Policy Reforms are a must for adoption of Tokenization – a near must for democratization of SPV investments
The Bottleneck: Regulatory Hurdles for SPV Tokenization
- The Investor-number Cap on 3(c)(1) Funds: SPVs relying on 3(c)(1) or 3(c)(7) under the Investment Company Act, which strictly limit the number of investors to 99.
- The Investor-type Cap on 3(c)(7) Funds: SPVs relying on this exemption can invite an unlimited number of investors but require ALL of them to be “qualified purchasers.”
- The Publicly Traded Partnership (PTP) Rules on 506(b) safe harbor under Regulation D of Securities Act: The U.S. tax law penalizes partnerships deemed “publicly traded,” stripping them of favorable pass-through tax treatment if interests (including tokens) are freely transferable. This forces SPV sponsors to impose tight transfer restrictions, undermining the liquidity that tokenization is meant to unlock.
All the above restrictions make broad, fractionalized ownership of SPVs – tokenization’s core value proposition – nearly impossible for most private U.S. deals.
Why Policy Reform Matters Now
Peirce has advocated for the use of “regulatory sandboxes,” modeled after approaches in other jurisdictions, to allow firms to experiment with tokenized securities under limited exemptions from certain regulations. So we can see that there’s a growing recognition that well-balanced, modernized regulation could unlock new capital sources, enhance investor protections, and keep U.S. markets globally competitive.
What Could Policy Reform Look Like?
1. Raising or Removing the Investor Cap: Allowing more than 99 investors in a 3(c)(1) SPV – especially when robust KYC, AML, and smart contract-based compliance are in place – would enable true democratization of private assets. With blockchain, it’s possible to automate investor qualification and enforce limits in real time.
2. Modernizing the PTP Rules: Updating the tax code to accommodate digital, blockchain-based transfer tracking could preserve partnership tax status even with secondary market liquidity. Smart contracts can enforce transfer restrictions and reporting, aligning with the spirit of the law while enabling innovation.
3. Conditional Exemptions for Tokenized Securities: The SEC is already considering conditional exemptions for tokenized securities, which could include tailored rules for SPVs that use blockchain for compliance, reporting, and investor protection. Such exemptions could allow more flexible transferability and broader participation, provided investor safeguards are met.
The Opportunity: From Compliance Headache to Competitive Edge
SPV tokenization is already delivering value in global markets – from fractional real estate ownership to venture syndicates – where regulatory frameworks are more accommodating. In the U.S., policy reform could transform tokenized SPVs from a compliance headache into a competitive edge. Here’s how:
- Enhanced Liquidity: Fractional ownership and secondary market trading become feasible, attracting a wider range of investors.
- Automated Compliance: Smart contracts handle investor limits, transfer restrictions, and regulatory reporting, reducing costs and errors.
- Transparency and Trust: Blockchain-based records provide real-time, auditable oversight for sponsors, investors, and regulators.
Conclusion: A Call to Action
The technology for secure, transparent, and compliant SPV tokenization is ready. What’s needed now is regulatory courage and creativity. And if Tokenized USD is already a reality, likely the regulators are already comfortable with this idea. By modernizing investor caps, updating tax rules, and enabling conditional exemptions, U.S. policymakers can move SPV tokenization from DOA to dynamic – unleashing a new era of innovation, liquidity, and access in private markets.
The future of SPV tokenization is not just a technical challenge – it’s a policy opportunity. The time for reform is now.
