Crypto Hedge Fund Risks- 
How to Deal with Unregistered Securities

Are digital tokens commodities or securities?

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Decentralized solutions are the main attraction, and the major risk and hurdle for institutional investors, due to existing regulations. The major risks are (1) whether the asset is un unregistered security and therefore a no-no for an institutional investor, and (2) the custody on self-custodial platforms.

Truly decentralised projects are not considered to be securities, and are treated by regulators as commodities. However, the consensus notion, and as it was taught in MIT's cryptocurrencies course by one Professor Gensler (currently the reigning chairman of the United States Securities and Exchange Commission), is that only Blockchain was conceived as a pristine and true decentralized blockchain, without long lasting control over its operations exercised by anyone- Satoshi Nakamoto gave up to the community the full command and influence over Bitcoin’s operations soon after the launch.

Ethereum represents a slightly different story. Even though it is deemed now a decentralized blockchain, it wasn’t the case in the beginning when Vitalik Buterin or his enterprise had control over the software and operations. The act of relinquishing this power and allowing the blockchain to take it over was what made Ethereum a true blockchain. The newer versions of Ethereum, however, raise the same concerns, as it will be anticipated that the control center will inevitably belong to its launch pad, at least for some considerable time.

What to look for- centralized control and utility

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To make it simpler, the non-registered security problem is a problem of an issuer: if there is one, and it controls or influences the blockchain, it’s a security. However, SEC has explained that not only a control and influence matter, but its utility, too.

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Some of the central issues to look for in doing a due diligence of a project, among many other tools of manipulating its token by an issuer, are:

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• Current and planned or anticipated governance

• New versions releases

• Lack of transfer of control to the community

• Airdrops to the community.

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Gary Gensler, again, has said that decentralized finance (DeFi) is highly centralized and urged projects to register with the SEC. Speaking to The Wall Street Journal, Gensler suggested that the decentralized notions implied by the term DeFi were “a bit of a misnomer:” “These platforms facilitate something that might be decentralized in some aspects but highly centralized in other aspects.”

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Gensler stated that many crypto projects are developed and controlled by a centralized team that is incentivized to promote its platforms. “There’s still a core group of folks that are not only writing the software, like the open-source software, but they often have governance and fees,” he said, “There’s some incentive structure for those promoters and sponsors in the middle of this.”

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Gensler further elaborated in his comments in an interview with Fox Business that such DeFi projects are centralized enough to fall under the scope of regulation:

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"These so-called decentralized finance platforms actually have a lot of centralization. There’s a group of entrepreneurs that are running these platforms. They should come in and to that extent work with us and get registered."

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A crypto-friendly "Crypto Mom," SEC Commissioner Hester Peirce, also warned of “shadow-centralization” within the DeFi sector: “if regulators can find a centralized part or group of people that they can grab hold of, they will grab hold of them,” as she urged for caution in how projects are built from the ground up: “If you want to be decentralized, you really need to be decentralized, and that is going to then put you in a different category from the perspective of regulators because that’s just not something that we’ve dealt with before,” stated Pierce.

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Cointelegraph reported on Aug. 3 that "the SEC chairman identified seven crypto-related policy changes currently being examined, including matters concerning token offerings, decentralized finance (DeFi), stablecoins, custody, exchange-traded funds (ETF), and lending platforms. Gensler also identified the crypto lending market as coming under the SEC’s radar.

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