William Hinman head of the Division of Corporate Finance at the SEC has today announced that the SEC does not consider Bitcoin (BTC) or Ethereum (ETC) to be securities subject to US securities laws. The reasoning provided by the SEC was that whatever offering process may have occurred at the early stages of these tokens’ respective developments, both of these platforms are now sufficiently decentralized and automated so as to not require passive reliance on a manager or operator in order for each platform to function as intended and perhaps provide capital gains or other forms on income to holders of each coin.
To be sure, this opinion does not apply to any token other than BTC or ETH, this means that the status of Bitcoin Cash, Litecoin, Ethereum Classic, and all other alt-coins is currently uncertain, and you are encouraged to obtain the opinion of competent counsel with respect to each proposed investment of funds into any form of cryptocurrency or token offering.
The above conclusion by the SEC is the perfect complement to Ethereum’s short term goal to dramatically shift its current mining protocol from “proof of work” where graphics cards are used to mine new coins, to a “proof of stake” model, where ETH is staked on the blockchain to process transactions and receive some type of dividend-like fee for this service. If ETH is not a security, that means anybody can now purchase ETH and stake it on the upcoming POS platform. Accredited investors will not be the sole group with access to this potentially lucrative passive income vehicle. This fact should make ETH a very attractive commodity or currency to even conservative Buffet-like investors. To be sure, the CFTC has determined BTC to be a commodity, and ETH is likely to be deemed the same type of investment. Other tokens may be deemed commodities or currencies.
The above should be a sign of relief to many who have been waiting with baited breath for some measure of certainty from regulatory authorities, as the market crashed. The SEC has stated that for the most part their policy has generally been one of “hands-off” the blockchain sector, as they claim to have no aim or intent to hinder this innovative technology sector. However, they have recently cracked down on crypto hedge funds, issuing subpoenas to about 90 such entities. Certainly, the SEC must weigh the interests of innovation with consumer/investor protections, and there is certainly some evidence that the SEC has acted in the minimum capacity necessary to protect public interests. Numerous fraudulent and rogue actors have been halted and fined for the improper issuance of securities and even charged in criminal court for outright theft of investor funds. Investigation and termination of fraudulent activity is certainly a valid reason to increase regulatory scrutiny.
Mr. Hinman has also issued some guidance with respect to Initial Coin Offerings and whether such offerings may change from initially being deemed securities into ‘utility’ tokens which are not subject to US securities laws, at secondary offering stages. At this point the SEC has determined that some securities offerings may turn into non-security offerings at a later point, generally at the time where the intended blockchain platform is fully or nearly operational and mostly automated, without having to rely on the promoter/offeror of the interests for the success of the enterprise. The SEC will not change the definition of a “security” solely for the crypto space, and continue to apply the Howey test for investment contracts, as well as review the particular facts behind each coin offering, to determine whether any such given fund-raising venture is a security or not.
If an offering is made before a platform is functioning or operating, then the tokens are likely to be deemed securities, depending on a few other factors. Furthermore, the SEC encourages the hybrid offering which consists of standard regulated offerings such as those made under Reg D, Reg CF, or Reg A at the initial stages of a venture, where no platform exists, which then at a later date transition to Initial Coin Offerings and may be offered to any retail purchaser. The tokens issued under the secondary and subsequent offerings would then be used to utilize the completed platform in order to purchase goods or services and would not be subject to US securities laws.
If you are considering making a crypto-related offering or investment, it is imperative that you obtain experienced legal assistance to assist you with the diligence and counsel necessary to navigate this burgeoning sphere of the economy. Failure to do so could leave you personally liable for any funds which are collected and potentially lost in an unregulated offering, and furthermore subject to SEC sanctions such as fines and bans from operating in the blockchain or securities space in the future. Obviously if criminal activity occurs with or without the knowledge of the offeror/promoter then there is the risk of criminal charges being brought to bear on those ignorant of the many pitfalls in this arena. Making an investment in the crypto space without appropriate due diligence may, of course, result in the total loss of your investment, without recourse.