The US Securities and Exchange Commission (SEC) once again dipped a toe into the realm of cryptocurrencies (COIN) (OTCQX:GBTC) this week and issued a fairly vague, but well meaning statement covering some legalities and offering advice.
As you may have gathered from the reaction in various cryptocurrencies, the market took no notice at all. If the SEC wants to throw water on the flames of crypto-mania they will need a much bigger bucket.
The statement came from SEC Chairman Jay Clayton and actually reads a bit like an opinion piece on Seeking Alpha. It even ended with this disclaimer,
This statement is my own and does not reflect the views of any other Commissioner or the Commission. This statement is not, and should not be taken as, a definitive discussion of applicable law, all the relevant risks with respect to these products, or a statement of my position on any particular product. Additionally, this statement is not a comment on any particular submission, in the form of a proposed rule change or otherwise, pending before the Commission.
However, the statement does offer some valuable insights, and it’s worth looking closely at the details. Cryptocurrencies will be under more and more scrutiny by the SEC, and this statement reveals at least one man’s thinking, which despite the disclaimer, is likely shared by others.
Ramping Up Regulation
The SEC has taken quite a hands off approach to regulation up to now. But they are clearly stepping up activity, and in September they created a new Cyber Unit.
The unit was created in September to focus the Enforcement Division’s cyber-related expertise on misconduct involving distributed ledger technology and initial coin offerings, the spread of false information through electronic and social media, hacking and threats to trading platforms.
This unit took its first scalp on December 4th when it announced it froze assets in Plexcorps, who “raised up to $15 million from thousands of investors since August by falsely promising a 13-fold profit in less than a month”.
Scams of this sort seem an immediate priority of the Cyber Unit. It’s going after the little fraudsters at the bottom of the food chain (or is it blockchain?). But only a few days ago, on the 11th December, another ICO halt was reported.
A California-based company selling digital tokens to investors to raise capital for its blockchain-based food review service halted its initial coin offering (ICO) after being contacted by the Securities and Exchange Commission, and agreed to an order in which the Commission found that its conduct constituted unregistered securities offers and sales.
This time it was not due to a blatant scam, but a more subtle point which could effectively halt the majority of future ICOs. The SEC’s main issue was the tokens were expected to gain in value and therefore act like an investment. As such they are required to be registered, regulated and treated as securities,
According to the order, in the course of the offering, the company and other promoters emphasized that investors could expect that efforts by the company and others would lead to an increase in value of the tokens. The company also emphasized it would take steps to create and support a secondary market for the tokens. Because of these and other company activities, investors would have had a reasonable belief that their investment in tokens could generate a return on their investment. As the SEC has said in the DAO Report of Investigation, a token can be a security based on the long-standing facts and circumstances test that includes assessing whether investors’ profits are to be derived from the managerial and entrepreneurial efforts of others.
Jay Clayton expanded on this point in his recent statement,
By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws. Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved.
I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws.
He also said,
Investors should understand that to date no initial coin offerings have been registered with the SEC. The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies. If any person today tells you otherwise, be especially wary.
I think this is enough of a hint to stay well away from future ICOs unless they come with official SEC registration. In the case of the halted ICO on the 11th December “Munchee Inc. refunded investor proceeds after the SEC intervened.”
Getting a refund is probably the best case scenario investors could hope for. I doubt all ICO investors will be so lucky.
Clamping down on scam ICOs and requiring future ICOs to register is a logical first step, but it feels like a case of shutting the gate after the horse has bolted; on the last count two weeks ago there were 1324 coins already in circulation.
Is it even possible for the SEC to regulate existing coins, which are traded globally? This is what Jay Clayton had to say on the matter,
It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction. Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset. In any event, it is clear that, just as the SEC has a sharp focus on how U.S. dollar, euro and Japanese yen transactions affect our securities markets, we have the same interests and responsibilities with respect to cryptocurrencies.
In other words, even if a cryptocurrency cannot be regulated as a security, it could still be regulated in the same manner as forex. After all, currencies are globally traded and have more in common with cryptocurrencies than a US based equity security.
I don’t see why this would be a concern for cryptocurrency traders. There was nothing in Jay Clayton’s statement suggesting the SEC were gunning for Bitcoin et al and were intent on bursting the bubble. Indeed, he left off on a positive note,
The technology on which cryptocurrencies and ICOs are based may prove to be disruptive, transformative and efficiency enhancing. I am confident that developments in fintech will help facilitate capital formation and provide promising investment opportunities for institutional and Main Street investors alike.
I encourage Main Street investors to be open to these opportunities, but to ask good questions, demand clear answers and apply good common sense when doing so.
As public interest in cryptocurrencies increases, so does the SEC’s. They have set up a Cyber Unit which has been active in December in halting ICOs, and future ICOs will be come under increased scrutiny and regulation. However, there is little to suggest the SEC has the intent or ability to regulate cryptocurrencies already in circulation in the same way. There may be future steps to treat them in a similar manner to foreign exchange transactions, but exactly when or how this will be implemented is not clear.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.