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  • J Huang and S Pettigrove

LBRY checks out: the end point of regulation by enforcement

LBRY Inc., the blockchain-based file-sharing network said in its last post that it would wind down following enforcement action by the US Securities and Exchange Commission (SEC). According to LBRY, its assets including the popular video sharing channel Odysee will be auctioned.

LBRY originally announced that it would wind down LBRY and its assets after losing a New Hampshire court decision in November 2022 in favour of the SEC. In that case, the SEC obtained summary judgment on its allegations that the "LBRY Credits" or "LBC" crypto tokens issued by the firm were securities, and that LBRY breached the registration requirements of US federal securities law by offering and selling these tokens. The SEC originally sought a financial penalty of US$44 million, but pared that down to a significantly lower $111,614 after court hearings.

In September 2023, perhaps motivated by Ripple Labs' partial victory against the SEC, LBRY backtracked on its decision to wind down by filling a notice of appeal against the SEC. However, the company announced in its post last month that it is finally throwing in the towel in its fight against the regulator,

LBRY Inc. must die, there is no escaping this. It has lost a judgment to the federal government, has several million dollars in debts, and has pledged to shut down.

LBRY's assets will be placed in receivership and used to satisfy its debts, including the civil monetary penalty owed to the SEC. The future of the LBRY blockchain remains unclear.

While the SEC heralded their victory against LBRY, the Commission itself has been split over the LBRY case and its broader implications. On 27 October 2023, Commissioner Hester Peirce, who is famous for voicing dissents to several SEC enforcement actions against crypto firms, issued what she called an "overdue" statement of dissents on the LBRY case.

According to Commissioner Peirce, the case against LBRY "unsettled" her. She asks:

Are investors and the market really better off now after the Commission’s litigation contributed to the demise of a company that had built a functioning blockchain with a real-world application running on top of it?

Commissioner Peirce points out that the case illustrates the "arbitrariness and real-life consequences" of the SEC's "misguided enforcement-driven approach to crypto". She questions the decision to target LBRY instead of genuinely fraudulent crypto projects that sold tokens with promises they did nothing to fulfill:

Why go after a company that sold a token for a functioning blockchain with an established use when we could have pursued plenty of other projects that were outright frauds and did not attempt to comply with the securities laws?

She also criticised the originally disproportionate remedies sought by the SEC, which was not supported by the court:

The Commission’s requested remedies were entirely out of proportion to any harm. Indeed, the court stated during the remedies hearing that “the absence of fraud allegations, [and] the fact that there was some measure of uncertainty” regarding the application of the securities laws when LBRY commenced its offering were facts that “should be taken into account when considering a penalty.

Finally, Commission Peirce points out that the application of the securities laws to token projects is not clear, a complaint similarly raised by other crypto firms (e.g. Coinbase) which seek to comply with the laws but find little guidance to do so:

There is no path for a company like LBRY to come in and register its functional token offering. Even if a company did manage to register its token offering, it would not be a particularly useful effort...

She also suggests that the SEC is missing the point of regulation by actively bringing enforcements,

The time and resources that we expended on charging LBRY could have been devoted to building a workable regulatory framework that companies like LBRY could have followed. Then the market could have decided LBRY’s fate.

As Commission Peirce suggests, the SEC's actions could hinder innovation in blockchain technology, and alternative approaches to crypto regulation are desperately needed. It is unfortunate to see projects like LBRY which have real-world blockchain-based use cases - LBRY aptly describes this as "technology that enables dissents" - being shut down by enforcement actions. To grasp the opportunities offered by blockchain technology, the US legislature and regulators must hasten their efforts to formulate a tailored regulatory framework for Web3 companies and start-ups.

Written by Jake Huang and Steven Pettigrove

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