Because of a regulatory loophole, the most well-known crypto-currencies â€“ bitcoin and ether â€“ will not be treated as securities. But that will not be the case for other future virtual currency offerings.
The US Securities and Exchange Commission has determined that bitcoin already issued will be treated as assets, meaning that their resale will not require SEC regulation. The decision, however, will not give new issues of crypto-currencies the same exemption.
Oversight of the now $700 billion crypto-currency market is urgently needed to ensure that players operate fairly, according to regulators Jay Clayton, chairman of the Securities and Exchange Commission, and Christopher Giancarlo, his counterpart at the Commodity Futures Trading Commission.
â€œIn recent months we have seen a wide range of market participants, including retail investors, seeking to invest in distributed ledger technology initiatives, including through cryptocurrencies and so-called ICOs, initial coin offerings,â€ say Clayton and GiancarloOpens a new window .
â€œMarket participants, including lawyers, trading venues and financial services firms, should be aware that we are disturbed by many examples of form being elevated over substance, with form-based arguments depriving investors of mandatory protections.â€
The SEC has decided to classify bitcoin as assets because of the lack of a profit motive at the time of their generation, according to William Hinman, head of the SEC’s corporate finance division. Bitcoins are mined by solving a complicated mathematical computer puzzle. The SEC says they are an asset, but since they were mined and not sold as an investment, regulations on securities do not apply.
Hinman explained recentlyOpens a new window that because of the way bitcoin is structured â€“ with a decentralized network, and without a third party expecting to make a profit â€“ the agency will not treat bitcoin and the similar crypto-currency ether as securities. Bitcoin’s appearance in 2008, before any regulations were in place, also enabled it to avoid regulatory scrutiny when first introduced.
A Global Phenomenon
â€œDigital currencies, token sales and blockchain initiatives of all types have ignited a global phenomenon unlike anything I have ever seen,â€ says J. Dax HansenOpens a new window , a partner at Perkins Coie and leader of its blockchain technology and digital currency industry group. â€œAs the technology underpinning these developments disrupts products and services in nearly every industry, lawmakers, regulators and law enforcement are scrambling to keep up.â€
The SEC policy on bitcoin is based on the Supreme Court case SEC v. W. J. Howey Co., which defines an investment contract as one in which the investor is led to â€œexpect profits solely from the efforts of the promoter or a third party.â€
The SEC is instead focusing on the ICOs that many other potential crypto-currencies are planning, saying that these offerings fall under securities regulations. â€œCalling the transaction an ICO or a sale of a â€˜token’ will not take it out of the purview of the US securities laws.â€ says Hinman.
In a public statement,Opens a new window the SEC has made clear that under US securities laws, all ICOs and crypto-currency exchanges must register and will be regulated to prevent fraud and market manipulation, although no crypto-currency exchanges have registered to date.
In the decade since the introduction of bitcoin, thousands of new digital currency issues have occurred. Coinmarketcap.com lists 1,627 crypto-currencies in total, worth a combined $291 billion.
As a result, the opportunity essentially to print money through the offering of new currencies has attracted numerous doubtful proposals.
One of the largest frauds was the crypto-currency Onecoin, which raised $600 million in Europe and Asia but was later revealed to be a Bulgarian Ponzi scheme. Chinese authorities arrested 98 people and recovered $268 million related to the scheme. Authorities then ordered the closure of all Chinese crypto-currency exchanges from September 2017.
SEC Kicks Off Enforcement
In the US, the SEC has begun enforcing securities laws related to issues of crypto-currencies.
In December 2017, the SEC’s new Cyber Unit filed its first complaintOpens a new window , alleging that crypto-currency firm PlexCorps defrauded customers and â€” more significantly â€” failed to follow rules for US securities offerings, and halted PlexCorps’ ICO. PlexCorp raised $15 million, but the SEC found no evidence that the firm was actually developing a crypto-currency or had any plausible business plan.
â€œTo skirt the registration requirements of the federal securities laws, [PlexCorp] has attempted to re-fashion the PlexCoin tokens as a â€˜crypto-currency’ and likened them to bitcoin,â€ the complaint states. â€œIn reality, PlexCoin tokens are securities within the meaning of the US federal securities laws.â€
Not everyone is happy to see the SEC regulate crypto-currency offerings. Controversial anti-virus software entrepreneur and ICO promoter John McAfee claims the SEC has exceeded its authority.
â€œI am submitting, now, to this law, but I will fight with every last breath to ensure that this absurd overreach by the SEC will not stand,â€ he says.
Others would like to see even tighter regulation: John Griffin, a University of Texas finance professor, believes that the kind of focus that the SEC is now directing to new offerings should also be applied to the existing bitcoin market.
Griffin conducted a study of the fluctuations of bitcoin pricesOpens a new window in 2017, concluding there was large-scale manipulation of the market, with sham transactions that caused its value to reach $20,000 last year. Critics argue that this is exactly the kind of situation regulators should prevent.
â€œAuthorities are rightly concerned that, given their inefficiency and anonymity, one of the main reasons for their use is to shield illicit activities,â€ says Bank of England head Mark Carney. â€œThis cannot be condoned. Anarchy may reign on the dark web, but in the UK it’s just a song that your parents used to listen to.â€