December 2024 Newsletter

The Startup Solution

Bo’s Notes

Hi there! In the rapidly evolving world of Web 3.0 and crypto startups, transparency and honesty aren’t just regulatory buzzwords—they’re essential for building trust and staying compliant. This month, we explore how aligning operations with disclosures, maintaining valuation accuracy, and understanding the limits of decentralization can safeguard your business

In a climate of shifting regulations and political uncertainty, here are three key takeaways to guide your approach:

Transparency Is Non-Negotiable: In crypto and decentralized finance, what you say must align with what you do. Misleading investors or regulators can lead to costly enforcement actions.

Decentralization Is Not a Get-Out-of-Jail-Free Card: Operating a decentralized platform doesn’t exempt you from securities laws. Accountability is still a requirement, no matter how “autonomous” your system claims to be.

Don’t Bet on Political Promises: Relying on campaign pledges or future regulatory leniency as a shield for non-compliance is risky. Compliance must be a proactive effort, regardless of political outcomes.

At FinTech Law, we help crypto startups and Web 3.0 innovators navigate these challenges with practical, forward-looking solutions. Dive into this month’s articles for insights on building a transparent and compliant foundation for your business.

Transparency

Why It’s Non-Negotiable for Your Company

In both traditional financial services and the fast-evolving world of Web 3.0, one requirement remains constant: honesty and transparency in business practices and disclosures. These are not just best practices—they’re legal obligations.

Don’t Say It Unless You Can Back It Up

Whether you’re in traditional finance or Web 3.0, one of the biggest mistakes you can make is presenting an idealized version of your business processes.

If you claim data and automation drive your trading strategy but rely on manual interventions behind the scenes, as Inspire Investing did, you’re setting yourself up for an enforcement action by the U.S. Securities and Exchange Commission (SEC).

In the digital asset world, if you tout a stablecoin as backed 1:1 by liquid assets, ensure it is. The SEC’s case against TrueCoin highlights how misleading claims can trigger legal action and severe penalties.

Decentralization ≠ Immunity

One misconception we see repeatedly in Web 3.0 is that decentralization offers immunity from regulation. But here’s the truth: It doesn’t matter how decentralized your protocol is, if you’re issuing tokens that meet the Howey Test for securities, you’re still subject to U.S. securities laws.

The Rari Capital case is a prime example. Despite being a decentralized platform, the SEC determined that Rari’s governance tokens were investment contracts and the platform’s operators were responsible for the lack of proper registration.

Transparency isn’t just about being honest—it’s about ensuring your business model aligns with the law.

Bridging the Gap Between Disclosures and Reality

A critical issue across the board is the gap between what firms disclose to investors and how they operate. Whether it’s overstating how automated your investment process is or failing to disclose the full extent of a crypto token’s risk, the discrepancy between disclosures and reality will always land you in hot water.

Lesson 1: Disclose the process you use today, not the one you hope to have tomorrow. If your system isn’t fully automated or cash reserves don’t back your tokens, say so. Investors make decisions based on the information you give them, and failing to be transparent could be considered fraud.

Lesson 2: Regularly update your disclosures. As your business model evolves or risks materialize, you need to inform your investors and regulators.

"Disclose the process you use today, not the one you hope to have tomorrow."

The SEC Is Watching: Traditional Finance or Crypto, It Doesn’t Matter

The SEC has shown no hesitation in enforcing regulations in both traditional finance and the crypto space.

Macquarie Investment Management failed to correctly value illiquid securities in traditional finance, resulting in a hefty $79 million settlement. For crypto startups, the case against Mango Markets highlights that decentralization does not protect you from enforcement actions.

Both worlds share a common reality: compliance isn’t optional. Ignoring regulations—or assuming they don’t apply to your innovative platform—can result in penalties that far outweigh compliance costs.

Conclusion: Integrity Is Your Best Defense

At the end of the day, whether managing complex financial instruments or building the next big DeFi platform, transparency and honesty are your best strategies. Investors rely on your disclosures to make informed decisions, and regulators such as the SEC are increasingly focused on ensuring that those disclosures align with reality.

Don’t wait for a costly SEC investigation to make changes. Review your business practices, update your disclosures, and if you’re uncertain about the regulatory landscape, consult with legal experts. Because in finance—whether traditional or Web 3.0—it’s always better to be safe than sanctioned.