Cryptocurrencies and other digital assets (“crypto”) are surging in popularity. If cryptos are securities (“investment contracts” under the Howey test), they must be sold in accordance with the federal securities laws. This likely requires registration with the Securities and Exchange Commission (SEC) and initial and ongoing public filings – the same arduous process that exists for public companies with centralized management teams rather than decentralized autonomous crypto networks.
For those cryptos found to be securities, there is a regulatory scheme in place, as ill-suited to the occasion as it may be. For cryptos that are not securities, there is substantial leeway to consider the best approach to balancing investor protection with allowing this important innovation to continue, whether the SEC or the Commodity Futures Trading Commission (CFTC) ends up with regulatory authority over crypto. A balance means not favoring a wild west approach, where it would all be unregulated and rely on common law fraud to police bad actions, nor would it mean implementing a heavy-handed securities-like regime prioritizing investor protection over innovation. The Biden administration just released an executive order calling for the development of a framework for regulating crypto, making this post especially timely.
In a new article, I start very much within-the-box on a regulatory proposal, acknowledging that some sort of disclosure should be given to protect investors. Disclosure reduces information asymmetry ex ante and allows fraud enforcement and deterrence ex post. How effective disclosure is, and whether its benefit outweighs its cost, depend on how much and what type of disclosure is required. My article’s suggestions keep these two questions – how much and what type of disclosure – front and center.
As for how much disclosure, it has to be less than what the public offering process for securities would require. Thus, my article starts by examining a recent SEC effort to offer scaled-back disclosure: crowdfunding. Crowdfunding offers an analogous situation to crypto offerings in that it allows selling risky investments to unaccredited investors via general solicitation. Yet this disclosure is still likely inefficient and unread by most investors. While crowdfunding is still new, early studies show that companies often do not comply with SEC-required disclosures or that investors often do not read what is provided. Critics call the required crowdfunding disclosures excessive for the small amounts being raised. So shorter disclosure is necessary, but not sufficient.
This leads to the second question – “what type of disclosure?” – and to another context where tailored disclosure has received even more attention: standard form contracts, or so-called contracts of adhesion. Unlike the newish crowdfunding, courts and scholars have wrestled with standard form contracts for a century. Mostly these contracts are enforced because consumers have a duty to read what they agree to. Empirical studies reveal, however, that almost no one actually reads standard form contracts, just as with crowdfunding disclosures. Perhaps consumers receive their relevant information about a purchase through other means: social media, friends, etc. Perhaps they are just ignorant. But innovations like requiring a consumer to scroll to the end of terms before clicking “I accept” do nothing to improve reading.
In light of the intractable standard-form contract problem, in 2014 Yale law professors Ian Ayres and Alan Schwartz made an interesting suggestion: Put a “warning box” disclosure on the first page of a standard form contract that includes only terms that would surprise and disadvantage the consumer. If a consumer would reasonably expect a term, no matter how onerous, it would not go in the warning box. Also, if the consumer would be surprised but in a pleasant way, there would be no need for a warning box disclosure. Only terms that most consumers would be unpleasantly surprised to learn would go in a warning box. This is an attempt at tailored and helpful disclosure that doesn’t go too far.
The warning box proposal does what securities regulation tries to do: eliminate information asymmetry on the stuff that matters. I use the Ayres/Schwartz suggestion to suggest a regulatory path forward for a tokenized future. Let’s not give crypto the overkill securities law treatment, but instead the Ayres/Schwartz standard-form contract treatment: short, simple mandatory disclosures of crypto features that would surprise and harm a buyer.
For well-known cryptos like Bitcoin, nothing would be required in the warning box. Risks from investing in BTC, from potential environmental damage to price volatility, are well-known. Tether developers, however, should have disclosed that its stablecoins were not fully backed by fiat currency reserves, and Ethereum developers should still be disclosing that gas fees can be much higher than normal transaction fees investors may be accustomed to. Appearing along with the crypto’s whitepaper and link to its official website, a warning box strikes a good balance between innovation and regulation.
 Ian Ayres & Alan Schwartz, The No-Reading Problem in Contract Law, 66 Stan. L. Rev. 545 (2014), at 553, 583-87.
This post comes to us from Darian Ibrahim, the Tazewell Taylor Professor of Law at William & Mary Law School. It is based on his recent article, “A Tokenized Future: Regulatory Lessons From Crowdfunding and Standard Form Contracts,” available here.