Adventures with the SEC: Bitcoin and Ethereum are Not Securities.
After not hearing any news from the SEC for months, there have been two recent developments. On June 6, SEC Chairman Jay Clayton made a brief appearance on CNBC. Just a week later the SEC’s Director of the Division of Corporation Finance, William Hinman, spoke at Yahoo Finance All Markets Summit. We can only guess that the SEC will start ramping up regulatory efforts soon.
On CNBC, Clayton notes two distinct areas where blockchain has a role in financial markets. The first is cryptocurrencies like Bitcoin that wish to replace or at least compete with fiat. Those are notsecurities, says Clayton. Next, he describes how most ICOs fit the classic definition of a security: Investing in a joint enterprise with the expectation of profits from efforts other than your own.
Securities law hinges on 1946 Supreme Court case SEC v. Howey. In this case, the Howey company owned a citrus grove and leased out parcels of its land to people who had no ability or experience with maintaining an orchard. The lease came with a contract for managing that portion of property as well. People bought the leases as a profitable investment, not to grow oranges. In short, dressing up an investment contract as a land lease did not fool the SEC or the Supreme Court.
“We’ve been doing this a long time, and there’s no need to change our fundamental approach.” – Jay Clayton
William Hinman’s address at the Yahoo Finance summit was directed at a specific question while clarifying the implication of securities law for cryptocurrency.
“Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?”
In cases where there is no longer a central enterprise to invest in, or the asset is sold primarily for use by members of its network, the answer is a qualified “yes.” The asset itself is not in question. The circumstances surrounding the asset, and how it’s sold, are what makes it a security offering or not.
At the core of decision is whether there is a centralized organization primarily responsible for the success or failure of the token. In the case of Bitcoin and Ethereum, there is no such central organization. It’s notable that Ethereum’s initial fundraising would have passed the Howey test, but it no longer does.
“The digital asset itself is simply code. But the way it is sold: as part of an investment to non-users by promoters to develop the enterprise; can be and, in that context, most often is a security” – William Hinman.
He also suggests that it might be easier to raise funds for a blockchain startup in the traditional manner, and distribute your tokens once the network is up and running. The overall message is that it doesn’t matter if you call it a utility token, or a coin. If your ICO is raising startup capital by selling tokens to US investors, you’ll have to answer to the SEC. The speech proves the wisdom of Bitcoin’s decentralized approach for evading government interference.
You have decentralization of validation (“node level”), block formation (“protocol level”), and decision-making and update-management (“political”). Your system isn’t decentralized without all three.