SEC’s Cautious Stance on Definition of Digital Assets Proves No Deterrent to Market Growth

On June 14, Securities and Exchange Commission Director William Hinman issued remarks on the definition of a security as it relates to the wave of digital assets that have flooded into the open market. Yet the commentary delivered at the Yahoo Finance All Markets Summit, which addressed the debate around whether a digital asset offered as a security can, over time, become something other than a security, has still remained largely undiscussed.

The unfortunate truth is that there was once a time, not too long ago, when the SEC weighing in on such a topic might have influenced the shape or direction of the ICO market. But with the U.S. ICO market having eclipsed the traditional venture capital industry by aggregate amount of annual capital raised year-to-date, it will remain entirely unaffected by any guidance short of legislation or a landmark court decision.

If anything, such a legal hard fork, to borrow an industry term, would be a welcome way to both legitimize the space and protect it from fraudulent actors who are undoubtedly poisoning the well for the broader market. But in a world of innumerous, highly bespoke digital assets, the SEC’s offer to “provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use” [1] is the equivalent of an offer from the U.S. Department of Agriculture to provide health inspections on a voluntary basis.

This kind of self-selective motion might be appealing to real businesses hoping to structure legitimate coin offerings. However, what is less obvious, is just how unhelpful this earnest offer is to actually eliminating bad actors from an industry plagued with them.

At the same time, nowhere in our careful, legal analysis do we want to admit that Hinman’s emphasis on the “economic reality” of an offering is false or unwise.[2] We cannot contest his persistent, underlying reminder that context is key and the form that a token or “digital information packet” takes is all but irrelevant.[3] The manner in which the digital asset is offered is what is important.

Accepting this truth calls into question the very feasibility of establishing any such broad sweeping legislation and, transitively, the effectiveness it would have on the digital asset space. Herein lies the dilemma faced by the SEC and the precise complication that has influenced its Directors toward guidance over regulation.

Moreover, and to Hinman’s credit, not all of his comments were echoes of previous statements. The declaration that certain digital assets, which might have been considered securities at the time of their issuance, might no longer be securities at all, is both interesting and paradoxical. When exactly is this point reached? Is it compliant to issue a digital asset in a manner similar to that of a security if the aim of the sponsor is to eventually cultivate a decentralized network of node operators that can support this digital asset independent of the sponsor’s own efforts? In other words, do the ends justify the means? If they do not, and such efforts are condemned at their outset, then how long will it be before such economic operations move offshore to more lenient, or at least more explicit, regulatory sanctuaries?

Hinman’s commentary has raised more questions than it has resolved, which is not altogether a bad thing. If anything, such discourse is probably necessary. In this light, there is only one course of action for reputable stakeholders in the digital asset market to take, and that is to persevere in the face of the industry’s stigmatic reputation and to take up the SEC’s offer of guidance which, as it turns out, is not as platitudinal as one might think.

After all, with Goldman-funded Circle’s $400 million acquisition of Poloniex and Andreessen Horowitz’s new $300 million Crypto Fund, it is clear that there is old money behind new — and that the digital asset industry won’t remain unregulated in the U.S. for long.[4]

[1] Hinman, William. “Digital Asset Transactions: When Howey Met Gary (Plastic).” SEC.gov, 14 June 2018, www.sec.gov/news/speech/speech-hinman-061418.

[2] Hinman, William. “Digital Asset Transactions: When Howey Met Gary (Plastic).” SEC.gov, 14 June 2018, www.sec.gov/news/speech/speech-hinman-061418.

[3] Hinman, William. “Digital Asset Transactions: When Howey Met Gary (Plastic).” SEC.gov, 14 June 2018, www.sec.gov/news/speech/speech-hinman-061418.

[4] Kelly, Jemima. “Goldman-Backed Startup Circle Buys Major Crypto Exchange Poloniex.” Reuters, Thomson Reuters, 26 Feb. 2018, www.reuters.com/article/us-crypto-currencies-circle/goldman-backed-startup-circle-buys-major-crypto-exchange-poloniex-idUSKCN1GA1N4. ; Loizos, Connie. “Andreessen Horowitz Has a New Crypto Fund — and Its First Female General Partner Is Running It with Chris Dixon.” TechCrunch, TechCrunch, 25 June 2018, techcrunch.com/2018/06/25/andreessen-horowitz-has-a-new-crypto-fund-and-its-first-female-general-partner-is-running-it-with-chris-dixon/.