Crypto Twitter loves to trash Gary Gensler and the SEC. Is the SEC run by a power-hungry lunatic, or are they just following the law?
Securities Law
I imagine for most crypto investors, securities laws seem pretty dumb. They’re just a bunch of silly rules that make it difficult for good, hard-working Americans to freely invest in whatever they want without using a VPN.
Not to mention they stifle innovation, they make America less competitive, and they’re going to absolutely ruin crypto. And now, to make matters worse, the evil moron Gary Gensler is trying to flex his evil moron muscles in a bid to expand the power of the Securities and Exchange Commission (SEC).
It’s all childish nonsense.
How many people are going to lose money from trusting Celsius? All of them? Most of them? How many of those people actually read and understood the terms of service or the risk disclosure?
I’ll bet none of them did. Why?
Because if they had bothered to read either one, no sane person would have ever given Celsius a penny. But millions of people did, and now they’re rekt.
What’s this got to do with the SEC? A lot. Celsius is not the first company to come along and swindle people out of their money. They were basically issuing unregistered securities, promoting them to retail investors, and running an unlicensed bank.
They tried to hide all of that flatly illegal behaviour with their carefully worded terms of service and risk disclosure. But here, tell me if this sounds familiar:
‘You have two thousand dollars,’ [the swindler] says. ‘The bank will pay you three per cent interest, or sixty dollars a year. Of course that will do you no good. You will have to live on the principal and in a couple of years it will be gone; but here is a perfectly safe investment that will pay you thirty five per cent a year. That will give you a sure yearly income of seven hundred dollars. You and the children can live on that quite comfortably!’
That was from an article about stock swindlers in The Saturday Evening Post on December 2, 1911.
The article details many of the wildcat stock swindles that were running rampant through the state of Kansas. Much like Celsius, those swindles had: smooth talking salesmen, long contracts that no one really bothered to read, and were clearly swindles to anyone who bothered to do their diligence (DYOR bruh).
The thing that finally stopped people from getting taken by those scams were state-level “Blue Sky” securities laws. Trouble was, when a state like Kansas enacted a law like that, the swindlers just moved to the next state over and started up again.
It became such a huge problem that the US passed national legislation — the Securities Act of 1933. With the new legislation came a new administrative body called — you guessed it — the Securities and Exchange Commission.
When legal analysis isn’t
A Twitter thread floating around the interwebs claims to demonstrate that Ethereum is not a security. It’s cute because it sounds like a plausible legal analysis.
But it’s not.
Beyond the Twitter thread, there is a more in-depth article. The guy who wrote it (Adam Cochran) has an MBA, not a law degree. And what Cochran wrote is a pure opinion piece. It has about as much legal merit as a potato chip bag.
Let’s break Cochran’s article down a bit. For those who don’t know, to be classified as a security, the law says the enterprise in question must be subjected to the Howey test.
The Howey test has three “prongs”: 1) an investment of money; 2) in a common enterprise; 3) with the expectation of profit from the efforts of others.
Prong One
Cochran agrees that buying Ethereum is an investment of money.
I agree.
Prong Two
Here Cochran concludes Ethereum is not a common enterprise because there is no horizontal or vertical commonality.
There are a couple issues here.
First, Cochran spends a lot of time talking about staking and validation. The general anti-commonality argument is: staked funds aren’t pooled; penalties and rewards are specific to the validator; validators are not “communal”; and block proposers need to contribute “effort”.
That’s all well and good, but the Ethereum network is more than just staking and validating.
Second, the idea that for Ethereum to become an investment contract it must pass the common enterprise prong isn’t necessarily true. Tracing back to the little history lesson above, the Howey court says:
The term “investment contract”…was common in many state “blue sky” laws in existence prior to the adoption of the federal statute…Form was disregarded for substance, and emphasis was placed upon economic reality. An investment contract thus came to mean a contract or scheme for “the placing of capital or laying out of money in a way intended to secure income or profit from its employment.”
Meaning, if it walks like a duck, squawks like a duck and flocks like a duck, it’s a duck. And from where I sit, most crypto projects are a duck, including Ether.
Prong Three
Here again, Cochran spends a lot of time and effort focussing on what validators do, or whether or not they are contributing effort.
And I’ll say again, Ethereum is more than just validating transactions. Yes, that is one way to profit from the network. Another way is price appreciation on the token.
