What Does "Decentralized" Mean?

Better question: should the chair of a bureaucracy that is currently exercising mafia-style authority over the crypto industry be expected to clearly define and/or acknowledge the word?

Last week was a very interesting week for the crypto markets. In addition to Ethereum transitioning from a proof-of-work to a proof-of-stake chain, SEC Chairman Gary Gensler was questioned by the Senate Banking Committee. Senator Pat Toomy’s questioning was really something to behold. You can watch Toomy’s entire exchange with Gensler below:

After a couple of different failed attempts at getting Gensler to articulate what the threshold is for determining whether a cryptocurrency, coin, or token is a security, Toomy went a bit more on the offensive. For me, this was the most meaningful moment from the exchange:

You’ve acknowledged there are tokens, plural, that are not securities. I think it’s because of this centralization that you come to this conclusion and my point is it is not reasonable to fail to provide clarity; to provide the definition of exactly where on this continuum you have a sufficient common enterprise where it qualifies as a security and where you don’t. You’ve said Bitcoin doesn’t. Some of your colleagues have said Ethereum doesn’t. But a reasonable developer who wants to comply with this doesn’t know where that line is drawn.

Senator Pat Toomy

Gensler immediately fell back to the Howey Test as a framework but again balked at defining how a common enterprise is determined. What people in crypto want to know is simple; in the eyes of the SEC, what level of centralization constitutes a common enterprise? While this might seem straight forward to some, in crypto it is often much less clear. This is partly why I wrote The Howey Test Framework Is Wrong back in June.

What exactly is a common enterprise? In June I argued Michael Jordan’s Fleer Rookie Card could conceivably be classified as a security since Fleer was the only issuer of Jordan’s RC. Buyers exchange money for the card with an expectation of profit. Profit that is derived from the work of somebody else; in this case, Michael Jordan. A skilled lawyer could almost certainly argue the Fleer Jordan is a security even though common logic would probably say that it isn’t. But that wasn’t the point. The Howey Test is a flawed framework and short of changing it, the best we can do is get clear guidelines on how the SEC makes the distinction between which issuers are common enterprise and which are sufficiently decentralized.

The reason crypto has an added layer of confusion is because many of these tokens aren’t issued by a single company or organization. Does a common enterprise have to be a centralized company? Or does a DAO constitute a common enterprise as well? A DAO is a “decentralized autonomous organization.” If a DAO can be considered a common enterprise, are there any token distribution metrics or tokenomic models that would still allow a token to pass Howey? For instance, we can all agree that Speedy Rewards points aren’t securities, right?

These are the kinds of questions the crypto community wants answers to precisely so that we can make the best decisions possible but Gensler won’t provide them even when pressed by a US Senator. Rather, Gensler chooses ruling by enforcement as we’ve seen previously with the Coinbase insider trading scandal where the SEC designated 9 highly obscure tokens as “securities” while maintaining that just about everything else in the market is also a security; except Bitcoin. For reasons that he won’t provide even when questioned. Is it because of the proof-of-work mechanism? Is it because of wallet address percentages? We’re left to guess.

Is Any of This Even Necessary?

Not to go all anarcho-capitalist on this one, but why do we even need any of this regulatory theater? Are the catastrophic losses felt by investors in Zillow, Carvana, or Smile Direct Club stocks acceptable simply because those companies paid the SEC’s registration fees? Is the gamma squeeze that 10x’d Tesla stock in under a year okay because Gensler was personally long the equity while it happened? Not to let crypto entirely off the hook, was Voyager a safer investment than something like NEXO token simply because Voyager had a registered equity? Voyager went bankrupt after the 3AC blowup and Nexo.io didn’t.

The point of this isn’t to say that making money from gamma squeezes is bad or that many tokens aren’t securities; many of them almost certainly are. The point is this agency appears to be highly arbitrary in its investor protections and I don’t think it’s a symptom of an agency simply not having the resources to enforce clear rules. Gensler’s SEC has sent cease and desist letters to dozens of crypto-focused entities. Gensler’s SEC provides poor logic for repeated spot Bitcoin ETF denials yet has approved the mindbogglingly risky single-stock leveraged ETFs from AXS Investments.

Let’s stop pretending the SEC is simply all about protecting investors from high-risk assets and get to the bottom of what the agency is really trying to accomplish. A great first step to understanding some of these motivations would be for Gensler to simply clarify what the rules are pertaining to crypto coins and tokens in a public setting. For whatever reason, he won’t do it.

Disclosure: I’m not an investment advisor. I merely share what I do and why I do it. You shouldn’t take anything I say as investment advice and always do your own research when making investment decisions. Cryptocurrencies, tokens, STONKs, and digital trinkets could all go to zero. I have no job and I live in my wife’s basement. I’m the last person on the face of the earth who you should listen to for financial advice or life advice.