From Orange Groves to Coin Offerings: Will the SEC Squeeze Crypto Assets?
Earlier this month the SEC launched its own ICO. The website for the crypto offering, www.HoweyCoins.com, is full of celebrity testimonials and promises of huge investor returns. There are even details about this “can’t miss investment opportunity” spelled out in an eight-page whitepaper.
The only problem? Howey Coins aren’t real. The ICO launch, it turns out, was nothing more than a way for the SEC to help educate investors about fraudulent ICOs and the dangers of investing in crypto coins and tokens without an appropriate level of due diligence. Kudos to the SEC for some serious regulatory trolling.
Howey’s Test
While the agency’s foray into the world of ICOs was completely fabricated, the name of its coin was cleverly tongue-in-cheek. The SEC uses what’s called the “Howey Test” to determine if a contract between two parties should be considered a regulated securities transaction. The test is in reference to a 1946 Supreme Court case over the SEC’s ability to prevent the Howey Company, a Florida-based citrus producer, from leasing land to investors. The agency claimed this was done for speculative investment purposes and should be a registered securities transaction. The Supreme Court agreed, and the Howey Test was born.
This standard has been dusted off in the last several years, as securities regulators examine whether or not the purchase and/or sale of crypto assets should be considered contractual investment agreements. The SEC’s jurisdiction in this area very much hinges on this definition, and if bitcoin or other cryptocurrencies and tokens are defined as securities then the SEC will have regulatory authority. The key question here is, does this even make sense?
No Easy Answers
The short of it is there’s no silver bullet or easy answers at this point. As important as it may be for regulators to have standards like Howey, crypto is unlike anything seen before, and trying to fit rules from 70 years ago into this emerging space may result in more problems than solutions.
Moreover, antiquated approaches to regulation may do nothing to protect crypto market participants from fraud. Because of the decentralized nature of cryptocurrencies, there are built-in features that are self-regulatory in nature, such as the transparency of transactions on a public blockchain. It’s important regulators consider and appreciate these unique attributes.
Notably, SEC Chair Jay Clayton acknowledged in a recent Congressional hearing that most people agree bitcoin is not a security. However, in the same hearing he also stated he believes most tokens are securities and should be regulated as such.
The term cryptocurrency can be a bit of a misnomer. The term really encompasses two things–coins and tokens. Assuming that Clayton and the SEC will continue to recognize that bitcoin-like coins are not securities, the conversation will remain focused on how regulators might look at tokens (e.g., ICOs).
Some Guidance…
Fortunately, there are a lot of smart folks thinking about how securities regulators should approach the oversight of crypto tokens. This week, Coin Center, a DC-based nonprofit that advocates for reasonable public policy in the crypto space, released a helpful framework for how regulators should think about this issue.
In its Principles for Clarifying Jurisdiction over Cryptocurrencies and ICOs, Coin Center suggests a few things policymakers could do to provide more clarity around the regulation of crypto and blockchain-related activities.
- First, they recommend that a clear line be drawn to separate a token from any investment contracts associated with that token. By drawing a line around a truly decentralized token (not a security) and any contractual agreements surrounding that token (which could potentially be securities), regulators would have a better sense of where to look for fraudulent practices, while token creators would have more clarity around their activity.
- Second, Coin Center wants to ensure that innovators in this area are not subject to civil or criminal liability for making simple mistakes regarding whether or not a token is a security. To do this, they recommend (among other things) that policymakers allow for tokens to be developed, sold or exchanged as long as the person doing the developing, selling, or exchanging of that token believes in good faith he or she isn’t pushing the token as a valuable future investment for others (i.e., no Howey Coins here).
These recommendations seem like a good start to thinking about how regulators may be able to provide additional clarity to market participants…without stifling innovation.
One Piece of a Complicated Puzzle
After the 2017 rise in cryptocurrency prices, most people assumed regulators would become very active in 2018 (i.e., when grandma starts asking if she should be mining bitcoin, regulators take notice). This has indeed been the case, but while there’s been a lot of activity–including the SEC taking steps to aggressively pursue fraud in the ICO space–US regulators have, to date, taken a mostly measured approach.
At this time, regulatory patience is important. However, like with any other innovative industries, uncertainty makes it more difficult to invest and grow crypto businesses. A slow, deliberate regulatory approach needs to be balanced with an appreciation from regulators that more clarity is needed in order for innovation to flourish.
It’s also important to remember that the SEC is only one regulatory agency with jurisdiction in the crypto space. Because of the broad application of crypto and blockchain-related technologies, there is a very complicated network of regulators with LOTS of moving parts. In the US there’s the CFTC, FinCEN, and the banking regulators, not to mention each of the 50 states regulatory apparatuses. All of these bodies have some type of claim to the oversight of crypto assets. Oh, and did I mention the international regulatory bodies? They’re in on this crypto action as well.
All of this, really, means one thing: regulatory clarity in this space will take time and patience.
Just like the leasing of orange groves was once unchartered territory for regulators, crypto assets will need time to ripen before the right balance between regulation and innovation is achieved.
