This week, the Securities and Exchange Commission tweeted out its guidelines for those launching and investing in ICOs, although many would say that over a year on from the peak of the cryptocurrency boom, the guidelines amount to too little, too late.
That said, the document still throws up several points of contention, including a rather gloomy outlook for cryptocurrency exchanges – even decentralized ones – and at least one possible violation of the First Amendment on the part of the SEC.
Cryptocurrency Promotion: A Knife’s Edge
The SEC defines a security as:
“A token or offering that promotes the likelihood for future returns based on the entrepreneurship or efforts of others.”
With that in mind, perhaps it’s no surprise that some prominent crypto executives have begun to declare themselves part of a “protocol” rather than a company in recent months. One example is Tron’s Justin Sun, who recently stated in an interview:
“We can see that Tron is also more like a protocol rather than a company. I think that’s also introduced like a brand new concept of the protocol rather than a company institution or profit or entity.”
A man with a reputation for marketing, Sun made a name for himself as the bombastic, bold founder who never shied away from making extravagant claims about future success. In late 2018, when Ethereum’s Vitalik Buterin was honest enough to admit that ETH’s 2017 bull-run was based on little more than hype, Sun took the opportunity to promote his own project, stating:
“Vitalik: next wave of crypto is not going to be built on hype.@VitalikButerin admits that #ETH lead the 2017 bull run built on hype. #TRON will lead next bull run built on massive adoption dapps and @BitTorrent.”
Tweets like these could be the very thing that attracts the attention of the SEC. Does this not flirt dangerously with the definition of promoting a security? It suggests that an investment in Tron will pay off thanks to the efforts of others – in this case, BitTorrent.
SEC: Exchanges May Violate Securities Laws [Even If They Don’t Know it]
According to the SEC, a cryptocurrency exchange would be in violation of securities laws even if it unknowingly facilitates the trade of security coins and tokens:
“If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.”
That explains why many “altcoin-heavy” exchanges tend to base their operations on foreign soil, such as in legal havens like Malta, or parts of South America. Yet even that might not be enough to save them, if the recent shutdown of Marshall Islands cryptocurrency exchange 1Broker is anything to go by.
Globe-hopping might not be enough to avoid the reach of the SEC, but what about exchanges that aren’t based in any physical location?
Decentralized Cryptocurrency Exchanges: Do They Violate SEC Guidelines?
According to the SEC, it doesn’t matter whether it’s a centralized, proprietary exchange, or a decentralized, autonomous piece of code – what matters is that unregistered buying and selling happens there:
“The activity that actually occurs between the buyers and sellers—and not the kind of technology or the terminology used by the entity operating or promoting the system—determines whether the system operates as a marketplace and meets the criteria of an exchange under Rule 3b-16(a).”
That explains the charges brought down on the EtherDelta exchange, and its creator, Zachary Coburn, last year. At the time, the SEC described Coburn’s crime as:
“[Providing] a marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders, and a smart contract run on the Ethereum blockchain.”
But according to the non-profit digital civil-rights group, Electronic Frontier Foundation (EFF), prosecuting people who upload open-source bundles of code to Github would be clear violation of First Amendment rights.
“This isn’t just dangerous because it could quell research; it’s unconstitutional. The free speech protections enshrined in the First Amendment and upheld through court cases across decades include the rights of individuals to publish their ideas without preemptively obtaining a license. And code itself is speech.”
The EFF sent a nine-page letter to the SEC on Tuesday, urging the commission to keep constitutional rights in mind when wielding their regulatory whip, specifically in relation to the Ether Delta and Zachary Coburn case. Read the letter here for a quick rundown on computer code’s legal status in relation to First Amendment rights.
EFF Crypto Exchanges SEC by on Scribd
What’s Next for Crypto Regulation in 2019?
It’s difficult to predict what happens next: on the one hand, the SEC has signalled its intention to refresh its focus on cryptocurrency in 2019. But at the same time, the commission is already discovering that not all branches of the U.S legal system agree with its definitions.
In 2018, the SEC brought the hammer down on nineteen different cryptocurrency projects. The number of cases in the previous five years combined was just twelve. In November 2018, the commission ruled that Paragon’s $12 million ICO, launched in 2017, must be paid back to those investors who desire it – despite the messy technicality of a 95% price drop in the intervening time period.
A Look to the Past
While the ICO space has changed a lot in the past year, the SEC’s view on initial coin offerings has not. As early as 2017, SEC Chairman Jay Clayton said:
“[A] token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders.”
That’s very different to what we have now, and the following analogy proved to be eerily accurate, despite being made before the heady peaks of the ICO gold rush:
“In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all still to come.”