decred channels is that this action by Poloniex was unwarranted, unjustified, and too preemptive. The logic behind these thoughts is that the guiding document by the SEC was only contemplative in nature, and not legislative. Furthermore, Poloniex has been inconsistent with their geo-fencing actions. While pre-regulating some assets, and promoting the Cosmos ICO at the same freaking time. Talk about hypocrisy.

Side note: a couple weeks latter Poloniex screwed their lenders by giving them a 16.5% haircut for Poloniex’s incompetence. So don’t use Poloniex.

Furthermore, Poloniex themselves “…don’t agree that they (Decred and others) should be considered securities but need to ensure we are in compliance with US law.” Which may or may not be a cop-out poor excuse, considering all the other security like assets they have listed on their exchange that they did not bother to geo-fence.

After some community push back the CEO of circle came out with this damage control response four days latter.

Further analysis by circle was offered on May 23rd explaining their logic in more detail.

After I read the SEC’s guidance and circle’s analysis, my gears started to turn.

So, by this time you should be asking is Decred a security? The straight answer is that we don’t know yet. The SEC has not come out with a binding rule set or criteria officially. All they have come out with is a preliminary guidance document on a proposed Framework to evaluate cryptocurrencies.

And luckily, it looks like they are going after bigger and easier ICO fish to catch. On June 4th the SEC Charged Kik (the messaging application platform) with conducting a $100 million unregistered ICO. It’s seriously not looking good for ICO’s in the USA, see this entertaining annotated break down of the case against Kik for more details (by Katherine Wu).

By design, Decred is smarter and leaner than most fish, but it still may be a fish to catch by the SEC. We’re slowly evolving wings, as seen in the approved decentralized treasury spending proposal (ironically this proposal was submitted on April 2nd 2019, the day before the SEC came out with it’s Framework).

But we may also be introducing new regulatory risk with the approval of Decred Decentralized Exchange Infrastructure, which is essentially a secondary market.

In any case, does Decred pass the ludicrously antiquated Howe based “Framework” the SEC came out with on April 3rd?

Yes…Maybe.

How do I know? Because I played devils advocate and went line by line through their damnable criteria and tested the Decred project against the proposed criteria.

Scroll past the picture for more context.

High quality picture here.

OneNote Document here.

Here’s a high quality version of the above picture

My logic for each criteria, argument and score is outlined briefly and is up for debate. So, if you disagree with a score, please let me know your logic. Or better yet, conduct your own mental walk through in the provided OneNote document, which is a copy of the above picture. Also, other cryptocurrency projects can use this same OneNote document to walk through each SEC criteria as a thought experiment.

My apologies if I offend anyone in this analysis. I tried to remain unbiased but may have overcompensated by being too critical of Decred’s weaknesses. At first I was very skeptical of the SEC Framework and Poloniex’s reaction. Even my original two working titles reflected this: “Rebuttal to Poloniex Delisting Decred for US customers” ; and “Shredding the SEC’s Framework for “Investment Contract” Analysis of Digital Assets: Testing Decred”

But, after going through this thought experiment (I hate to say it)… I think the regulators may have a point.

My intention is not to alarm Decred project supporters, but to inform them of this possible challenge that we may find ourselves caught up in. By identifying the pain points, we can patch them up and come out the other side of this a better project. And to be honest, many of these pain points have already been identified by Decred project lead members and are currently being worked on by these same highly competent people. (However, the Decred DEX proposal may be a pain point in the making, with its own regulatory risks if it is not implemented with care).

But, do regulators even matter? Probably not. But they may have a point, because their Framework identifies the centralized pain points in the Decred project, which we should strive to make better. And in truth, I think the Decred project is doing that in good faith, it’s just taking a lot of time, sweat, and oh so much code (God bless the Decred Devs, you crazy cypherpunks).

So, with that long rambling, here is the overall results from my thought experiment:

Not bad, but not great either. These scores are the sum of all the smaller scores I gave in the thought experiment. There are probably other ways to do this analysis, and for the most part it’s arbitrary and up to the scorer. But I believe my scoring and reasoning behind my scoring identifies some important factors at play in the Decred project that are understandably not discussed in the more positive echo chambers.

Most projects ignore these pain points at their own peril. But I believe Decred is a different animal. After all Decred has governance, we can evolve.

My hope is that the Decred community can identify these pain points, come up with solutions, implement them and move on to more important matters.

I trust the right people will listen, act appropriately, and at least use cautious language moving forward when marketing the Decred project.

Furthermore, it’s interesting to see that the above score represents the situation, with Poloniex choosing to geo-fence Decred and Bittrex choosing not to geo-fence Decred. Even though Bittrex, geo-fenced over a dozen assets recently, they did not follow suit with Poloniex and geo-fence Decred. A good sign, but they could eventually follow Poloniex’s action.

This further confirms that the 50/50 chance of Decred being a security is the reality, making it difficult for exchanges to know out what to do. Furthermore, I imagine that the regulators are not keen on taking direct action against a project that they may have a 50/50 chance of winning a case against.

Rather, my best guess is that the current strategy by the SEC is setting the ground work for an easy win with KIK. They can then use that win as a template to go after bigger fish with deeper pockets. (Here’s looking at EOS).

For now, Decred is safe from direct action by regulators. The market cap of our treasury is way below their radar and there are much bigger, easier fish to go after. However, we may become affected tangentially by any decisions that come out from these cases. Which is why it’s good to be aware of our pain points and to work on patching them now. Though I expect some denial and push back from the Decred community at first on this file.

Don’t shoot the messenger, but this Decred canary still needs wings.


The Regulators Are Coming was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.