Between July 22, 2014, and September 02, 2014, the Ethereum Foundation offered 72 million ETH for sale to the public and raised approximately $18 million dollars (BTC equivalent) in the process. From the original whitepaper, the stated goal for Ethereum was to:
Create an alternative protocol for building decentralized applications, providing a different set of tradeoffs that we believe will be very useful for a large class of decentralized applications...
People that bought Ethereum at the time of launch probably did so because they expected the software that Buterin, Hoskinson and others wrote to become successful.
The people associated with the project give it traction. Buterin is one of four core developers, all of whom will get a cut from the initial fundraiser.
What was the expectation from raising money? Obviously, the expectation was the software would become popular, so more people would want to buy Ether, and then the price would go up, thus making everyone a profit.
The developers of Ethereum offered the general public an opportunity to invest in a software project that everyone expected (hoped) would become profitable. Meaning there was:
An investment of money;
In a common enterprise;
With the expectation of profits derived solely from the efforts of others.
And when the developers did this, they did not register that offer with the SEC. They also did not seek an exemption from registration from the SEC.
Thus, at least from one legal standpoint, the developers appear to have offered unregistered securities to the general public without an exemption.
The counterpoint to that narrative is people that bought the Ethereum token did so to use the network. To perform a transaction on Ethereum requires Ether.
Some people might have bought Ether hoping the price would go up, but that wasn’t the intention behind selling Ether. One is an investment contract, the other is a ticket to the show.
The real trouble is people in crypto have known all along what they’re doing is probably against SEC regulations. There’s been a whole lot of “wink, wink, nudge, nudge” going on since the beginning.
Move fast, screw the rules, what are they going to do to us anyway kind of thinking has absolutely dominated the industry. There will be a price to pay for that attitude.
We just can’t say how high it will be until the bill comes due.
The real problem for the SEC = time
The problem the SEC has now is not that the vast majority of crypto projects are (rather clearly) securities. That almost goes without saying, at least under current law.
The problem for them is they’ve been sitting on their hands for almost a decade while the crypto markets have been going gangbusters. This is essentially the argument Ripple Labs are making right now.
The time for the SEC to flex it’s enforcement powers was eight years ago. But eight years ago, crypto was just a novelty to most regulators. It was written off as a passing fad that will burn out as soon as everyone figures out it’s the next tulip mania.
Today it’s a trillion dollar market. And unfortunately for the SEC, you can’t put toothpaste back in the tube, nor will closing the barn door after the horse escaped be helpful.
I personally think they’re burnt. Clearly that doesn’t mean they won’t try.
Administrative law vs. statutory law
The SEC is an administrative monster. Congress delegated their law making powers to the SEC to enforce the provisions of the Securities Act.
But Congress still holds the ultimate key. By an act of Congress, the SEC could be disbanded. They could also pass a law that says the SEC has sole jurisdiction over all digital assets. Or Congress could pass legislation that says all digital assets are commodities.
Most likely Congress will be forced to pass something in-between, but likely closer to commodities. I imagine once that happens, existing projects will be grandfathered in.
As in, they’ll technically be securities, but will be allowed to continue operating under commodities rules. That is, provided the project doesn’t make some sweeping change that runs afoul of the new rules.
As I’ve said before, legislation is coming. What the crypto industry needs to do is demonstrate leadership. They need to get out in front of this stuff.
They need to work with legislators and educate them about the technology. One of the many reasons I’m a huge fan of Binance is all the work CZ is doing in this direction.
But the clock is ticking. And with that ticking clock, we can’t afford to be getting riled up and wasting time trying to wiggle around the law with silly legal arguments on Twitter.
Conclusion
There are hundreds of billions of dollars on the line in the crypto markets. If we’re going to be successful, savvy investors, we can’t afford to rely on information simply because someone has a lot of followers on Twitter.
Social media engagement is a business all on its own. And it’s very much a niche business, of which crypto investing opinions, commentary, news, and hype can be very profitable.
But that content isn’t there primarily to inform. It’s there to drive interest, web traffic, product sales, ad revenue, vanity, pretty much everything but providing nuanced, credible, and reliable information.
Understanding the legal status of a crypto project you are thinking about investing in is an important part of making sound investment decisions. That’s true for both Trad-Fi and crypto.
But sometimes it means digging a little deeper than the latest opinion trending on Twitter.
These are just my opinions. I’m not a financial advisor, this isn’t financial advice, and always DYOR. Following any of these ideas might cause you to lose all of your money. I am 100% serious about that. I like tinkering with this stuff, but I’m on record acting like a total baboon. Invest accordingly.
Until next time, be safe, be smart and be sure to tie the camel.
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