Stablecoins, The SEC and Securities: Is Reclassification The Order Of The Day?
>> This article is for informational purposes only and is not financial advice. The information does not constitute investment advice or an offer to invest.
Stablecoins have become the latest target for eager SEC regulators working in the blockchain space.
Recently, the SEC’s Senior Advisor for Digital Assets, Valerie Szczepanik stated at an event that certain stablecoins could certainly be classified as securities. According to Szczepanik, stablecoins can be divided into three distinct categories: stablecoins tied to assets, stablecoins tied to a fiat which is held in reserve or a third category which is the latest to cause major concern for regulators. This third, troublesome category consists of stablecoins which supposedly manipulate prices and guarantee profits to investors.
Could this put centralized stablecoins at risk of reclassification as a security in the US?
Breaking Down Securities
A security in the financial industry typically refers to a tradable financial asset, subject to regulation by the agencies such Security and Exchange Commision, or the CFTC in case of commodities. In the United States, securities are broadly divided into three different categories:
- Debt securities, such as bank notes or bonds.
- Equity securities such as stocks.
- Derivatives such as futures and swaps.
Until very recently, cryptocurrency in the US has remained a largely unregulated industry.
There are a handful of exceptions, such as Wyoming and Ohio which are implementing a mass of blockchain and crypto-friendly regulations, but these states are still the minority. Delayed regulatory actions in the cryptocurrency space by the SEC have however not prevented them from taking action against ICO’s and companies such as Basis which was forced to shut its doors in 2018.
The How And Why Of The Howey Test
According to Szczepanik, the SEC views certain stablecoins as being at-risk of price manipulation and other behaviors detrimental to investors due to the ability of a majority stakeholder to influence supply and pricing. The difficulty is that the SEC’s definitions of a security are also generalized and broad, making it difficult to apply to a new industry.
During the peak of the ICO craze, the SEC used the “Howey Test” to determine if an offering would be subject to the securities law. The Howey Test is over seventy years old, and determines whether a transaction can be classified as an investment contract, and whether the investor has been led to expect profits through the promotions created by a third party. It also measures whether the instrument represents an investment in a common enterprise
Criticisms of this method of classifying cryptocurrency have been brought forward by the community, maintaining that this method of testing is too old, too inaccurate and more. Notably, both the CFTC and IRS have regarded Bitcoin, the biggest cryptocurrency, as a commodity, which is not considered to produce returns.
When In Doubt, Reclassify?
Reclassification by the SEC could put stablecoins in the same category as stocks, subject to the same registration, disclosure, and accreditation of investors that demands. These projects, if reclassified, could face enormous fines for brokering what is considered to be the sale of unregistered securities within the US. Beyond eye-watering fines, the Securities Act of 1933 actually allows for jail sentences in some cases. The chairman of the SEC, Jay Clayton, has previously maintained that the majority of ICO’s are securities.
This could paint a grim picture for some stablecoins like MakerDAO.
The Stablecoin Standoff
Szczepanik has stressed that when there is a central party controlling a certain amount of the token offered, the possibility of price manipulation and inflation increases and puts investors “at risk”. This type of asset, or offerings by companies guaranteeing profits could be considered as a value and therefore be subject to the securities law.
Due to the generalized nature of the law, each offering would have to be considered by the SEC on an individual basis, an arduous and slow task. Sczepanik’s comments have come at a time when stablecoins are attracting more investors than ever before. Moreover, new stablecoin projects are under development with Facebook reportedly launching their version soon. It will be interesting to see how bigger players will be treated by the SEC going forward.
Stablecoins are a very important part of the ecosystem, they solve huge problems that crypto natively can not yet address — provide merchants a stable digital currency, provide investors a fiat-like currency they can exit into, and more. While certain projects could be classified as securities, clarified regulations need to be made available in order to allow businesses to comply, and most important, not stifle innovation in this newly developing space. In an industry with such a rapid pace of development, evaluation on a case-by-case basis might not be enough to keep up with the demand. The entrance of bigger entities like Facebook should be enough to validate its’ use case and importance to the world.
About the Author: Kirill Bensonoff is a serial entrepreneur with multiple exits, blockchain investor and advisor. He’s also the host of the Boston DLT Meetup, founder of the Boston Blockchain Angels, producer and host of The Exchange with KB podcast and leads the Blockchain + AI Rising Angel.co syndicate. Learn more by visiting www.kirillbensonoff.com and follow him on Twitter @prankstr25.
Disclaimer: Virtual currency is not legal tender, is not backed by the government, and accounts and value balances are not subject to consumer protections. This article is for informational purposes only, and is not financial advice. The information does not constitute investment advice or an offer to invest.
