ERC dEX & Regulation
As a non-custodial token exchange, ERC dEX finds itself in a regulatory gray area. The existing securities laws were written with custodial securities exchanges in mind. If we can be certain that the tokens traded on our exchange are not securities, this uncertainty might not be an issue… but that, too, is a gray area. SEC has made clear that tokens that fail the Howey Test are securities, but it has also hinted that the Howey Test may not be the only way by which such a conclusion can be reached.
We are committed to making ERC dEX as compliant as possible, so it behooves us to survey the entire regulatory environment and do what we can to adhere to existing laws and position ERC dEX to be able to comply with likely future laws, rules, and actions.
Federal Regulators
One of the most challenging aspects of formulating a regulatory strategy in this space is the ambiguous official guidance on the topic. While some countries have taken great strides toward reducing the risk of playing in this space, with regulatory sandboxes like those adopted by Canada and Malta, regulators in the US, where we’re based, have not yet given a lot of clear guidance. Thus, we are left to our own devices in discerning the intent of each agency on a case-by-case basis, as outlined below.
Securities and Exchange Commission (SEC)
[Update 12/12/17]
Just days after releasing this article, SEC Chairman Jay Clayton released a statement that offered some clarification around the thinking of senior leaders in the SEC with respect to cryptocurrencies and “Initial Coin Offerings”. We find much of his statement encouraging and feel that in large part, it confirms our analysis below.
[/Update]
There are a handful of actions from the SEC that we can use to extrapolate the agency’s potential future actions, but on the whole, there is simply not much to go by. Some of the relevant sources include:
- The DAO report
- The Investor Bulletin on Initial Coin Offerings
- Enforcement actions like the one against PlexCoin
- Investigations like the one that shut down Prostarr
Based on these actions, it’s clear that the SEC has little patience for unregistered tokens that may be considered a security (especially those that are allegedly outright scams or that run afoul of “anti-touting” laws.) Note that the SEC has not yet taken retroactive enforcement actions on issuers or exchanges.
Commodity Futures Trading Commission (CFTC)
The CFTC, which regulates trading of derivatives in the US, seems to be a bit more crypto-friendly, as it recently approved the trading of derivatives based on bitcoin. While we think this is a step in the right direction, the CME (Chicago Mercantile Exchange Inc.) and CBOE (Chicago Board Options Exchange) are centralized exchanges — it remains to be seen how the CFTC will react to decentralized, non-custodial derivatives on cryptoassets, like those we plan to offer.
Federal Trade Commission (FTC)
The FTC has had dealings in the crypto space, including taking actions against sellers of mining rigs, publishing opinions on the use of crypto for payments, and suing app developers who allegedly surreptitiously mined crypto on users’ phones. While we think it’s unlikely that the FTC would have an issue with our operations, it’s not entirely outside the realm of possibility. Encouragingly, the FTC holds open forums to discuss innovation in this space and takes a stance of wanting to “keep consumers protected while encouraging innovation for consumers’ benefit”. We think ERC dEX does exactly that.
US Treasury
The US Financial Crimes Enforcement Network (“FinCEN”) is a department within Treasury that is concerned with money transmission. FinCEN has demonstrated its willingness to take significant enforcement actions against exchanges that it believes run afoul of US Anti-Money Laundering laws. Perhaps encouragingly, Treasury’s Office of Inspector General has recently said it will review FinCEN’s current thinking and procedures with respect to cryptocurrency.
Self-Regulatory Organizations
Portions of the workload of regulating trade are offloaded from the government onto non-governmental agencies called Self-Regulatory Organizations (“SROs”.) Often, to be compliant with federal regulations, one must also be compliant with SRO regulations. Below are a few of the SROs that we feel may be relevant to ERC dEX.
Financial Industry Regulatory Authority (FINRA)
FINRA is the SRO with which most financial marketplace participants have to register, which conducts the licensing examinations required for most financial industry professionals, and which enforces and arbitrates alleged violations of the rules it sets. Fortunately, FINRA has taken a very open stance to blockchain technologies (what it calls DLT or Distributed Ledger Technology), as demonstrated in this quote from its 2017 report on blockchain:
FINRA welcomes an open dialogue with market participants to help proactively identify and address any potential risks or hurdles in order to tap into the full potential of DLT, while maintaining the core principles of investor protection and market integrity. Technological innovations in the industry, operating in accordance with these core principles, have the potential to provide investors with greater access to services and enhanced experiences, offer firms increased operational efficiencies and enhanced risk management, and enable further transparency in the marketplace.
The report goes on to outline some of the considerations financial institutions should keep in mind when contemplating the integration of blockchain technology into their business. FINRA followed this report up with a conference that brought regulators and industry together about six months later. All of this, we feel, is very encouraging, enlightening, and likely pertinent to ERC dEX.
Other Jurisdictions
State
As a Delaware corporation, ERC dEX, Inc. is particularly interested in the legislative stance of our state of incorporation. Fortunately, Delaware has taken a very pro-crypto stance by enacting its Delaware Blockchain Initiative. Under the legislation, among other things, we now enjoy:
- the assurance that virtual currency and blockchain businesses will not face new proscriptive regulation in Delaware
- the Governor’s support for the amendment of Delaware law to accommodate distributed ledger shares
This is exactly the kind of stance we’re hoping to see from other jurisdictions — an innovation-friendly approach and no new regulation. While other state jurisdictions are experimenting with applications of blockchain technology (as of this writing, Arizona, California, Delaware, Hawaii, Illinois, Maine, Nevada, New York, and Vermont have legislation in varying states of progress), no single theme yet prevails.
International
Just as many US states have varying degrees of openness to the idea of adopting and regulating crypto, many foreign governments are experimenting with blockchain technologies. Because ERC dEX is a global cryptoasset exchange, we have to be cognizant of these developments and react accordingly. For example:
- Russia: Russia has published 5 new regulations (link in Russian) that cover topics like treating ICOs as IPOs, registration and taxation of miners, and a regulatory sandbox.
- China: At the beginning of November 2017, China shut down the last of the China-based exchanges, after ruling their activities illegal. Prior to that, it also outlawed ICOs. These actions should not be mistaken as the country taking an anti-blockchain stance, but rather a desire to leverage the blockchain in a more regulated manner.
- Venezuela: President Maduro recently announced a plan for a national cryptocurrency backed by the country’s natural resource reserves.
- Uganda: the United Nations African Institute for the Prevention of Crime and the Treatment of Offenders (or “UNAFRI”) recently presented a report that provided guidance to Ugandan regulators on how to regulate cryptocurrency in the country.
Our Approach
We believe this space will get more and more (clearly) regulated, and that’s a good thing. Conscientious developers and companies in the industry want regulation to clear out the scams and fraud so people can understand and embrace the possibilities posed by a decentralized world. As it stands, everyone has to navigate the ambiguity. We want to stand by our brand promise of empowering traders, but we can only do so if we’re around long enough to see that mission through. Thus, we will:
- Avoid listing tokens that we believe are securities (registered or not) or possible “scam coins”
- Perform due diligence on issuers that wish to be listed and require indemnity from them
- Be proactive in working with regulators, seek licensing and registration so we can eventually list registered securities
We will be publishing a future blog post about the specifics of our token listing rubric, but the above gives the broad strokes.
We would love feedback on this thinking, so please leave comments and claps below and connect with us on our other platforms:
