Galaxy: What does the SEC's inaction on DoubleZero mean for the industry?

Source: Galaxy; Compiled by Jinse Finance

The U.S. SEC's Division of Corporation Finance has taken a milestone step by issuing a no-action letter ("NAL") regarding the proposed issuance of the 2Z token by DoubleZero, stating that "based on the facts provided, the Division will not recommend enforcement action."

This week, a cryptocurrency project sought forward-looking guidance on the legal status of its proposed token issuance and received a productive response.

Previously, during Gary Gensler's tenure as chairman of the U.S. Securities and Exchange Commission (SEC), the regulatory environment faced by crypto industry practitioners was quite distinctive: the SEC's guidance was almost entirely "retroactive enforcement" — projects that were originally invited to "register" ultimately received Wells Notices when exiting the process. Although this victory for cryptocurrencies is largely attributed to the shift in the SEC's viewpoint and leadership, the legal team at DoubleZero clearly outlined the design of the tokens, which is also commendable.

The SEC's no-action letter indicates that the agency's staff does not intend to recommend enforcement action against the parties involved in the proposed activities, providing regulatory comfort to the requesters, but does not formally bind the SEC. Although such letters are not legally precedential, they often carry weight, clarifying the gray areas of securities law and guiding industry practices, thereby serving as an effective signal of regulatory tolerance and expectations.

Before this NAL, we remember that the only other such forward-looking guidance issued by the SEC regarding token offerings was the NAL published in April 2019 for TurnKey Jet. In that NAL, SEC staff indicated that as long as the tokens were not traded on the secondary market, maintained a stable value of $1, and could only be used to purchase services from the issuer (essentially, it had to operate like airline miles or other reward programs, a highly restrictive design), the SEC would not take enforcement action. The DoubleZero NAL reflects a positive view of tokens with significant improvements in utility and tradability, thus representing a major advancement favorable to the crypto industry from the SEC.

DoubleZero's promotion is quite interesting: 2Z is not a speculative profit grab, but a functional incentive token designed to coordinate decentralized physical infrastructure (DePin). The project aims to establish a globally underutilized fiber bandwidth network to create a decentralized dedicated internet for distributed systems like blockchain. This network is intended to incentivize fiber infrastructure owners (network providers) to fully utilize their idle fibers and encourage operators (network participants) to coordinate traffic routing between network providers' infrastructures to maintain the network's robustness and fault tolerance. Network users who access this private internet need to pay to access the network; this fee will be programmatically allocated in the form of 2Z tokens to efficient network providers and participants.

In the letter to the SEC, the DoubleZero team focused on the fourth aspect of the Howey test: whether holders can reasonably expect to profit based on the efforts of others. DoubleZero effectively explained that the 2Z token merely serves to coordinate bandwidth suppliers and users. The profits (and losses) expected by network providers and participants are directly attributable to their own contributions and operational actions within the Double Zero network, rather than the actions of others. DoubleZero defines network providers and participants as working within the incentive structure of the network's operational rules, which the SEC has already given a green light to (twice). Assets must pass all aspects of the Howey test to be considered investment contracts (and therefore also considered securities); without the fourth aspect (expectation of profits from the efforts of others), the 2Z token is not subject to SEC regulation.

Commissioner Hester Peirce publicly praised this letter and used it to reiterate one of her long-held views: that the SEC's securities analysis should be based on economic substance rather than form. Peirce has long been a counterbalance to the overreach of the SEC under her predecessor Gary Gensler, and she has disagreed with many of the SEC's cryptocurrency enforcement actions. After being appointed head of the SEC's newly formed cryptocurrency working group, she delivered a "new paradigm" speech, pointing out that many digital assets are not securities and advocating for a tailored safe harbor for tokens. This week's NAL is one of the first concrete actions taken by SEC staff in this regard. Under Peirce's leadership, the cryptocurrency working group has hosted five industry roundtables and held over 150 meetings with cryptocurrency companies and other stakeholders.

Galaxy's View:

The SEC's move is an encouraging step for the cryptocurrency industry. For years, cryptocurrency projects have been defaulted as criminal enterprises and faced one of the following terrifying choices: being cracked down by law enforcement; going through an opaque and slow registration process (currently, only one project has successfully registered); or refusing to provide services to U.S. residents (nevertheless, many U.S. residents have managed to circumvent the geographical restrictions).

Before the release of this announcement, the only crypto project we know of that has succeeded with the SEC (if it can be called the SEC) is Blockstack (later renamed Stacks) and its STX token. Stacks issued its tokens through a Reg A crowdfunding exemption, allowing for minimal disclosure of information. Two years later, Stacks self-determined that its network was decentralized enough not to fall under the category of securities, and thus stopped submitting applications to the SEC. After a three-year investigation, the SEC chose not to take action against Stacks. This is in contrast to its explicit acknowledgment of DoubleZero this week, which can be seen as tacit approval of the project's position.

This is obviously a victory for DoubleZero, but it may also be a great blessing for global token designers. It provides a roadmap for building and developing functional utility tokens that the SEC will not view as investment contracts, but importantly, the NAL can only be seen as interpretive guidance for tokens that are fundamentally similar to the design described by DoubleZero. While SEC staff have clearly stated that they will not take enforcement action against DoubleZero on the grounds that such token issuance constitutes an investment contract, the NAL does not comprehensively articulate the SEC's views on all types of token designs. This relief is conditional and determined on a case-by-case basis. It is relief at the staff level, rather than a broad change in rules. It will not legalize prior allocations or token flows outside of limited design. If the facts change or the SEC's views change (for example, under different government leadership), it does not preclude future enforcement. For every token attempting to mimic the 2Z structure, legal teams need to demonstrate discipline, documentation, and strict adherence to the "utility-first" structure described in the NAL.

Although this is a highlight for the cryptocurrency industry, it may be the last piece of news we hear from regulators for a while, whether good or bad. The federal government is in a shutdown due to budget disputes, which unfortunately is not uncommon in past administrations. Before the dispute is resolved, our expectations of regulators are low (the market predicts that the government shutdown will last more than two weeks).

According to a report by The Information this week, the current government shutdown could indeed delay other cryptocurrency actions that we expect the SEC to take soon, such as a key "innovation exemption" that would allow stocks to be traded within DeFi applications, which the SEC is working to achieve "as soon as possible."

Meanwhile, the Commodity Futures Trading Commission (CFTC) is in a predicament as the nomination of Brian Quintenz as chairman has been withdrawn, leaving acting chair Caroline Pham as the sole member of the normally five-member commission. So, enjoy the good news brought by the DoubleZero fund, as the next victory may take some time.