The SEC, The ICO, and You

Today the SEC posted this press release that outlines the findings of an investigation they opened into, a German corporation that held what amounts to an Initial Coin Offering (ICO) as a means to raise capital for its projects. This short summary will not get into the specifics of that report (though I do recommend you read it), but instead attempt to elucidate what potential impact the key points touched upon in the press release will have on entrepreneurs, investors, and ICOs in the future.

But first, a few acronyms and definitions:

Securities Exchange Commission (SEC): enforces and creates securities laws and regulates the stock market and electronic securities exchanges in the United States

Decentralized Autonomous Organization (The DAO): the SEC considers The DAO to be “ a virtual organization embodied in computer code and executed on a distributed ledger or blockchain”

Initial Coin Offering (ICO): an issuance of coins/cryptocurrency tokens that are used to raise capital for a new (cryptocurrency) venture

Great, now that we’ve got all that out of the way, let’s get down to what the SEC’s findings were and what it means for the cryptocommunity.

The SEC found’s issuance of DAO Tokens, which would be used to fund future ventures, to be equivalent to the company issuing securities (stocks), much like a company that planned on going public would issue stocks during an IPO. Because such securities are subject to strict laws and are regulated in the United States, the SEC may require entrepreneurs to register their ICO and comply with U.S. securities laws. That is, of course, only applicable if the coins are issued to individuals that reside in or are subject to the legal jurisdiction of the United States.

In my opinion, the findings will mean very little to investors and exchanges for the time being. The SEC is not trying to, nor can they, regulate cryptocurrecy market participants and cryptocurrency as a whole; they are mostly interested in the creation of tokens and their subsequent issuance as a means of raising capital.

To the agency’s credit — there have been several ICOs that are scams or amount to mere “pump and dump” schemes. Requiring start-ups that plan to hold ICOs to register with the SEC would provide a layer of credibility and safety for investors that wish to participate.

It is worth noting that in this case, the SEC declined to bring charges against, but seemed to indicate that this could change for ICOs that fail to run their business through them in the future. The report and press release sent a pretty clear signal that the SEC wants to bring the days of the wild west of ICOs and new token slinging to a halt. Their report is a

caution [to] the industry and market participants: the federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.

It should also be noted that because cryptocurrency is recognized as a capital asset, gains and losses are required to be reported to the IRS on an individuals annual tax return. However, the agency seems to be having trouble getting access to the data that will help them enforce those laws.

In summary, the U.S. government, for better or worse, appears to be getting more involved in the cryptospace many of us operate in today, but ultimately I am left with a few questions:

How will the IRS enforce reporting on gains and losses derived from the sale of crypocurrencies? They seem to be formulating a plan, but given the agency’s track record on data security and shrinking budget, they’ll certainly have their work cut out for them.

Given the language of the press release, will the SEC actually follow through with the enforcement of the securities laws relative to ICOs, or was it more of a warning to investors?

Would there be new rules for entrepreneurs that want to hold an ICO, or would the SEC simply enforce existing rules?

If the SEC does decide to step in and strictly enforce regulation of ICOs, what mechanism will the SEC use to administer the new rules they create?

Answers to these questions will certainly come to light as crypto grows and matures as a technology. Stay tuned!

UPDATE: as pointed out by a reader, and not expounded upon or fully fleshed out by my write-up, the SEC will not have the authority nor seek to regulate all ICOs; rather, their intent seems to be focused on ensuring that ICOs and token issuance that fall under their definition of a security (DAO-like tokens) and operate in their jurisdiction are regulated accordingly. A great example of regulatory issues hindering a cryptocompany’s operations in the U.S. is Iconomi:

The Platform, the Website and DAAs are not offered for use to natural and legal persons, having their habitual residence or their seat of incorporation in the following countries: i) the United States of America, i) Saint Vincent and the Grenadines (“Restricted Areas”).

The two main points I want to stress are: 1) as of right now, the SEC’s statements have little to no impact on the majority of cryptocurrency investors and market participants, and 2) the U.S. government is gradually becoming more involved and interested in crypto, and its presence and impact is something market participants, entrepreneurs, and enthusiasts should monitor.