Competing legal theories over how crypto vaults should be treated under federal securities laws are exposing a divide within the crypto industry and highlighting the challenges facing the SEC as it seeks to regulate the rapidly evolving world of decentralized finance.
Last week, trade group Crypto Council for Innovation, alongside members Bitwise, Galaxy Digital and Morpho, submitted a 238-page report to the SEC outlining when vaults should and shouldn’t be considered securities. Now, three DeFi players — Aave Labs, Veda Tech Labs and Kamino Foundation — are pushing back with a competing legal analysis that questions how much human control and discretion should matter in determining whether a decentralized protocol falls under federal securities laws.
At the heart of the problem is a question crypto has wrestled with for years: How do you regulate new technology using a rulebook written decades ago?
The SEC relies on laws and legal tests developed long before software and smart contracts began taking over the roles of traditional financial intermediaries. Should a smart contract executing investment strategies onchain face the same rules as an asset manager like T. Rowe Price? And what if humans are still making decisions, but through a decentralized entity like a DAO rather than a traditional company?
Where the two sides disagree is what that human involvement means under the law.
CCI’s framework emphasizes the degree of discretion and control exercised by people managing vaults, with the strongest case for non-security treatment applying to strategies governed by fixed rules and limited human intervention. For example, a vault that automatically lends crypto under fixed rules, without a human manager dictating where the funds go, would have a stronger case for avoiding securities regulation.
But Aave, Kamino and Veda argue that approach is too restrictive and could have significant implications for existing DeFi business models, including potentially their own. Their report, submitted to the SEC last week, contends that even actively managed vaults and DAO-governed lending protocols can fall outside securities laws, provided the arrangements don’t create the legal relationships those laws are designed to regulate.
On the face of it, an actively managed vault sounds a lot like a traditional investment company. Curators select lending markets and adjust how users’ assets are allocated. Someone is exercising investment discretion with other people’s money, so why wouldn’t securities laws apply?
While CCI’s analysis raises the possibility that these arrangements could be regulated as securities or investment companies, Aave, Kamino and Veda see things differently. They argue that deciding where users’ assets go doesn’t automatically mean someone is running an investment fund. Under the Howey test, relying on another person to generate returns is only part of the equation. There must also be a common enterprise — an investment venture in which users have pooled their funds. Aave, Kamino and Veda argue that users retain rights to their assets rather than investing in a separate venture.
The three companies also argue the Investment Company Act raises another question. Is there a legal entity, such as a trust or organized group, holding those investments and issuing interests in that entity? The paper argues that simply making investment decisions on behalf of users isn’t enough to establish one.
Under the Investment Company Act, a related question is whether an identifiable issuer, like a trust or an organized group, holds the investments as its own assets and issues interests in that undertaking. Therefore, the three companies argue that a manager’s investment decisions do not establish an issuer.
Both sides acknowledge that managers providing compensated investment advice involving securities would still face regulation under the Investment Advisers Act.
Many protocols, like Aave, rely on decentralized governance to adjust interest rates, collateral requirements and other risk parameters. Rather than leaving those decisions to a single company or individual, protocols can allow governance token holders to propose and vote on changes. Their concern is that protocols where no intermediary takes custody of user funds or promises a return could face securities regulation because of their governance structures.
“Decentralized governance is a critical pillar of blockchain networks,” said Aave’s Chief Legal and Policy Officer Linda Jeng. “When a community sets a market’s rules in public and gives users time to leave before anything changes, that is running a marketplace, not managing anyone’s money.”
Jeng warned that tying securities regulation to whether a protocol can be modified could lead the SEC to pick winners and losers by favoring certain blockchain designs over others.
The report comes as SEC staff also weighed in on decentralization this week, addressing the role of governance in an updated FAQ on crypto asset investment contracts. The guidance acknowledges that decentralized governance can involve discretion without necessarily amounting to centralized control.
“Immutability shouldn’t be the dividing line for what gets regulated,” Veda General Counsel TuongVy Le wrote on X in response to the FAQ, arguing that protocols need the flexibility to respond to changing market conditions, emerging risks and security incidents.
The guidance does not directly address whether crypto vaults qualify as securities. But the SEC could take up the issue following a statement from former Commissioner Hester Peirce seeking industry feedback on whether existing regulations need to be modified to accommodate vaults. The challenge for regulators will be deciding where to draw the line between decentralized financial software and regulated investment products.
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